November’s US presidential election casts a deep shadow over global markets
‘Trumponomics’ portends heightened economic uncertainty and more market volatility
A week is a long time in politics, but the eight-month lead-in to this November’s US presidential election could be an excruciatingly long wait for global markets. The one thing markets hate most is uncertainty and they are clearly heading into the great unknown on who becomes the next president of the United States. Markets could well be in for a severe shock.
Judging by the way the US primaries are heading, it looks likely to end up a head-to-head contest between the main Democratic contender Hillary Clinton and Republican front runner Donald Trump. While Clinton is likely to be more of a transparent, business-as-usual successor to President Barack Obama, it is the uncertainty over Trump’s economic policies that could be a dangerous future wild card for markets.
Much of the focus so far has been on the billionaire businessman’s history of corporate failures, his record as a reality TV personality and his confrontational political style. His background may be colourful, but there is a real risk that markets are failing to come to terms with the consequences of a Trump victory for the US economy and financial markets.
On the positive side, Trump aims to bring back production and jobs to the US, hoping to restore the nation to its heyday of robust growth. His intentions may be commendable, but the means will be a problem. Trump’s economic plans – nicknamed “Trumponomics” – envisage slashing personal and corporate tax rates to boost demand and throwing up a protective trade wall around the US economy to defend its domestic manufacturers.
The problem is that the US economy has been down this “supply-side” road before and it ended in tears for the economy. During the 1980s, US President Ronald Reagan aimed to clear up the nation’s economic mess with widespread tax cuts, draconian spending cuts and curbs on government to spur on the private sector and boost growth.
Unfortunately, “Reaganomics” led the economy into extremely loose fiscal policy, tighter money and a rampantly stronger dollar. The result was yawning twin deficits, with massive budget and trade holes punched in the economy, while struggling US manufacturers deserted America in droves, forced offshore to survive.
The same could easily happen again. The problem is the US is extremely consumer driven, with more than 70 per cent of the economy dominated by consumer spending. Much of this demand spills abroad and widens the US trade deficit with imports brought in from overseas. If Trump slashes taxes all it will achieve will be to bloat the trade gap again.
Putting a protective trade barrier around the US with punitive tariffs on imported goods is no guarantee that US producers will ever flock back home to rebuild the domestic supply chain. Trump has already threatened a 45 per cent tariff on all imports from China, but increasing protectionism will simply lead to higher US inflation, quite apart from the damage to international relations.
Any sanctions which impede the free flow of international trade would inflict another serious shock that the world can ill afford right now. The global economy is already suffering with world trade flows down around 10 per cent from a year ago. A tit-for-tat trade war would end up tipping the global economy into a very dangerous hard landing, which would be extremely bad news for global equity markets.
The impact of a Republican president on US monetary policy is another potential risk to factor in. There has been fierce Republican criticism of the US Federal Reserve’s role in monetary intervention in recent years, especially the impact of zero rates on savers’ returns and the inflationary threat from the Fed’s explosive acquisition of quantitative easing assets. In the past seven years these have built up to US$4.5 trillion. Unwind too quickly and bond yields could skyrocket.
The fixation for sound money could see Trump, backed by a Republican-dominated Congress, try to switch the Fed’s present mandate for targeting inflation and employment, in favour of an inflation-only goal. Any interference in the Fed’s monetary independence would quickly lead to a rapid rise in US interest rates and higher long-term yields, with adverse consequences for the economy and markets.
There is still a long way to go, but markets will soon start to weigh up the risks. If Trump is heading to the White House, it is likely to mark a period of radical political change, with heightened economic uncertainty and more market volatility.
David Brown is chief executive of New View Economics