- At a presentation to the Economic Club of New York last week, Donald Trump unveiled his plans for the U.S. economy. Specifically, he pledged to restore growth of 3.5% per annum and to create 25 million jobs over the next decade.
- To achieve these goals, he would lower taxes and slash business regulations much like Ronald Reagan did. However, in contrast to President Reagan, Trump is at heart a mercantilist who believes trade deficits are bad for workers and the economy. As such he would renegotiate trade treaties, and he would declare China to be a currency manipulator.
- How are investors likely to respond? My take is equity investors would embrace tax cuts and deregulation, while bond investors would worry about outsized budget deficits. The principal uncertainty is how the dollar would fare: It soared in the first term of the Reagan Administration, but Trump’s protectionist policies could weaken the dollar and risk a trade war that would unsettle markets.
Similarities to Reaganomics
With the election now less than two months away and polls showing a close contest, investors will likely pay closer attention to the economic policies of the candidates, beginning with the upcoming debates. At a presentation to the Economic Club of New York last week, I listened to Donald Trump’s plans.
In many respects, the proposals Trump discussed were reminiscent of the “supply-side” policies that President Reagan pursued in the 1980s. Trump’s primary goal is to revive the American economy and to restore economic growth back to its long-term trend rate of 3.5% p.a. while also creating 25 million jobs in the coming decade. He rejects the consensus view among economists that the potential growth rate today is closer to 2% due to slower growth of the labor force and diminished growth in productivity. In his view, pro-growth strategies that lower and simplify tax rates combined with significant reductions in the regulatory burdens businesses face are the keys to success.
On the spending side of the ledger, Trump pledged to increase military expenditures to combat terrorism, and he also favors increased spending on infrastructure projects to create new jobs. He does not want to pare back entitlement programs, such as social security and Medicare and Medicaid, which most economists believe will lead to outsized budget deficits in the future. Instead, he proposes to cut back spending on other programs by 1% per annum over the next ten years.
Hearing these ideas resurrects the debate that occurred in the 1980s, when the Reagan Administration contended that widespread tax cuts and increased military spending would not lead to large budget deficits. The argument was that lower tax rates would boost economic growth and tax revenues, and that increased military spending would be offset by cutbacks in non-defense spending. However, the latter did not occur, as a Democratic Congress favored larger increases in social programs. The end result was that both the U.S. budget and external deficits rose to record levels as a percent of GDP (Figure 1).
Figure 1
U.S. Budget & Current Account Deficits (% of GDP)
| 1979 - 87 | 1988 | 1989 | 1990 | |
|---|---|---|---|---|
| Europe | 2.1 | 3.7 | 3.4 | 2.7 |
| Germany | 1.7 | 3.6 | 4.0 | 3.3 |
| France | 1.9 | 3.7 | 3.6 | 3.1 |
| Italy | 2.5 | 3.9 | 3.4 | 3.0 |
| UK | 2.2 | 4.3 | 2.4 | 1.1 |
| Spain | 2.4 | 5.0 | 4.9 | 4.1 |
| Japan | 4.5 | 5.7 | 5.0 | 4.5 |
| USA | 2.7 | 4.4 | 2.9 | 1.5 |
Source: JPMorgan, World Financial Markets, February 1990.
The context for setting policy today, to be sure, is very different from the 1970s when U.S. inflation soared to double digits and the U.S. dollar was chronically weak. Accordingly, President Reagan supported the Fed’s efforts to combat inflation and his administration favored a strong dollar. Today, by comparison, inflation and interest rates are at record low levels, and Trump is less supportive of the Fed; indeed, he contends it has become a very political institution.
A Critical Difference: Trade & Exchange Rate Policies
The biggest difference in policies favored by Donald Trump from those of Ronald Reagan, however, has to do with trade and exchange rate policies. President Reagan believed it was imperative to restore confidence in the dollar and to combat high inflation. Therefore, he was not concerned when the dollar soared and the U.S. trade imbalance climbed to record levels during his first term. It was not until 1985, when the U.S. economy weakened that the Reagan Administration collaborated with policymakers in Japan and Europe to produce an orderly depreciation of the dollar.
By comparison, Donald Trump has a mercantilist view of the world, in which U.S. trade deficits are perceived to be a sign of economic weakness. He blames NAFTA and China’s entry into the World Trade Organization for causing the loss of manufacturing jobs in the United States and for contributing to slower economic growth. Accordingly, he supports renegotiating trade agreements so they are more favorable to the United States, and he indicated one of his first actions as President would be to declare China to be a currency manipulator.
In adopting this stance, Trump does not acknowledge any benefits from agreements to promote free trade that U.S. consumers have reaped, or from the role China and other countries have played in financing the U.S. fiscal and current account deficits. Nor is there any appreciation of the role China played as an engine for world economic growth, especially after the 2008 financial crisis. Finally, he did not discuss the repercussions of foreign countries retaliating against the United States, which would raise the prospect of a trade war.
Implications for Investors
Should Trump win the election and pursue the policies described above, my assessment is the markets’ response would be varied. On this score, equity investors would be encouraged by the prospect of lower tax rates for households and businesses, as well as by the commitment to reduce regulatory burdens. Therefore, Trump’s election could produce an initial stock market rally much as Reagan’s election did.
Ultimately, the responses of the bond market and currency markets will carry considerable weight. The biggest worry for bondholders is that Trump’s policies would produce massive budget deficits, as revenues are likely to fall short of his optimistic assumptions while overall government spending would soar. In an attempt to lessen such concerns, Trump’s latest plan calls for federal taxes to be cut over the next decade by $4.4 trillion, or less than half of his original $10 trillion target. He claims the shortfall in revenues would amount to $2.6 trillion, assuming the economy grows at the projected rate of 3.5%. However, the likelihood is that the deficits will prove to be much greater than the projections. In these circumstances, the Federal Reserve no longer would be compelled to buy unlimited quantities of government debt, and real interest rates would likely rise substantially.
The tricky call is how the dollar will fare. During the Reagan era, the dollar soared as the combination of expansionary fiscal policy and tight monetary policy produced record high real interest rates that attracted foreign capital to the United States. Should Trump win the election and pursue policies that are perceived to be protectionist, however, the risk is that foreign governments will counter, and the dollar could come under pressure if foreign capital flows diminished. In this respect, the experience under a Trump presidency could be very different from that of the Reagan era. Should a trade war ensue, moreover, markets would become unsettled, as it would risk a global recession.
