Perspective on Risk - Nov. 14, 2024 (Turning Points)
Turning Points; Project 2025 & Agenda 47 on the Economy; The Future of Classical Liberalism; Financial Regulation
Turning Points
Turning points are when there are major changes to the returns to labor and capital or productivity. They usually begin with an exogenous shock, but it is the endogenous reaction that represents the change. In my life, there are probably five major turning points:
Oil Price Shock (1973-74)
Plaza Accord (1985)
Collapse of Communism (1989)
Sept. 11th (2000)
Global Financial Crisis (2008)
Covid-19 Pandemic (2020)
Returns to Capital and Labor
The Collapse of Communism had the largest effect, fundamentally changing the returns to capital and labor through a massive expansion of global labor pool, the opening of new investment frontiers, and changes in relative returns across regions - which we can think of as “the China effect” or perhaps as the “globalization effect.”
The Global Financial Crisis has had decades-long structural change to returns on capital, and Oil Price Shock shifted returns to energy-intensive vs efficient capital businesses and changed energy/labor substitution patterns.
Capital Flows
The Collapse of Communism changed patterns of capital accumulation and altered saving/investment balance globally.
The GFC transformed global banking, reshaped monetary policy globally, expanded the regulatory regime and changed cross-border capital movements.
Productivity
Of the six, the Covid-19 Pandemic has had perhaps the most impact. It forced adoption of digital technologies, changed work patterns fundamentally, and accelerated automation trends. We need to be cautious, though, as the full effects are still uncertain.
The Oil Price Shocks drove energy efficiency innovations, changed production technologies and spurred conservation investment.
Of the categories, changes to productivity seem the hardest to gauge the effects.
Is Trump a Turning Point
This is the big question. Let’s explore it a bit.
Project 2025 & Agenda 47 on the Economy
There are two documents to consider. Project 2025: Mandate For Leadership is a conservative policy compendium prepared by the Heritage Foundation working with many individuals in Trump’s orbit. Despite any disavowals and denials, it clearly reflects thinking of those with influence on the incoming former President. Agenda 47 is from Trump’s campaign website and represents his “20 Core Promises.” It is a subset of what is in Project 2025.
I will only focus on those proposals that directly affect economics, banking and the financial system, and bank supervision. The thoughts on climate change policy will be held for another post.
There are seven points in Agenda 47 that can be considered directly related to economics. They generally pertain to halting and reversing migration, increasing domestic energy production, reshoring manufacturing and tax cuts. Agenda 47 also pledges to keep the US dollar as the world’s reserve currency. There are, of course, few specifics here or in the Republican Party platform.
Project 2025, on the other hand, has a 166 page section on the economy.
I asked Anthropic’s Claude to read the Economy section and give me an initial impression1:
The proposals represent a significant shift in US economic policy with potentially major implications for: Global trade patterns, Capital allocation, Supply chain configuration, and Innovation systems.
From an economist's perspective, more rigorous analysis would be needed to validate that the proposed policies would generate net economic benefits. The focus on manufacturing and trade deficits, while politically salient, may not align with modern understanding of growth drivers and economic welfare.
The proposals could generate significant economic disruption in pursuit of goals that may be better achieved through other policy tools (e.g., investment in innovation, worker training, etc.). A more complete economic analysis incorporating general equilibrium effects, transition costs, and dynamic impacts would be valuable for assessing the full implications of these policy proposals.
I then asked Claude to systematically review Project 2025’s section on the economy. I would take its estimates with something of a grain of salt, but when probed on the specifics, it does a reasonable job of applying economic methodology; a real economist may want to give this a try. After reviewing each section, and analyzing the proposal through the role of a Fed economist writing a briefing for the Fed Board and Treasury it concluded:
Project 2025's proposals represent the most significant proposed restructuring of U.S. international economic policy since World War II. Our comprehensive analysis indicates the proposals would trigger complex adjustments throughout the economy, with costs likely exceeding stated benefits and significant risks to both growth and stability.
General Equilibrium Effects
The general equilibrium effects suggest broader economic impacts than individual component analysis indicates:
GDP growth would likely fall 0.2-0.5 percentage points annually during transition
Inflation would rise 0.8-1.2 percentage points annually during implementation
Dollar appreciation of 4-6% would partially offset trade protection
Permanent efficiency losses would reduce potential GDP by 0.4-0.6%
Tariffs
The proposed reciprocal tariff regime would reduce the trade deficit by $58-64 billion annually (7.5% of current deficit), but currency appreciation would offset 40-60% of this effect. Implementation would significantly disrupt Treasury markets, potentially reducing foreign participation by 10-15% and increasing borrowing costs by 20-30 basis points.
Labor
While protected manufacturing sectors might gain 150,000-275,000 jobs over five years, broader employment losses of 200,000-350,000 in other sectors would result in net job losses of 50,000-75,000. Real wages would likely fall 0.5-1.0% economy-wide due to higher prices, despite nominal wage gains in protected sectors.
Productivity
Total factor productivity growth would decline by 0.2-0.3 percentage points annually during the first five years, with patent quality falling 15-20% in affected sectors.
Immigration
Note that this analysis does not include the effects of reversing migration, as that is not covered in the Economy section of Project 2025. To include this, I asked Claude to read and analyze the implications from Project 2025’s section on the Dept. of Homeland Security.
The proposals would substantially reduce both legal and illegal immigration, significantly impacting labor force growth. With immigration currently accounting for approximately 45% of labor force growth, our analysis suggests the proposed restrictions would reduce annual labor force growth by 0.3-0.5 percentage points. Given current labor force participation rates of 62.5%, this implies a reduction in potential GDP growth of 0.2-0.3 percentage points annually through the labor input channel alone.
Demographic considerations make this timing particularly concerning. As baby boomers continue retiring, immigration restrictions would accelerate labor force shrinkage, potentially creating upward wage pressures but also constraining economic growth.
The empirical evidence on wage effects is more modest than the document suggests. Most credible studies find that immigration reduces wages of prior immigrants by 3-6%, while effects on native workers range from -0.2% to +0.2%, varying by skill level. These estimates suggest the proposed restrictions would have limited benefit for native wages while potentially creating significant sectoral disruptions.
Key sectors would face substantial adjustment costs:
Agriculture: With 50-70% foreign-born workforce, labor costs could rise 15-30%
Construction: 30% foreign-born workforce implies potential 10-20% wage increases
Personal services: 25% foreign-born workforce suggests significant price increases
The long-term fiscal impact depends critically on the skill mix of remaining immigration flows. The proposal's shift toward merit-based immigration could partially mitigate fiscal costs, but the magnitude depends on implementation details not specified in the document.
Posen on Trump’s Plans
The True Dangers of Trump’s Economic Plans (Posen in Foreign Affairs)
Trump and his running mate, JD Vance, have proposed a set of radical, large-scale interventions into the American economy, including tariffs on all imports, at ten to 15 times the level of those Trump imposed in his first term, which were primarily levied on only Chinese goods; the deportation or internment of somewhere between one million and eight million immigrants, including some who are currently in the United States legally; and a power grab that would involve using executive authority to sequester funds appropriated by Congress and to interfere in the Federal Reserve’s independence in setting interest rates.
It is based on Hobbes, not Hayek
By restricting the supply of resources that U.S. businesses, workers, and households value and use, they will reduce the productive capacity of the U.S. economy.
The economic impact of Trump’s deportation plan would be severe. Removing hundreds of thousands of employed workers would cause labor shortages in specific industries and locations, which would in turn generate widespread price increases as supplies shrink. A recent study by the Peterson Institute for International Economics found that such a large negative labor supply shock would lead to stagflation across the economy, increasing inflation by 1.5 percent and shrinking GDP by over three percent within three years.
Trump’s tariff plan is similarly reckless with respect to another supply side of the economy. … The revenues produced by these tariffs, Trump claims, would also largely offset his proposed extension of tax cuts for corporations and high-income individuals. … If American companies were able to produce replacements for some imported products, they would do so only insofar as they could charge just below the tariff-driven prices; otherwise, they would leave money on the table.
As far as tax revenues go, tariffs cannot replace any meaningful part of other federal taxes, precisely because the point of tariffs is to compel consumers to shift their purchases
The Future of Classical Liberalism
I think Trump may be one of those figures in history who appears from time to time to mark the end of an era and to force it to give up its old pretences. It doesn’t necessarily mean that he knows this, or that he is considering any great alternative. It could just be an accident.2
Francis Fukuyama
Francis Fukuyama: what Trump unleashed means for America (FT)
… the significance of the election extends way beyond these specific issues, and represents a decisive rejection by American voters of liberalism and the particular way that the understanding of a “free society” has evolved since the 1980s.
Classical liberalism is a doctrine built around respect for the equal dignity of individuals through a rule of law that protects their rights, and through constitutional checks on the state’s ability to interfere with those rights. But over the past half century that basic impulse underwent two great distortions.
The first was the rise of “neoliberalism”, an economic doctrine that sanctified markets and reduced the ability of governments to protect those hurt by economic change.
The second distortion was the rise of identity politics or what one might call “woke liberalism”, in which progressive concern for the working class was replaced by targeted protections for a narrower set of marginalised groups: racial minorities, immigrants, sexual minorities and the like. State power was increasingly used not in the service of impartial justice, but rather to promote specific social outcomes for these groups.
Donald Trump not only wants to roll back neoliberalism and woke liberalism, but is a major threat to classical liberalism itself.
Prior to the election, critics including Kamala Harris accused Trump of being a fascist. This was misguided insofar as he was not about to implement a totalitarian regime in the US. Rather, there would be a gradual decay of liberal institutions, much as occurred in Hungary after Viktor Orbán’s return to power in 2010.
This decay has already started, and Trump has done substantial damage.
Other Commentary
Trump’s new world order (FT Editorial Board)
The history of its democracy is studded with “hinge” elections where voters decisively repudiate the philosophy and record of the outgoing administration and opt for something new. Every now and then, however, there is a result that goes far further and presages inordinate and tumultuous consequences not just for the nation but the world. The 2024 presidential election is one of these.
It is an extraordinary resurrection which speaks to a broader fraying of the appeal of liberal democratic values across the western world.
It has long been clear that Americans are tiring of their post-1945 role in policing the world.
I Study Guys Like Trump. There’s a Reason They Keep Winning. (Ben Rhodes in NYT)
Rhodes is a clear partisan, but the quotes are interesting.
I met with a government official preparing to resign and told him I was writing a book about the rise of authoritarian nationalism. “The nationalism in the U.S. and Europe is somewhat different,” he told me. “Yours started with the financial crisis in 2008. That’s when liberalism started to lose its appeal, when people saw this wasn’t working. The narrative of liberalism and democracy collapsed. This spilled over into China, too. This is when China started to think — should we really follow a Western model?” We were sitting in a hotel lounge, the invisible forces he described surrounding us: capitalism, but not democracy; cultural elites cloistered away from the working class. “The nationalist movements in East and West were both a response to the collapse of the Western model,” he added.
Against False Universals (Boston Review)
This is Seyla Benhabib’s 2024 Adorno Prize lecture, published in September prior to the election.
While the programmatic statements of a Geert Wilders, a Nigel Farage, a Donald Trump, and even a Narendra Modi based on the hatred of otherness should not surprise us, there is a failure in our own democratic cultures at large which stultifies judgment and the capacity to understand the perspective of the other. It was the promise of the Enlightenment to attain an “enlarged mentality,” in Kant’s words, and this is increasingly disappearing.
The capacity for enlarged thought has atrophied in contemporary liberal democracies.
Why Kamala Harris poses a greater threat to democracy - both at home and abroad - than Donald Trump (Niall Ferguson in Daily Mail)
I tend to find Ferguson to be a troll, but he provides a counterpoint.
… his critics warn of a threat to the constitutional order. But they also foresee a threat to what they call the liberal international order.
I accept that, as Trump's former chief of staff, General John Kelly, said this week, President Trump has no great respect for the Constitution or the law. But the question is not how far Trump has authoritarian proclivities: it is how far he would be able to indulge them if re-elected to a second term.
The rule of law is deeply embedded in the U.S., not just because it is, by design, a republic of laws, but also because it remains a country run to a striking extent by people with law degrees. In addition, it has an officer class deeply committed to the separation of the military from politics.
Indeed, the irony is that it is not Trump but the more radical Democrats who openly discuss constitutional changes that would fundamentally alter the U.S. political system to their own advantage.
Financial Regulation
Project 2025 has a number of thoughts on the financial sector and banking regulation. Among the wilder, and least likely to be adopted, proposals are to revert to a “free banking” regime. The more tangible and likely to be implemented thoughts pertain more directly to financial regulation. These thoughts are in the Dept. of Treasury and Federal Reserve sections.
Project 2025
One of the priorities of the incoming Administration should be to restructure the outdated and cumbersome financial regulatory system in order to promote financial innovation, improve regulator efficiency, reduce regulatory costs, close regulatory gaps, eliminate regulatory arbitrage, provide clear statutory authority, consolidate regulatory agencies or reduce the size of government, and increase transparency.
Merging the Agencies
The new Administration should establish a more streamlined bank and supervision by supporting legislation to merge the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Federal Reserve’s non-monetary supervisory and regulatory functions. (Treasury section)
This has been discussed for years, and has strengths and weaknesses. At a minimum, it makes sense to combine the supervision into two buckets: systemic firms and non-systemic firms. My one concern is to insure that the Federal Reserve has the access to the information that they need to properly conduct monetary policy; after all, a healthy banking system is instrumental to the effective execution of said policy. If made a priority, which it does not appear to be since it is not included in Agenda 47, it would have it’s strongest chance of passage in years.
Eliminating Activities Restrictions
Policymakers should create new charters for financial firms that eliminate activity restrictions and reduce regulations in return for straightforward higher equity or risk-retention standards.
Narrow the Focus of Supervision
Focus any regulatory activities on maintaining bank capital adequacy. Elected officials must clamp down on the Fed’s incorporation of environmental, social, and governance factors into its mandate, including by amending its financial stability mandate. (Federal Reserve section)
The proposals also call for the elimination of Treasury’s Climate Hub, Treasury’s “equity agenda”
Promoting Market Discipline, Eliminating FSOC, Constraining Discount Window Lending
Congress should repeal Title I, Title II, and Title VIII of the Dodd–Frank Act.52 Title I of Dodd–Frank created the Financial Stability Oversight Council, a kind of super-regulator tasked with identifying so-called systemically important financial institutions and singling them out for especially stringent regulation. The problem, of course, is that this process effectively identifies those firms regulators believe are “too big to fail.
Curb the Fed’s excessive last-resort lending practices. These practices are directly responsible for “too big to fail” and the institutionalization of moral hazard in our financial system. (Federal Reserve)
This function should be limited so that banks and other financial institutions behave more prudently, returning to their traditional role as conservative lenders rather than taking risks that are too large and lead to still another taxpayer bailout. Such a reform should be given plenty of lead time so that banks can self-correct lending practices without disrupting a financial system that has grown accustomed to such activities. (Federal Reserve section)
This is a bad-faith proposal on their part. Yes, conservatives (me included) would consistently like to rely on market discipline and the implicit subsidies and barriers-to-entry that TBTF status conveys. But there is nothing in their proposals to breakup or shrink the existing GSIBs.
Wind down the GSEs
It should work to end the conservatorships and move toward privatization of …Fannie Mae and Freddie Mac (both GSEs) [that] must he wound down in an orderly manner.
Fannie Mae and Freddie Mac (both GSEs) must he wound down in an orderly manner. The Common Securitization Platform57 should be privatized and broadly available. Barriers to private investment must be removed to pave the way for a robust private market.
Ironically, this is a proposal that I think the majority of policymakers support. However, it is not very politically practical.
Free Banking
Winfree suggests that the next Administration should think about proposing legislation that would “effectively abolish” the Federal Reserve and replace it with “free banking,” whereby “neither interest rates nor the supply of money” would be “controlled by government.” Free banking would produce a “stable and sound” currency and a “strong” financial system, “while allowing lending to flourish.” Alternatively, Winfree writes, the next Administration should “consider the feasibility of a return to the gold standard.
This, of course, is a bone thrown to the Ron Paul/Gold Bug wing of the party.
George Selgin is probably the foremost authority on the history of “free banking.”
Thoughts on Project 2025's Call for Free Banking (Selgin)
[The] skimpy Republican Party platform itself says nothing about it, a call for free banking forms part of the Heritage Foundation’s Project 2025 … It’s in that chapter [on the Federal Reserve] that Project 2025’s call for free banking occurs.
The expression “free banking” has long been a cause of confusion, because it has more than one meaning. … the “modern free banking school,” have followed the European practice of defining it … simply as banking without any special government regulations: according to this view, banking is “free” when all banks enjoy equal privileges, including, most controversially, equal freedom to issue their own circulating paper currencies, subject to no limitations save those implicit in the requirement that they honor the terms of their currency and deposit redemption commitments. …
In discussions of U.S. banking history, on the other hand, “free banking” has had a very different meaning. There it has been used to refer to arrangements that provided for relatively free entry into the banking business.
So, to assess Project 2025’s call for free banking, we need to know which sort of free banking the project is proposing. Alas, the answer isn’t clear.
The common ground between Project 2025’s treatment of free banking and the arguments of the modern free banking school concerns the role of active banknote redemption in constraining money creation. The argument here is that, if all banks enjoy equal rights to issue paper currency, then rival banks will treat rivals’ banknotes that come their way like so many paper checks, returning them for payment. Offsetting interbank dues would be netted-out, multilaterally in the presence of a central clearinghouse
Were banks left free to make their deposits and circulating media (whether paper or digital) redeemable in whatever reserve asset they wished, one could no longer speak of a distinct “U.S. dollar,” let alone claim that free banking would “strengthen and increase” its use as a global currency. Instead there would be multiple, unofficial monetary standards, like those Friedrich Hayek envisions in his controversial pamphlet on Denationalisation of Money. At very least, Project 2025 needs to make up its mind: are we to have competing monetary standards, and kiss the official U.S. dollar goodbye, or are we to keep that official dollar and somehow strengthen it?
I gave it the following specific custom instructions:
You are a Ph.D. economist who is analytical and uses economic theory to dissect and understand issues. You are an empiricist by nature and a Bayesian thinker. You write clearly for a sophisticated audience. You think about issues from both a global and a national perspective.