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Wednesday, January 18, 2017

The Real Trump Effect in 2017

by Roy C. Smith

Suddenly, after Donald Trump’s surprise election in November, a weak economic outlook looked rosy and investors thrust caution aside as visions of tax cuts, infrastructure spending and regulatory reform danced through their heads.Stock markets around the world (except for Mexico and China) soared as, even before being sworn in, Trump demonstrated that he would be a powerful global player.

Now, with the price-to-earnings ratio of the S&P 500 above 26 (vs. a long-term average of about 15), some think the year-end rally was too much. This remains to be seen, of course, but what might we expect from the real Trump in 2017?

His agenda, based on many campaign promises, is more ambitious than any of his recent predecessors. But his plans lack important details and his cabinet and advisors lack the skills necessary to push complex bills through Congress. And, having trailed Hillary Clinton by more than 2% in the popular vote, his mandate to run things his way may be far weaker than he thinks.
He will probably start off with a wide-ranging repeal of Executive Orders issued by Obama, which will be welcomed by the private sector. Not all of these will make much of a difference, but they will be appreciated for their signaling effect – less regulation and government interference in business. The costs of regulation in the US have grown steadily over the years and now, according to some estimates, represent a drag on growth of 1% to 2% per year.

Next, he will attempt to bring forward two broad legislative programs – one involving a debt-financed economic stimulus package involving many components, and the other, the ”repeal and replacement” of two key Obama programs in healthcare and financial service regulation.

The stimulus program was never described as such – instead it was sold as a necessary reaffirmation of American values involving tax cuts, and enhanced spending for public infrastructure and national defense, together with a naming and shaming effort to recover jobs lost to manufacturing abroad. This initiative, however, is not supported by offsetting cuts in public spending so it would significantly increase the federal budget deficit and the amount of government debt outstanding (already at 104% of GDP, the highest level since WWII).

However, the debt component of the Trump stimulus effort is likely to meet considerable opposition among conservative Republicans. So, for this legislative effort to succeed there will have to be significant downsizing and compromise, and this could drag things out several months. Nevertheless, it is likely that some of the Trump stimulus plan will survive. How much it will boost growth and job creation in a still sluggish but recovering economy now operating at full employment is very uncertain, but it is likely to be modest in 2017.

The second legislative effort will be to “repeal and replace” Obamacare (the Affordable Care Act that provides health insurance for those otherwise uninsured), and the Dodd Frank Wall Street Reform Act, both of which narrowly passed with no support from Republican members of Congress. Trump has the votes to repeal these landmark legislative achievements of the Obama administration, but as yet no clear plans for their replacement.

Both issues are controversial and are unlikely to be settled quickly or without a lot of confusion as to what will happen next. The healthcare industry represents about 16% of US GDP, and banking another 10%. Health care could actually contract because of the uncertainty as to what will replace it and when. Republicans in the House of Representatives have a plan for replacing Dodd-Frank that many large banks will appreciate, but these banks are still required to comply with Basel III and its latest additions to capital “cushions” and similar requirements. Despite some considerable relief in the Trump stock market for healthcare and banking stocks, 2017 doesn’t look like a year of substantial profit improvement for either industry.

Finally, Trump will have to decide exactly what he wants to do to change trade relations with China and Mexico. His “America First” theme to recover manufacturing jobs lost to these countries either because of unfair trading practices or badly negotiated trade agreements (Nafta) has had a lot of popular support, but reflects little appreciation of legal and economic realities. He has threatened to raise tariffs significantly on imports from both countries, which some fear could start a trade war.
He can easily make a case that Chinese government subsidies of exporters and its non-tariff barriers to US exports and foreign direct investment, and the occasional case of dumping, have distorted trade relations to the point where corrections are necessary. President Nixon took such a position in the early 1970s when he raised tariffs suddenly on Japanese imports, gaining concessions as a result.
Trade of course is a very thorny issue, with US manufacturers’ supply chains and major agricultural exporters right in the middle of it. Mexico’s case is arguably more complex and less urgent, and Mexico has noted before that as its growth rate declines, illegal immigration to the US increases, wall or no wall.

Here we must rely on Trump’s long history of deal-making. He announces big objectives, threatens and blusters to get the attention of the other side, then finds a workable compromise that he can describe as a success. As with his Twitter-fed negotiations with Carrier, Ford and some other large US companies, a few moderate concessions can be enough for a victory celebration.

Deal-makers are not ideological; they just need to show that they can pull off big, unexpected transactions, often by conceding a lot themselves.

The good news for those scanning prospects for 2017 is that the Trump effect most likely will be less disruptive than many have feared, but will still be a net positive contributor to US economic growth, especially as compared to a Clinton presidency.

The bad news, however, may be that Trump’s bold, blustery, and populist approach to politics and economics will be seen as successful enough in Europe to encourage imitation in the several important political contests scheduled for 2017. There, however, even modest shifts towards nationalism could significantly impair the ability of the EU and the Eurozone to cope with increasing pressures that are developing to dissolve them.

Thus, an unexpected irony of Trump’s election, may be that it could have more effect in Europe in 2017 than in the US.

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