Lessons from Trump’s triumph
The morning after: New US president challenges the globalised liberal order
BELIEVE it. Donald Trump will be the 45th president of the United States. That’s reality. Whatever your views, it marks a sharp repudiation of the status quo. I was there when this happened on Nov 8, 2016 – to be exact, at Harvard winding up a two-week stay, calling on old friends; making new ones and of course, attending the fall meeting of the Graduate School of Arts & Sciences (GSAS) Alumni Association Council, on which I have been a member since 1993 (and its chairman, 2002-2005).
That weekend, Dudley House celebrated its 25th Anniversary. Since 1991, it has been home to Harvard’s GSAS students – providing them a place to gather and the opportunity to meet people outside their degree programmes. “It’s a fabulous place located in the Yard. This is the student’s home away from home.”
Lessons to learn
Yes, after a campaign long on invective and short on policy, Trump delivered a resounding victory against the ultimate establishment candidate. As I see it, the results exposed the profound fault lines in American society, brought on by the recent global financial crisis.
“His campaign appealed to nativism, isolationism and protectionism. He railed against immigration … castigated allies in Europe and Asia … pledged to tear up trade agreements in order to protect and reclaim American manufacturing jobs.” Observing developments from the vantage point of Harvard, Trump’s “untruthful” rhetoric and compulsive tweets resonated among ordinary Americans, who felt marginalised by globalisation.
Inequality has risen and median incomes have stagnated (or even fallen) in recent years, especially among blue-collar workers. Not since Andrew Jackson has a winning candidate so defied the settled order, for better or worse. But, to be fair, Trump’s winning was always an outside possibility. To his credit, Trump scouted around corners to spot political opportunities where most thought there were none.
Trump’s support is a testament to the democratic power of discontented voters – long ignored by politicians, the press, et al. There are lessons to be learnt: first, wishful thinking does come to pass; second, self-critical, open-minded forecasters do a better job; and third, the favourite doesn’t always win. Indeed, the politics of 2016 does point to the failure to prepare for perfectly foreseeable possibilities. It’s never too late to learn.
There is much talk that Trump could be the second Ronald Reagan (RR) – cutting taxes and priming the pump running deficits. US stocks started an 18-year rise early in RR’s term. Many like the analogy. But the parallel does not hold because the economy and market were in a different position in 1981 – short bonds had never been cheaper (yielding 15%), and stocks were at their cheapest (at eight times PE, i.e. ratio of price relative to earnings).
Long-term bond yields stood at 12.5%. The economy was in recession. Yields had peaked and started a long-term decline. Indeed, the situation was ripe for fiscal stimulus. As Trump takes over, bond yields hit a post-war low of 1.5% in the summer and are now rising. The Fed stands ready to raise rates. Stocks are far more expensive at 27xPE. The economy is doing reasonably well and there is far less slack than when RR arrived. Already there has been a sharp rise in inflationary expectations.
So, a big Keynesian expansion at this time is far more questionable. Indeed, it’s hard to see how Trumponomics can possibly duplicate Reaganomics as Trump takes over. Historical evidence suggests no Reagan boom; it’s likely present high stock valuations will cap any impending rally.
The darker side of tightening financial conditions and higher yields are beginning to show. The stronger US dollar (especially given its rapid rise) has already exposed weaknesses that have been ignored by investors in the markets.
In the third week of this November, they put US$28bil into global equities and pulled US$18bil out of bonds. The stronger dollar also meant weaker currencies all round, notably euro and yen. Most emerging currencies have significantly depreciated, including the Chinese yuan and the ringgit.
From the growth perspective, there is already a noticeable timing mismatch. Any fiscal stimulus will take time to take effect – at best, not until later in 2017 and beyond. But the impact of tighter financial conditions is being felt more quickly. Rising rates will affect mortgage demand and consumer spending, while the strong US dollar threatens to crimp US corporate profits and exports.
Meanwhile, for the eurozone, times have since changed. 2017 looks more uncertain – given elections in France, Germany and the Netherlands, not to mention the constitutional referendum in Italy. No doubt, the falling euro has begun to reflect the higher political-risk premium.
Talk is circulating once again on the prospect of US dollar-euro parity. Markets aren’t good at reading nuanced messages of the unpleasant mix evolving in Europe (German yields have risen but Italian yields have risen further and faster).
Attempt at Reaganomics
Resort by Trump to a re-run in Reaganomics is likely to do more harm than good. Other than its bad timing, experience suggests three big areas of concern.
First, financial instability – interest rates were remarkably high in early 1980s (thanks to Volker’s firm efforts at taming inflation), pushing up the value of US dollar (up 40% in first half of 1980s).
As a result, debt-ridden developing economies were unable to service it; high sovereign debt then led to defaults, saddling US and European banks with large losses, pushing some to insolvency. Today, such vulnerabilities remain.
Interest rates are already rising and the US dollar has strengthened significantly. A bout of chaotic capital flight could threaten global growth and stability – could even prompt a return of capital controls. Trump will probably be slow to lend a hand.
Second, side-effects of Trumpian Reaganomics.
In the early ‘80s, the strong US dollar culminated in the Plaza Accord to bring down the value of the US dollar, which led eventually (in 1987) to sanctions on Japan. The rising US dollar since the elections, already at a 13-year high, is beginning to threaten US exports and jobs. Mexican peso is now down by more than 10% against US dollar. Sprawling global supply chains means that punitive tariffs are obviously less effective than they once were.
Asia’s sophisticated electronics supply chain and massive labour pool are obstacles in Trump’s way. Any trade or currency war with China could prove more troublesome, economically and geopolitically, than the Plaza negotiations.
Third, any boost to growth from unfunded tax cuts and fiscal expansion is unlikely to be distributed evenly – pushing already wide economic divisions to politically toxic levels – alienating Trump’s very voter base at the lower middle-income strata. This can only do more harm than good.
Nafta – an inconvenient truth
Trump: “the North American Free Trade Agreement (Nafta) is the worst trade deal maybe ever signed anywhere, but certainly ever signed in this country.” Such hyperbolic rhetoric isn’t supported by the facts: (i) Mexico gave up more tariff protection than the United States did when the agreement was signed in 1993. In the event Nafta does end, both nations will revert to “most-favoured nation” tariffs under WTO (World Trade Organisation).
That would hurt, not help, the United States. (ii) Trump slams Nafta on the 16.5% VAT paid by Mexican imports from the United States.
This is misleading because the tax does not discriminate – it applies to all transactions on foreign and domestic made goods; importer recovers it by charging the customers. Simple Econs 101. (iii) Under Nafta, Mexico is “stealing” US jobs. An interconnected North American economy has made US manufacturing moreglobally competitive, with US value-adding in innovation, design and marketing, making its final output among the most high quality, low-price products globally.
This synergy has made the US auto industry attractive to investment – pulling in two-thirds of the net investment flows of US$70bil from 2010-2014. This generated 265,000 new jobs in motor-vehicle production and parts between 2010-2016, a 40% gain in employment despite rising use of robotics. Shut-down Nafta and US workers would pay. (iv) US agriculture will also suffer. US farm products enter Mexico tariff-free (third largest market for the United States). Repeal of Nafta means US exporters will face up to 39% in import duty; industrial goods will pay up to 8% (now duty free). So Trump is not just politically incorrect; he is also factually incorrect.
What then, are we to do
Here’s my take. Americans just celebrated Thanksgiving – the oldest US festival; far older than the Republic and the most distinctively American of all festivities. It gives many citizens a chance to count their blessings, which may be particularly welcome this year after the election of Trump. I guess at least one-half of the population sees no reason to be thankful for this. Whatever it is, Trump’s victory has made those with stocks suddenly richer.
In president Lincoln’s Second Inaugural in 1865, he urged his “fellow countrymen” to work towards reconciliation and domestic peace: “with malice towards none, with charity for all.” His words seem particularly appropriate given that Trump’s victory has also elevated global uncertainty, partly because of the dangers of a trade war and partly because it is not clear which part of his very divisive agenda will be implemented. Above all, what worries most is the long-term outlook.
Four points need to be made.
First, the US economy Trump inherits is in pretty good shape. Real growth is up in recent months; jobless rate (at 4.9%) is close to full employment. S&P500 earnings have rebounded smartly and inflation is still moderate. The global economy is showing some signs of life.
All of these, except for political uncertainty, can be positive, especially for stocks but not for bonds. Second, the uncertainty and volatility following the election will, for now, make it highly likely the Fed will raise interest rate later this month.
I guess, the Fed may even feel that they may need to raise rates more aggressively in 2017 to make up for lost time. Third, it should be noted that there remains a gulf between Trump’s agenda and that of many “establishment Republicans” who may well be wary of unfunded tax cuts or stimulative spending increases.
There are indications that the new president and congress will probably move more slowly on trade protectionism measures. The world waits nervously to see if Trump the president will differ from the candidate. His shift to a more positive tone since the election gives hope. It all depends if he was sincere. After all, Trump prides himself on understanding the “art of the deal.” For him, politics in a democracy is the art of compromise.
Finally, it is clear that voters have chosen change over caution, Already, Trump’s victory feels like a grievous blow to the liberal international order. But as president, his job is to instil confidence and provide reassurance. Experience points to politicians tending to respond to what voters want, rather than what they need.
In the light of the Brexit vote and the US elections, 2016 has proved decisively that populism is a good political strategy. Much now depends on Trump’s actions and deeds. Whether they prove to be good for long-term economic prosperity is something we will just have to wait and see.
Former banker, Harvard educated economist and British chartered scientist, Dr Lin is the author of “The Global Economy in Turbulent Times” (Wiley, 2015). Feedback is most welcome; email: email@example.com.