Against the tide: The impact of Trumpism

The inauguration of the new US president Donald Trump set the economic and financial scene for 2017, not only in America, but also in Europe, Russia, the burgeoning emerging economies of Asia and Latin America. Everybody must react to the uncertainties of Trumpism.

The US equity markets and the dollar have so far leaped ahead on expectations of tax cuts and rising fiscal spending. But this ‘reflation trade’ equally pushes bond yields higher. Higher interest-rate expectations will ultimately follow. This will add to the plethora of risks that come with a populist leader like Trump, who highlights the costs of globalization and immigration. 

A slightly more emollient Trump has surfaced since last November’s election. But is it for real? After all, if Trump only fiddles with Obamacare, eschews trade wars and the ripping up of international relationships and at the same time throws money at the (full employment) economy, it might be business as usual with a bit more growth and inflation, a more hawkish Fed, higher equities and a stronger dollar. 

But populist politicians say what they will deliver and deliver what they say. This limits the extent to which Trump can continue to backtrack on commitments to his voters without provoking a backlash against himself. Trump was elected by white, ageing, economic losers; a big slug of whom are from the rust belt. He offered them specious explanations of their plight with globalization and immigration to the fore. He believes in his diagnosis and must deliver the ‘cure’.

Our (liberal democrat) culture lulled us into underestimating the power of the anger vote. Pollsters made the same mistake, as anger voters probably do not participate in their surveys. It now makes us prone to misjudge the consequences. Typical of this mindset is that many still expect Brexit to be reversed by the workings of the law and the strength of many UK parliamentarians’ belief in EU membership. It won’t be. 

In 2017, western Europe is where the ‘anger’ shoe could fall next, most immediately in Italy and in France (where the National Front’s Marine Le Pen could well win over the traditional conservative Francois Fillon and the disarray that is the socialist wing of French politics).

So this year the risk is rising for trade wars that reverse globalization and weaken global alliances. Both will open the door to large and disruptive power plays by China and Russia in exploiting western weakness. 

Sequencing is important. If Trump’s spending boost and tax cuts come first in terms of announcements, global bond markets will continue to tank, US equities will keep on rising and the dollar will be strong. But once the isolationist policies begin to bite (and they can be implemented far faster because many of them are within the purview of the president), the equity and dollar trend could reverse dramatically. 

Equities would suffer from the disruption of efficient US corporate global supply chains even more than from a mercantile contraction in trade. The reality is that globalization made supply chains far more economically important than any nation’s imports and exports. And bonds would suffer more from a dearth of foreign demand for the US dollar as a reserve currency and retaliatory selling of US treasuries by China.

The positive impact of Trump’s tax and spending intentions can last a while. That entails buoyant US equities, a tightening Fed and a stronger dollar with continued deterioration in bond markets. I suspect that one global consequence of this will be the reflation trade.  The intellectual framework is fiscal deficit spending to fill the void left by tired and increasingly ineffective central banks. But if the US government is out there spending money it does not have, it will not be long before many others are at it. The short-term boost to demand will be inflationary as productivity will not be improved. The increase in demand will result in more nominal than real GDP growth. 

In this scenario, it is hard to see the euro as a safe-haven hedge for the dollar as the populist threat is an existential danger to the European venture in a way that the sovereign debt crisis never was. Russia (now a friend of Trump) might benefit from higher demand, particularly for energy. But the protectionist threat, if it turns into reality, would more than offset this for the factory economies of Asia.