When US President Donald Trump was elected, stock markets rallied impressively. Investors were initially giddy about Trump’s promises of fiscal stimulus, deregulation of energy, healthcare and financial services, and steep cuts in corporate, personal, estate and capital gains taxes. However, will the reality of Trumponomics sustain a continued rise in equity prices?
It is little wonder that corporations and investors have been happy. This traditional US Republican embrace of trickle-down supply-side economics will mostly favor corporations and wealthy individuals, while doing almost nothing to create jobs or raise blue-collar workers’ incomes. According to the nonpartisan Tax Policy Center, almost half of the benefits from Trump’s proposed tax cuts would go to the top 1 percent of income earners.
Yet, the corporate sector’s animal spirits might soon give way to primal fear: The market rally is already running out of steam and Trump’s honeymoon with investors might be coming to an end. There are several reasons for this.
Illustration: Mountain People
For starters, the anticipation of fiscal stimulus might have pushed stock prices up, but it also led to higher long-term interest rates, which hurts capital spending and interest-sensitive sectors, such as real estate. Meanwhile, the strengthening US dollar will destroy more of the jobs typically held by Trump’s blue-collar base.
The president might have “saved” 1,000 jobs in Indiana by bullying and cajoling air conditioner manufacturer Carrier; but the US dollar’s appreciation since the election could destroy almost 400,000 manufacturing jobs over time.
Moreover, Trump’s fiscal stimulus package might end up being much larger than the market’s current pricing suggests. As former US presidents Ronald Reagan and George W. Bush showed, Republicans can rarely resist the temptation to cut corporate, income and other taxes, even when they have no way to make up for the lost revenue and no desire to cut spending. If this happens again under Trump, fiscal deficits will push up interest rates and the US dollar even further, and hurt the economy in the long term.
A second reason for investors to curb their enthusiasm is the specter of inflation. With the US economy already close to full employment, Trump’s fiscal stimulus will fuel inflation more than it does growth. Inflation will then force even US Federal Reserve Chair Janet Yellen’s dovish institution to hike up interest rates sooner and faster than it otherwise would have done, which will drive up long-term interest rates and the value of the US dollar still more.
Third, this undesirable policy mix of excessively loose fiscal policy and tight monetary policy will tighten financial conditions, hurting blue-collar workers’ incomes and employment prospects. An already protectionist Trump administration will then have to pursue additional protectionist measures to maintain these workers’ support, thereby further hampering economic growth and diminishing corporate profits.
If Trump takes his protectionism too far, he will undoubtedly spark trade wars. The US’ trading partners will have little choice but to respond to US import restrictions by imposing their own tariffs on US exports. The ensuing tit-for-tat will hinder global economic growth, and damage economies and markets everywhere. It is worth remembering how the US’ 1930 Smoot-Hawley Tariff Act triggered global trade wars that exacerbated the Great Depression.
Fourth, Trump’s actions suggest that his administration’s economic interventionism will go beyond traditional protectionism. Trump has already shown his willingness to target firms’ foreign operations with the threat of import levies, public accusations of price gouging and immigration restrictions (which make it harder to attract talent).
Nobel laureate economist Edmund Phelps has described Trump’s direct interference in the corporate sector as reminiscent of corporatist Nazi Germany and fascist Italy. Indeed, if former US president Barack Obama had treated the corporate sector the way that Trump has, he would have been smeared as a communist; but for some reason when Trump does it, corporate America puts its tail between its legs.
Fifth, Trump is questioning US alliances, cozying up to US rivals such as Russia and antagonizing important global powers such as China. His erratic foreign policies are spooking world leaders, multinational corporations and global markets generally.
Finally, Trump might pursue damage control methods that only make matters worse. For example, he and his advisers have already made verbal pronouncements intended to weaken the US dollar. However, talk is cheap, and open-mouth operations have only a temporary effect on the currency.
This means that Trump might take a more radical and heterodox approach. During the campaign, he bashed the Fed for being too dovish and creating a “false economy.” And yet, he might now be tempted to appoint new members to the Fed who are even more dovish, and less independent, than Yellen, to boost credit to the private sector.
If that fails, Trump could unilaterally intervene to weaken the US dollar, or impose capital controls to limit dollar-strengthening capital inflows. Markets are already becoming wary; full-blown panic is likely if protectionism and reckless, politicized monetary policy precipitate trade, currency and capital-control wars.
To be sure, expectations of stimulus, lower taxes and deregulation could still boost the economy and the market’s performance in the short term. However, as the vacillation in financial markets since Trump’s inauguration indicates, the president’s inconsistent, erratic and destructive policies will take their toll on domestic and global economic growth in the long run.
Nouriel Roubini, a professor at New York University’s Stern School of Business and chairman of Roubini Macro Associates, was senior economist for international affairs on the White House’s Council of Economic Advisers during former US president Bill Clinton’s administration.
Copyright: Project Syndicate
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