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Will the Center Hold?

Changes in tax, regulatory, or budget policy can be rescinded – albeit with difficulty – by a subsequent administration. A perception that the US is no longer prepared to stand up for its allies in the international community is much less reversible.

CAMBRIDGE – The most important question facing the United States – and in many ways the world – after the events of 2017 is this: Will Yeats’ fearful prophecy that “Things fall apart; the center cannot hold” come true? Will it continue to seem that “The best lack all conviction while the worst are full of passionate intensity”? It is hard not to be concerned, but it is too soon to anticipate failure.

The US now has a president who regularly uses his Twitter account to heap invective on leaders of nuclear-armed states, the American news media, members of his own cabinet, and religious and racial minorities, while showering praise on those who traduce the values of democracy, tolerance, and international law.

Countries such as China, Russia, Turkey, and Saudi Arabia are more authoritarian, more nationalist, and more truculent on the world stage than they were a year ago. And then there is the surely more belligerent and possibly more erratic leader of North Korea, a country on the brink of developing the ability to deliver nuclear weapons at long range.

Europe also faced trials in 2017. Aside from the United Kingdom’s decision to proceed with its withdrawal from the European Union, the far right won seats in the German Bundestag for the first time in decades, and far-right parties and candidates did better than ever in a number of European elections. In mid-November, 60,000 people marched through Warsaw demanding a “White Europe.”

So there is plenty of passionate intensity. And much of it is directed at the traditions and understandings that have made the last several decades the best in human history, in terms of living standards, human emancipation, scientific and artistic progress, reduction in pain and suffering, or minimization of premature and violent death.

Will things stay together? Can some kind of center hold? Financial markets offer a remarkably optimistic view. The US stock market has broken one record after another in the year since Donald Trump’s election as president, while indicators of realized stock-market volatility and of expected future volatility are at very low levels by historical standards. And some stock markets around the world have done even better.

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While high equity prices and low volatility may seem surprising, they likely reflect the limited extent to which stock-market outcomes and geopolitical events are correlated. For example, Japan’s attack on Pearl Harbor, the assassination of President John F. Kennedy, and the 9/11 terrorist attacks had no sustained impact on the economy. The largest stock-market movements, such as the 1987 crash, have typically occurred on days when there was no major external news.

Stock markets are buoyant because they comprise individual companies, and, to a remarkable extent this year, corporate profits have been both rising and predictable. How long this will last is difficult to judge, and there is a risk that investors are increasingly taking on leverage or pursuing strategies – such as contemporary versions of portfolio insurance – that will cause them to sell if markets decline. It is worth remembering that, looking back, markets do not appear to have been remarkably bubbly prior to the 1987 crash.

There is also the question of financial institutions’ health. While major firms appear far better capitalized and far more liquid than they were prior to the crisis, market indicators of risk suggest we may not be quite as far out of the woods as many suppose. Despite apparently large increases in capital and consequent declines in leverage, it does not appear that bank stocks have become far less volatile, as financial theory would predict if capital had become abundant.

Financial markets are widely cited, including by US President Donald Trump, as providing comfort in the current moment. But a relapse into financial crisis would likely have catastrophic political consequences, sweeping into power even more toxic populist nationalists. In such a scenario, the center will not hold.

Beyond the kind of near-term risks that markets price, there is the question of an economic downturn. The good news is that sentiment is positive in most of the world. Inflation seems unlikely to accelerate out of control and force a lurch toward contractionary fiscal and monetary policies. Most forecasters regard the near-term risk of recession as low.

But recessions are never predicted successfully, even six months in advance. The current expansion in the US has gone on for a long time, and the risk of policy mistakes there is very real, owing to highly problematic economic leadership in the Trump administration. I would put the annual probability of recession in the coming years at 20-25%. So the odds are better than even that the US economy will fall into recession in the next three years.

The risk from a purely economic point of view is that the traditional strategy for battling recession – a reduction of 500 basis points in the federal funds rate – will be unavailable this year, given the zero lower bound on interest rates. Nor is it clear that the will or the room for fiscal expansion will exist.

This means that the next recession, like the last, may well be protracted and deep, with severe global consequences. And the political capacity for a global response, like that on display at the London G-20 Summit in 2009, appears to be absent as well. Just compare the global visions of US President Barack Obama and UK Prime Minister Gordon Brown back then with those of Trump and Prime Minister Theresa May today.

I shudder to think what a serious recession will mean for politics and policy. It is hard to imagine avoiding a resurgence of protectionism, populism, and scapegoating. In such a scenario, as with another financial crisis, the center will not hold.

But the greatest risk in the next few years, I believe, is neither a market meltdown nor a recession. It is instead a political doom loop in which voters’ conclusion that government does not work effectively for them becomes a self-fulfilling prophecy. Candidates elected on platforms of resentment delegitimize the governments they lead, fueling further resentment and even more problematic new leaders. Cynicism pervades.

How else can one explain how the candidacy of Roy Moore for a US Senate seat? Moore, who was twice dismissed for cause from his post on the Alabama Supreme Court, and who is credibly charged with sexually assaulting teenage girls when he was in his 30s, could enter the US Senate as many of his colleagues look the other way.

If a country’s citizens lose confidence in their government’s ability to improve their lives, the government has an incentive to rally popular support by focusing attention on threats that only it can address. That is why in societies pervaded by anger and uncertainty about the future, the temptation to stigmatize minority groups increases. And it is why there is a tendency for officials to magnify foreign threats.

We are seeing this phenomenon all over the world. Russian President Vladimir Putin, Turkish President Recep Tayyip Erdoğan, and Chinese President Xi Jinping have all made nationalism a central part of their governing strategy. So, too, has Trump, who has explicitly rejected the international community in favor of the idea that there is only a ceaseless struggle among nation-states for competitive advantage.

When the world’s preeminent power, having upheld the idea of international community for nearly 75 years, rejects it in favor of ad hoc deal making, others have no choice but to follow suit. Countries that can no longer rely on the US feel pressure to provide for their own security. America’s adversaries inevitably will seek to fill the voids left behind as the US retrenches.

Changes in tax, regulatory, or budget policy can be rescinded – albeit with difficulty – by a subsequent administration. A perception that the US is no longer prepared to stand up for its allies in the international community is much less reversible. Even if the US resumes its previous commitments, there will be a lingering sense that promises broken once can be broken again. And once other countries embark on a new path, they may be unable or reluctant to reverse course.

So, will the center hold? Will the international order remain broadly stable? The answer will depend on the Trump administration’s choices and other governments’ responses. But as other countries watch America, they will be looking at more than its president, especially as his popular approval continues to decline. That is why it is more important than ever that all Americans proclaim their continuing commitment to democracy and prosperity at home and to leadership of the global community.