The potential economic consequences of Mr Trump

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Reverse globalisation in action

Political events in 2016 (Brexit and the election of Donald Trump) triggered a morphing of macroeconomists from central bank watchers into ballot box watchers:

  • Central banks are still important: people still care about how the US Federal Reserve (the Fed) will respond to Trump, how the Bank of England (BoE) reacts to Brexit and how the European Central Bank (ECB) deals with eurozone break-up risk
  • However, politicians are driving the agenda, and central banks are now responding to events just like the rest of us

What happens at the ballot box matters for investors. Politicians can influence:

  • the cyclical dynamics of the economy (growth, output gap and inflation)
  • the supply side of the economy (trend growth)
  • the regulatory landscape, which is critical for specific sectors
  • and at the limit, politicians can reshape the fundamental structure of an economy
  • … and fundamentally shift the return on investments

The focus in this post will be on the economic implications of one of two key events at the ballot box in 2016, namely:

  • The election of President Trump
  • This, along with the UK’s vote for ‘Brexit’ can be seen as forms of ‘reverse globalisation’

Trump’s plan

President Trump has been clear about what he wants to do in the economic sphere:

  • Restrict immigration and increase deportation
  • Cut regulation
  • Lower tax rates
  • Realign US trade policy
  • Increase spending on infrastructure and the military

Trump’s basic economic goal is also clear: to create jobs

  • Emphasis on bringing jobs home: discouraging offshoring and blunting competition from imports

It is however not clear that his agenda will achieve his goal

  • In the long run, prosperity is determined on the supply side and Trump’s policies could prove counterproductive
  • The negative impact of policies on migration and trade is likely to prove (much) larger than any plausible positive impact from deregulation… the US economy is already highly deregulated
  • In the short run, any boost to GDP from fiscal stimulus in an economy close to full employment ought to be offset by monetary policy
  • The net effect of his policies may be to reduce the competitiveness of the US export sector by inflating the value of the dollar

Fiscal policy

Baseline expectations: large fiscal stimulus is coming (eventually)

  • Republicans will support the fiscal stimulus package on the assumption that Trump will significantly raise US trend growth
  • Democrats may support aspects of the package (infrastructure spending, middle class tax cuts)

The US will spend more, tax less and issue more debt:

  • Increased spending on military
  • Increased spending on infrastructure
  • Lower revenue on corporate and personal tax cuts
  • Indications of possible cuts to non-defence spending
  • No indication of entitlement reform

It’s arguably irrelevant whether you think that large fiscal stimulus is wise at full employment when the debt load is already high. It’s more important to think about the probable consequences:

  • Higher short-term interest rates
    • Unless Trump can neutralise the Fed through appointments to the Board
  • Higher long-term interest rates
    • Increased issuance of government debt
    • Increased concern about the underlying policy framework (inflation and credit risk premium)
  • Higher US rates then feed through into the broad constellation of asset prices

Protectionism

The most surprising aspect of the market response to the election of Donald Trump was that so little attention was attached to his position on trade

  • Trump has been a vocal critic of US trade policy for several decades
  • The market implicitly assumed that Trump wasn’t serious about trade or that his advisors would dissuade him
  • Similar assumption have been made about other aspects of his agenda too (e.g. immigration policy)

Trump talks trade

What is the first thing you would do on entering the Oval Office?- 1990, Playboy magazine

“Many things. A toughness of attitude would prevail. I’d throw a tax on every Mercedes-Benz rolling into this country and on all Japanese products, and we’d have wonderful allies again.”

Trump wants to bring jobs back home and the only uncertainty is how he will try to do that

  • Tariffs versus Border Adjustment Tax?
  • Targeted (certain goods, certain countries) or across the board taxation?
  • Also expect a retreat from the multilateral WTO approach

Economists don’t like protectionism/ autarky

  • Reverse globalisation will increase the cost of living and reduce productivity
  • In the long run, the gain in competitiveness from across the board is likely to be eroded by an appreciating US dollar
  • There is a clear risk of retaliation and a downward spiral into a destructive trade war.

See also: The potential economic consequences of Brexit

Published 2 April 2017

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