Playing with fire: Trump’s unstable boom is a high-stakes experiment

All the levers of economic stimulus in America are pushed to the maximum, setting the conditions for torrid overheating and an unstable boom by the end of the year.

Bank deregulation, credit expansion, a weaker dollar, lower interest rates, stealth quantitative easing (QE) and neo-socialist affordability gimmicks are combining to stretch the economic cycle and deliver roaring growth in time for the midterm elections in November.

This is either a courageous experiment in “running the economy hot” or an insane mix of the worst policies from the 1970s, depending on your ideological colouring.

Dario Perkins, from economics consultancy firm TS Lombard, compares it to Britain’s “barber boom” in 1972, or the “dash for growth”, as it was known.

Back then, Anthony Barber, the Tory chancellor, unshackled the banks and let rip with corporate tax cuts, insisting that it was safe because his supply-side measures would raise the non-inflationary speed limit of the UK economy to 5 per cent.

Many cheered him on at the time. It was the zeitgeist.

Barber got his boom. It lasted about 18 months. I am old enough to remember the crushing stagflationary bust that followed.

The art of economics is knowing when to use stimulus. It is best reserved for a depressed country with an “output gap”.

This gap has entirely closed in the US and is currently a “positive” 2.2 per cent of GDP – i.e. overshooting – the second-highest reading in half a century.

Scott Bessent, the hedge fund poacher turned gamekeeper at the US Treasury, must know he is playing with financial fire. His high-octane propellant is banking deregulation and manipulation of the credit channel.

A report by finance specialists Alvarez & Marsal says the blast of deregulation is being done “the American Way: large in scale and rapid in execution”.

The critical measures are to free banks from the remaining constraints of the Dodd-Frank reforms, cut the Common Equity Tier 1 core capital ratio and cut the total loss-absorbing capacity requirement. The effect should unlock $US2.6 trillion ($3.7 trillion) of new lending and capital market business.

One purpose is to make it easier for banks to soak up the flood of US Treasury issuance, estimated by Fitch Ratings at a net $US2.3 trillion this year. The International Monetary Fund says the “general government deficit” was already 7.4 per cent of GDP last year.

Tax cuts and rebates from the one big beautiful bill will add another 1 percentage point this year. Donald Trump has talked of handing out a $US2000 “tariff dividend” to each American as a pre-election bribe. The cyclically adjusted deficit will go further through the roof.

Bessent is relying on the Faustian pact of “activist Treasury issuance” to manage runaway deficits, lifting the share of short-term bills to 40-50 per cent of monthly issuance, which he himself called “stealth QE” when practised by the Democrats.

It is a breach of the Treasury’s 20 per cent safety ceiling. It takes the strain off the bond market – which sets rates for mortgages, car loans, companies, etc – but at the price of greater roll-over risk down the road.

I agree with Bessent that the post-Lehman banking rules across the West were ill-timed, too deflationary and deepened the long economic slump.

But the problem with stoking a fresh banking boom today is that shadow banks have moved in to fill the vacuum. We are already back into credit bubble territory.

Risk spreads on corporate BBB-rated debt are at a wafer-thin 94 basis points, even more compressed than they were at the peak of the subprime saga in 2007. I never thought I would see that again in my journalistic lifetime.

The S&P 500 index may be wobbling a little as investors choke on capex spending for artificial intelligence (AI) but it is still up 14 per cent in a year and has been hitting fresh records for months.

The Shiller price-earnings ratio is at 40.12 – higher than the pre-Lehman peak (27.55) and close to the all-time peak of the dotcom bubble (44.19).

The Atlanta Fed latest GDPNow reading suggests that growth was running at 4.2 per cent in the fourth quarter of last year and inflation is starting to pick up again.

So what will Kevin Warsh do when he takes over as chairman of the US Federal Reserve in mid-May, and how will he respond to Trump’s misuse of the criminal justice system to intimidate his colleagues?

We can guess. Trump strongly hinted on Truth Social that Warsh would not have got the job unless he had promised to cut rates. His billionaire father-in-law is a close friend of Trump and an instigator of the Greenland push.

Warsh is billed as an anti-inflation hawk in the press, but that is a “category error”, in the words of Nobel economist Paul Krugman. Warsh is a lawyer, not an economist, and can only be understood as a political animal.

“He’s for tight money when Democrats are in power, but all for running the printing presses hot when a Republican is in the White House,” Krugman says.

The margin for misjudgment or bad luck is zero.

The friendly view is that Warsh genuinely thinks that AI will lead to a surge in productivity and therefore prove to be “a significant disinflationary force”, much like the internet in the late 1990s. “AI is going to make everything cost less,” he says.

In this, he may be right. Some of the world’s leading AI gurus think it could lift trend growth rates by 1.5 or 2 per cent of GDP, though whether that implies lower interest rates is a hotly contested theme.

The harsher verdict is that Warsh has jettisoned long-standing views to curry favour. As a junior Fed governor, he opposed QE at the height of the global financial crisis and persisted in arguing throughout the deflationary aftermath that it would set off inflation.

He did not understand how QE works, whether via the canonical New Keynesian model or via the quantity theory of money model. “During the biggest, most consequential monetary debate of modern times, Warsh got it totally wrong,” Krugman says.

The test for Warsh, the Fed and US monetary credibility, is what he will do later in 2026 and even more so in 2027 if, as many expect, the Bessent boom causes inflation of 3 per cent-plus to become embedded.

The bigger test is what happens if there is any external shock. A new paper for the Bank of International Settlements argues that once public debt reaches a certain level – and the US is clearly past that point – it becomes ever harder for a central bank to resist the pressure for debt monetisation and fiscal dominance.

This threat can remain latent in good times. The spiral begins in earnest if an exogenous cost shock hits out of the blue, causing inflation to spike just as the economy goes into recession. Geopolitics could do that in a heartbeat.

The Bessent boom is a hair-raising adventure. The Bessent-Warsh duo may just pull it off if everything goes their way. The margin for misjudgment or bad luck is zero.

The Telegraph, London

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