Trumpenomics, tailwinds and headwinds | Deloitte UK has been saved
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Before the US election many commentators thought a victory for Donald Trump would be a Brexit-like moment, fuelling uncertainty and hitting equities, business confidence and growth.
So far those predictions have proved wide of the mark. The S&P500 equity index has risen 2.0% since 8th November and the dollar is up 3.4%.
The mood among US Chief Financial Officers I spoke to at a Deloitte conference in Washington last week was generally pretty positive. I found no signs of the sort of sharp decline in confidence we saw among UK CFOs in the wake of the Brexit vote.
How could the surprise election of a political outsider with such radical and changeable views have ignited such optimism?
Markets are betting that Mr Trump is likely to get at least some of his plans for tax cuts, increases in infrastructure spending and deregulation through Congress. This policy mix should give the US economy a tailwind, bolstering growth and corporate profits.
Yet it is hard to see how such policies could meet Mr Trump’s aim of raising America’s long-term growth rate from 2.0% to 4.0%. Discovering policies that would double America’s sustainable growth rate would be to crack the most fundamental of all economic problems. No mature industrialised economy boasts a 4.0% growth rate. The last time US growth averaged 4.0% a year over any five year period was in the late 1990s technology boom.
Tax cuts and more infrastructure spending should help raise US growth in the short to medium term. In any case US activity, which slowed in the first half of this year, was reaccelerating before the election. It should not be difficult for the US to better this year’s insipid 1.5% growth rate in the next couple of years.
The real question is what Trumpenomics will do for US growth in the long term. Here the story is more mixed. Markets are focussing on the tailwinds to growth that the new administration may create. But Mr Trump’s policies could also create headwinds.
International trade is widely, though not universally, seen as being mutually beneficial. Mr Trump campaigned as a sceptic on trade. The new President’s hostility to free trade seems likely to sound the death knell of the TPP and TTIP trade-liberalising deals with Asia and Europe. Mr Trump also seems inclined to scrap or renegotiate NAFTA, the deal which opened up trade between the US, Canada and Mexico. (The Peterson Institute for International Economics estimates that the US economy is $127 billion a year richer as a result of the increased trade growth fostered by NAFTA).
Implementing Mr Trump’s campaign pledge to impose punitive tariffs on Mexican and Chinese imports could trigger a trade war with two of America’s closest trading partners. The result would be higher prices for US consumers and lower trade volumes.
Nor would foreign producers be the sole casualties. Big US-based manufacturers run interconnected production processes based on the movement of intellectual property, components and semi-finished goods across borders. Few complex manufactured products, such as cars or aircraft, are designed and made from scratch in a single factory. Thus Apple’s high value research, design and marketing takes place in the US while low value assembly is contracted out to Foxconn plants in China. In the auto sector Fiat Chrysler and GM manufacture in Mexico and the US. The distinction between a US and a foreign company is not one of where it produces, but one of history, the nationality of board members, where tax is paid, headquarters are located and shares quoted.
The equity market reaction to Mr Trump’s victory recognises that some US multinationals with overseas operations would be vulnerable to protectionist policies. Shares in US auto producers with Mexican facilities and technology bellwethers, including Apple, are trading below their pre-election levels.
The strong dollar poses a further, related risk to US growth. Mr Trump’s election, and the prospect of more government spending and borrowing, has accelerated the ascent of the dollar. It is now trading at the highest level since 2003 and is looking overvalued. The Economist’s Big Mac index provides a light-hearted estimate of equilibrium exchange rates by comparing the price of a Big Mac between countries. In July the index showed sterling was undervalued by 22% against the dollar. Since then the pound has continued to decline. Last week I paid almost 40% more to buy a Starbucks coffee in Washington than I would have paid in London.
Ironically the initial effect of Mr Trump’s victory has given imports into the US, especially from Mexico where the Peso has fallen by ten per cent, a fillip. Dollar strength will dampen US exports and corporate profits and will boost imports into the US. This is not what the new administration wants and it could strengthen Mr Trump’s resolve to impose tariffs on imports.
A third risk is rising interest rates. The era of super-cheap money seems to be drawing to an end. US growth was gathering pace before the election and Mr Trump’s policies are likely to reinforce the momentum. Last week the Chairwoman of the Federal Reserve, Janet Yellen, said that, “an increase in interest rates could well become appropriate relatively soon”. Markets interpreted that to mean that the Fed will increase US rates next month.
Meanwhile investors are anticipating a surge in government borrowing. This has led to a sharp decline in the value of US government debt – and a rise in the interest rates paid on it. This matters because interest rates on new and refinanced mortgages are linked to yields on US government bonds. In this way a sell-off in US government bonds raises the cost of mortgages and dampens housing activity.
In economic policy there are no free lunches. All policies have drawbacks and carry the risk of unintended consequences. The prospect of debt-financed infrastructure spending is boosting the dollar and pushing interest rates higher. Putting tariffs on Mexican imports raises prices for US consumers. And so on.
These are early days. The President is yet to set a course for economic policy and, even when he does, Congress will have a big say in what actually happens. Tax cuts and more government spending should be good for US and world growth. For the rest of the world perhaps the biggest economic uncertainty is whether Mr Trump will put his protectionist rhetoric into practice.
PS - The High Court’s ruling on Article 50 prompted speculation that pro-EU MPs might use their majority in Parliament to block the Brexit process. This looks much less likely now that a series of senior Labour figures, including John McDonnell, the Shadow Chancellor, Tom Watson, the Deputy Leader and Keir Starmer, Shadow Brexit Secretary, have said that the Labour Party will not block or delay Article 50.
Ian Stewart is a Partner and Chief Economist at Deloitte where he advises Boards and companies on macroeconomics. Ian devised the Deloitte Survey of Chief Financial Officers and writes a popular weekly economics blog, the Monday Briefing. His previous roles include Chief Economist for Europe at Merrill Lynch, Head of Economics in the Conservative Research Department and Special Adviser to the Secretary of State for Work and Pensions. Ian was educated at the London School of Economics.