All over the West, nationalism is on the rise, Donald Trump has been elected for the second time, like the Rajapaksa’s were in Sri Lanka in 2018, despite being ousted four years earlier, free trade is on the retreat, and spurious economic doctrines are the order of the day.
Donald Trump is trying to create an anti-globalist utopia with extreme economic nationalism.
The Second Coming
He was elected for a second time, after failing to win a second term in a chaotic presidency, and a more sensible, traditional president, Joe Biden, came in.
Biden was also kicked out without a second term amid high inflation and public discontent.
Of course, he implemented many socialist and green policies, which exasperated some, including executive orders made without congressional approval, which is a bad idea; many of these will likely be reversed.
Other than inflation, most policies and even some of the executive decisions were not so bad, and in the international arena, the US went back to its earlier role.
But inflation hits people in the stomach. All these things hardly matter when people have to lower their living standards to please the employment target or inflation target.
So, Trump was elected again.
What all these show is that the true decision makers in an election are not the voters or billionaires who fund them, but the central bankers who create inflation and stabilization crises that make life difficult for the general public. In the US, the stabilization crisis has not yet hit. Trump came in when the US economy was at the top of the credit cycle.
Eerie Parallel in Sri Lanka
Trump’s election mirrors the election of Gotabaya Rajapaksa. The central bank created two inflation and stabilization crises in Sri Lanka in 2015/16 and 2017. Next, a quick-fire currency crisis in 2018 and another stabilization crisis in 2019.
In both, the corrective interest rate was kept down by a frenzy of foreign borrowings as maturing debt was not repaid with domestic credit turned into dollars, which requires deflationary policy at high interest rates, but with new borrowings.
The Yahapalana administration came to power defeating the protectionist first Rajapaksa regime. The Yahapalana regime also did its share of socialism. The NMRA was created to put price controls on drugs.
As the central bank debased money for competitive exchange rates (REER targeting), potential output targeting and flexible inflation targeting, sweeping price controls were imposed on everything from hoppers to pharmaceuticals.
Desperately searching for a saviour, both businesses and the people voted for Gotabaya. Big businesses, including those targeted by the administration, backed him.
It is not just Elon Musk’s money that elected Trump, as claimed by the leftists. The people were tired of socialism and inflation as well, and wanted a change. Immigration was a very big issue, just like how anti-Muslim sentiment was whipped up in Sri Lanka.
Trump has forgotten that his first presidency was chaotic and believes his own propaganda that the first one was good; he is engaging in more chaotic behaviour with ‘gazette reverse’ style actions.
The Nationalism Crisis of 1953-56
In Sri Lanka, nationalism came to the fore in the 1956 elections. That is where the Sinhala Only Act became an election issue.
In the immediately preceding years, Sri Lanka went through a stabilization crisis with severe fiscal correction, where the budget balance was turned into a surplus.
According to central bank data, when the currency board was abolished, Sri Lanka’s gross official foreign reserves were 11 months of imports.
In 1951 (this was the year the battle for Fed independence took place and the Fed hiked rates), after driving up commodity prices, Sri Lanka had 216 million dollars of reserves. In a currency board, rates would have moved in tandem with the US slowdown.
However, the entire idea of the central bank was to end the ‘automaticity’ of the East Asian currency board.
As the central bank printed (effectively running a credit cycle longer than the US to which the rupee had just been pegged), reserves fell from 216.4 million dollars to 163.8 million dollars and 114.5 million the next year, which was now 4.7 months of imports. The stabilization crisis that followed led to the ouster of the government and the rise of nationalism.
Japan suffered the exact same stabilization problem in 1953.
The BoJ was giving credit to businesses, including discounting import bills and advancing foreign exchange credit. Following a 40% growth in private credit and 26% in the following year, there was a 247 million dollar BOP deficit.
BoJ stopped refinancing credit and hiked rates, leading to difficulties, especially for small businesses.
When Minister of Industries and Trade Hayato Ikeda (who was earlier Finance Minister during the Dodge Line Stabilization) said “even if five or ten small businessmen commit suicide, it can’t be helped”, he was forced to resign.
Though liberals came back to power in Japan (he became Prime Minister in 1960 and was behind the income-doubling plan), in Sri Lanka nationalism took root. Liberals lost their way with Dudley Senanayake being ousted by the central bank’s refinancing of rural credit.
Nationalists Ousted
It must be noted that Hitler came to power after a similar stabilization crisis under then-Chancellor Heinrich Bruning, on top of the Great Depression. As a result, the Social Democrats were discredited.
After massive inflation during the last stages of World War II, the Nazis were rooted out of society and liberals came roaring back. The Ordoliberals took control, killing the Reichsbank and setting up the Bundesbank.
The Deutsche Mark was actually issued by the Bank Deutscher Länder, which was under the full control of the Ordoliberals through the Allied occupational authority.
The Americans urged an independent central bank. Initially, the Ordoliberals did not bite, but as the occupational authority was dismantled, after much haggling, the Bundesbank law was finally passed.
When there is inflation and monetary problems, nothing works. Neither socialists, nor nationalists, nor liberals can operate. This is what happened during the Gotabaya Rajapaksa administration. The central bank printed money as if there were no tomorrows.
Bad Money
But it did not happen in isolation. Just like the policy rate infected European central banks from the Fed, Sri Lanka was also influenced by the Abundant Reserve Regime of the Fed.
In Sri Lanka and the US, the cycles are a few years out of step.
Sri Lanka tightened its policy in April 2022. The US in March 2023. The stabilization crisis is yet to bite in the US. Meanwhile, the Trump Administration is behaving like the Rajapaksa administration, trying to fix the trade deficit with import duties and reversing policies in a gazette-style manner.
He is pushing Powell to cut rates. It may be recalled that President Gotabaya Rajapaksa summoned the central bankers and lambasted them for not granting central bank refinancing.
Bad Money, Political Instability
All over Europe, nationalism is on the rise, with liberals and the left also discredited. In Germany the AfD is on the rise with a vote share almost equal to that of the Nazi party, though it is concentrated in East Germany.
Although Friedrich Merz of Germany is a full-scale economic liberal, he is undermined by the ECB’s Abundant Reserve Regime. He may end up like Biden.
Unless the ECB is fixed, or Germany goes back to the Deutsche Mark, he may end up like Biden or Scholz.
Germany is rearming against Vladimir Putin’s aggression, and it may all end up with the Afd as the third force. The Social Democrats are already discredited like the Yahapalana administration, but the CSD/CSU has got a second chance.
After years of stimulus, the US is unravelling.
In the US, after years of quantitative easing and stimulus budgets, the markets are totally shot, and people are wary of buying long bonds. Welcome to the Gross Financing Need.
That is why the parliament should have strict control over the central bank. If the parliament does not, public finances will be destroyed, energy SOEs will make losses, and the country will not be able to service its foreign debt.
Who Decides?
In Sri Lanka, a third force has come to power in the form of the NPP. Nationalism is destroyed for the moment. President Anura Dissanayake seems to be making decisions carefully. The NPP has got votes from the minorities.
However, it is unclear whether the economic nationalism that has plagued this country, largely due to foreign exchange shortages, will end. Bad policies so far have come from the Ministry of Trade, through price controls, which have created red rice shortages.
Sri Lanka’s extraordinarily high rice, dairy and protein prices come from the Nazi Autarky (self-sufficiency) policies and sky-high food taxes inherited from nationalist regimes of the past.
If the new regime continues price controls, does not choose free trade, expands the government with unemployed graduates and revives dead SOEs at the expense of the public, and fails to get out of the debt crisis and slows growth, or fails to tackle corruption that the public wants, that is one thing.
But if the new regime is ousted by monetary instability, which stems from the 5% inflation target or rate cuts or potential output targeting, as central bank refinancing did to past regimes, that would be unfortunate.
It is not the oligarchs who finance political parties or the voting public that decides what the next government will be; it is the monetary board or Treasury officials seconded from the central bank who decide what the interest rate is.