Comparing Donald Trump to Ronald Reagan is wrong and misleading. The two eras are diametrically different in most respects. Rising budget deficits, interest rates and dollar will hit U.S. economy and financial markets hard.
The U.S. economy is undergoing a clear slowdown in the last year. The industrial sector, especially capital investments, is already in the midst of a recession, and other leading sectors of the economy are exhibiting tangible signs of weakening and possibly even changing course and direction.
The automobile industry is experiencing record high inventory levels combined with a sales plateau since the beginning of the year. After a long time, used car prices are also down. Mortgage and refinancing activity is rapidly slowing and simultaneously we see weaker homes sales rates.
High-end real estate markets such as New York City, Miami, Chicago and the San Francisco-Bay Area are already experiencing a precipitous price fall while the rate and scale of foreclosures increased.
Retail sales trends are close to recession-level, particularly transportation and restaurant-related businesses show significant slowdown. In fact, a majority of the six commonly defined economic engines of growth are showing signs of halting and some even reversing course. While there are indications of a somewhat surprising rebound in the last several months, it stems from unsustainable factors: An increase in exports and inventories.
A more robust indicator is the unmistakable diminishing rate of domestic end-buyer sales. On the bright side, exports constitute a ray of light, but there are nearly impossible to overcome difficulties of global economic weakness, a strong dollar and the inevitable loss of competitiveness.
Global economic slowdown is compounded as the zero-interest-rate driven expansive-monetary policy’s effects dissipate, while the negative attributes of this policy grow more influential. This is a process that both inflicts current damages on the global economy and gains momentum as it progresses. Vis-a-vis Asian currencies including China, the dollar is as strong as its 2009 levels, let alone Canada, Mexico, Europe and South America. This will inexorably hurt U.S. exports, generate an increase in imports and will create deflationary pressures on the U.S. economy.
Long-term interest rates have already risen by almost 1% in the last several months at a time when the Federal Reserve was only beginning the process of an interest rate hike. This increase will adversely impact mortgages, refinancing, car leasing rates, student loans credit and other interest-sensitive finances.
The U.S. 10-Year rate reached 2.40%, a figure destined to hurt stock markets, especially dividend-stocks, as well as significantly make mergers, acquisitions, and share repurchases more expensive—the three most supportive and maybe only factors supporting U.S. equities in the last few years.
This development is further made worse by ongoing retail money and investments being pulled out of the stock market in addition to the sovereign wealth funds and oil producers playing a substantially smaller role in incoming capital. Oil prices will either stay stable or not significantly rise in the foreseeable future, so the cumulative mostly negative effects of falling energy prices will continue to affect the economy and financial markets.
It is thus safe to assume that the general outlook for the next year is, to say the least, gloomy, even before we try to factor-in the long term adverse consequences of the economic policy candidate Donald J. Trump laid out during his campaign.
The central themes of President-Elect Trump’s economic plan are: Tax cuts on individuals and corporations; substantial increase in infrastructure investments; a critical revisiting and possible pull out of international trade agreements; imposition of protective customs tariffs on imports; and the repatriation of money from Corporate America with a one-time reduced tax (maybe 10%).
I am purposely ignoring the possibility of the Dodd-Frank act being wildly amended or overturned completely both because I believe the macro-economic effects are inconsequential (excluding the effect on the highest-paid individuals in the financial sector) and because of the low probability that the Senate will actually overturn it.
For starters, Trump’s economic plan will first and foremost increase the budget deficit rather than expand budget outlays and activity-generating investments. It goes without saying that increasing infrastructure investment and expenditures—however non-significant they may be in terms of GDP and employment—will only be expressed at the earliest in 2018 and more so by 2019. The repatriation, as we’ve seen from President Bush 2003 (HIA), will have but a trivial impact on investment and, if anything, may add to the stronger dollar trend.
The ramifications for markets and the economy are pretty clear cut:
1. Long-term interest rate will continue to increase
Already, at the 2.5% vicinity it is a blow to a financial system long accustomed and addicted to much lower rates.
2. A strong and further strengthening dollar has severely unfavorable implications on exports and imports
In dollar terms, the U.S. is the world’s largest exporter reaching $2 trillion. The exposure and vulnerability the U.S. thus has is monumental. It is clear, politically and economically, that imposing import tariffs will entail countermeasures from other countries, leading to inevitable price hikes and hurting household available incomes. Substituting imports is possible, but it is a very lengthy process, not to mention the damages incurred by the import-related system in the U.S.
3. Corporate tax cuts
It is inconceivable that a weakening economy will invest more just because corporations enjoy tax cuts and breaks. It is much more reasonable to assume that the corporate bond bubble of the last few years, used primarily for stock buy-backs and mergers& acquisitions activity, will be used to improve cash flow and debt repayment. As for individual tax cuts, clearly sufficient time has to elapse and money has to be accumulated for it to have a durable impact on middle-class consumerism.
4. Limitations and quotas on immigration and granting
Limitations and quotas on immigration and granting of work permits will further affect growth at a time when GDP-per capita growth has been low in recent years. It will primarily have a negative impact on retail sales, housing starts and housing prices.
After the election, the business and financial communities sounded elated and euphoric comparing Trump to Ronald Reagan. The analogy is both wrong and misleading. The two eras are diametrically different in most respects. Reagan entered the White House in 1981, when the U.S. was in a deep recession, with inflation high but decreasing and interests rates—real and nominal—at an all-time high.
The defining policy was the Paul Volcker-led Federal Reserve implementing an aggressive plan to lower those rates. U.S. national debt at the outset of the 1980s decade was insignificant, while today it is over 100% of GDP. The U.S. dollar was strong but started then a steady and consistent process of weakening that proved a great impetus for exports.
Late 2016 is marked by the opposite: The dollar is strong and Trump may further strengthen it to the detriment of American exports; deflationary process is nearing its end; interest rates are increasing; public and private debt are weighty.
Reagan had the G-5, (later the G-7 ), essentially at his disposal. The perceived threat from the Soviet Union allowed the U.S. to devise, determine and execute G-7 policies based on U.S. interests with relative ease. This included a variety of financial decisions: joint intervention in currency markets and monetary and fiscal policy.
When the U.S. deemed it necessary to stop the dollar from strengthening, it had both the economic and diplomatic tools to do so. Just recall James Baker as the final arbiter in all G-7 summit decisions. Today you cannot seriously imagine such contours and terms when Brexit is imminent and the Euro-block is absorbing tremendous pressures.
In retrospect, the Reagan economic era is positively remembered and cherished due to the end of the recession and the aggressive monetary expansion, highlighted by a sharp interest rate decrease (from over 20% levels) that impelled the stock market to catapult 300% from the lows of the 800 points it plummeted to. It is equally worth remembering that the Reagan-era euphoria ended abruptly on “Black Monday,” October 19, 1987.
The DJI index fell by 23% that day and 40% in three weeks. Yet at the time, Washington had the financial, fiscal and political/diplomatic instruments to deal and redress what had happened. Stabilizing the system, at a cost to G-7 countries—by consent—was achievable and in fact implemented. The subsequent dissolution of the Soviet Union, and the high-tech revolution, further assisted the U.S. and the world to recuperate.
Today it is hard, if not impossible, to see such tools at America’s disposal in the event of a similar crisis. During Reagan’s era, it took the stock market over six years before it encountered the 1987 crash. If President-Elect Trump follows through on the policy he presented during the campaign as his agenda, such an economic and financial crash will arrive much much sooner.
One last remark
I deliberately refrained from dealing with Trump’s domestic social agenda or his foreign policy statements and general references to global affairs. Notwithstanding, I will stress that those may exacerbate the above economic outlook.