The dangers of Trump's coming boom

Forecasters not only said Mr Donald Trump would lose last month. They also thought markets would collapse if he won. Quite the opposite has happened. Investors expect all the good things Mr Trump promised and none of the bad. Instead of global trade wars and mass deportation of immigrants, the equity markets foresee tax cuts, deregulation and big spending. Almost every index has hit recent highs since Nov 8, adding more than US$1 trillion (S$1.4 trillion) to US equity valuations and almost 5 per cent to the US dollar's trade-weighted value. Global markets are gearing up for a Trump boom. In that respect, Mr Trump is already heir to Mr Ronald Reagan.

But the seeds to the reversal of the "Trump trade" are already sown. The biggest threat will come from the US Federal Reserve. Tomorrow, Fed chairman Janet Yellen will almost certainly raise US interest rates for only the second time in a decade.

Before Mr Trump's victory, the Fed signalled it was likely only to increase rates three or four times before 2019. That was because it anticipated continued fiscal retrenchment. Mr Trump's victory has blown that up. A unified Republican government is poised to bring about the fiscal stimulus that it has been blocking Democrats from carrying out for years.

The effect on the US economy will be reflationary. Even if you halved Mr Trump's plans for US$5.7 trillion in tax cuts and US$1 trillion in infrastructure spending, his fiscal stimulus would still be huge. Since US unemployment is already well below 5 per cent, Dr Yellen will have little choice but to accelerate the Fed's planned interest rate increases. There are upsides to this. US monetary policy would return to normal far quicker than expected, which would give the Fed greater firepower to counteract the next recession. Goodbye to the "new normal" of zero lower-bound rates. Hello to the old one where central bankers wrestle with the economy's animal spirits.

But there are also two glaring downsides. The first is that it will set up a clash between the Fed and Mr Trump. No president likes the central bankers who take away the punch bowl just as the party is hotting up. Dr Yellen's term comes to an end in early 2018 - barely a year away. Mr Trump's campaign promise to fire Dr Yellen is one of the bad things markets assume he has now discarded. At any rate, a US president does not have the power to sack a Fed chief. But Mr Trump could make life impossible for Dr Yellen. Who he nominates to fill the two vacancies on the Fed's board will give a clearer idea of which direction he wants the Fed to go. One of them may be Dr Yellen's designated successor. How Mr Trump responds to the Fed's interest rate increases, via Twitter or elsewhere, will be key. It is one thing to tweet disapproval of the Fed on the campaign trail but quite another when you are sitting in the Oval Office.

Little weight should be attached to Mr Trump's pledge to appoint someone more hawkish to replace Dr Yellen. Republicans have a history of decrying loose monetary policy when in opposition but embracing it when in power. The same applies to fiscal deficits. Former vice-president Dick Cheney captured this when he said: "Reagan proved that deficits don't matter." As a highly leveraged property developer, Mr Trump has often described himself as "a low interest rate" guy. He will want to be a low-interest president. If Dr Yellen upset that, Mr Trump could always revive his support for the "audit the Fed" legislation on Capitol Hill.

The second big downside is the effect on the US dollar. When you combine fiscal loosening with monetary tightening, the currency will inevitably appreciate. That will further reduce the costs of imports and raise the price of exports. The US trade deficit - including that with China, which stood at almost US$400 billion last year - will rise. Mounting current account deficits are another feature of Reaganism. The big difference is that Mr Trump has vowed to reduce them. Reversing globalism and repatriating US manufacturing was at the core of Mr Trump's campaign. Can he afford to abandon that? How would that affect poll numbers?

This is where the bad Trump campaign vows come back into the picture. The US markets are wise to bet that Mr Trump will shelve his threats of global trade wars in the short term in favour of an expansive Reaganite boom. His nomination of investment bankers to the key economic roles - mostly from Goldman Sachs - has reassured Wall Street. The first phase of Mr Trump's presidency will be "Government Sachs" as normal. But that will change when things turn difficult.

The temptation to undermine the Fed's independence, make a scapegoat of China, revive talk of deporting immigrants and slap tariffs on Mexico will grow with the trade deficit. At which point, the markets will recall what it was they originally feared about Mr Trump.

But that is still some way off. For the past 18 months, Mr Trump has led an anti-elitist presidential campaign without peer. Over the next few months, America's elites can expect to receive their largest tax cut and asset-price-boosting windfall in years. Little wonder the markets are so giddy.

FINANCIAL TIMES

A version of this article appeared in the print edition of The Straits Times on December 13, 2016, with the headline 'The dangers of Trump's coming boom'. Print Edition | Subscribe