Our election, your problem
Posted by hkarner - 11. November 2016
Source: The Economist
A Trump presidency will be bad for the world economy and worse for places outside America
IT IS not clear precisely how Donald Trump will govern, the extent to which he will carry out some of his scarier promises on trade and immigration, and who will be his economics top brass at the Treasury and in the White House. But a decent first guess is that President Trump will be bad for the world economy in aggregate; and a second is that his actions are likely to do more harm, in the short term at least, to economies outside America.
When America has in the past stepped aside from its role at the centre of the global economic system, the damage has spread well beyond its borders. In 1971, when Richard Nixon ended the post-war system of fixed exchange-rates that had America at its centre, his Treasury secretary, John Connally, told European leaders, “The dollar is our currency, but your problem.” This election result, to paraphrase Connally, belongs to America but is potentially a bigger economic problem for everyone else.
The scale and nature of that problem depend on the interplay of the two main elements of Mr Trump’s economic populism. The first is action to boost aggregate demand. Mr Trump favours tax cuts and extra public spending on infrastructure. The second element is trade protectionism. He has pledged to slap tariffs on Chinese imports and to renegotiate the North American Free-Trade Agreement (NAFTA) with Mexico and Canada. To the extent that he leans more on the first element and less on the second, the immediate damage to America’s economy will be limited. But even in that event, the net effect of a Trump presidency on economies outside America is still likely to be harmful.
To understand why, go back to the subject of Connally’s gibe: the dollar. As it became clear that Mr Trump would win the election, the greenback fell against rich-country currencies, such as the euro, yen, Swiss franc and pound, as investors sought a haven from policy uncertainty in America. An index of its value against major currencies dropped by 2% in early trading on November 9th. Within hours it had regained almost all the lost ground, as investors pieced together a positive story for the dollar, based on the prospects of a boost to demand in America’s economy and an inflow of capital from abroad.
Bringing it all back home
A deal between Mr Trump and Congress to cut corporate taxes, goes the logic, would spur flush American companies to repatriate retained profits held offshore. It would also allow them to increase capital spending in America, because they would have more ready cash; and consequent profits would be taxed more lightly. The larger budget deficits entailed by tax reform, along with more public spending on infrastructure, would underpin yields on long-term Treasury bonds. Indeed, after falling in the initial aftermath of Mr Trump’s victory, yields on 10- and 30-year Treasuries are on the rise again (see chart). Add the potential for higher inflation from the stimulus and the likelier use of some protectionist tariffs, plus a Federal Reserve with a more hawkish tilt, as Mr Trump’s appointees alter the complexion of its interest-rate-setting committee, and you have the makings of a renewed dollar rally.
A fiscal stimulus coupled with an investment splurge in the world’s largest economy should, all else equal, also be good for global aggregate demand. And if this kind of “reflation populism” improves the near-term prospects for America’s economy, it may dissuade Mr Trump from resorting to full-strength “anti-trade populism”. Well, perhaps. But given his leanings, it is easy to imagine him resorting to soft protectionism that keeps much of the additional demand within America’s borders. He might for instance lean on companies to favour domestic suppliers, or attach local-content conditions to publicly funded infrastructure projects. What is more, the repatriation of profits by American firms would draw resources away from their subsidiaries abroad.
In 1971 the world feared dollar weakness. These days, dollar strength tends to have a tightening effect on global financial conditions. The waxing and waning of the dollar is strongly linked to the ups and downs of the credit cycle. When the dollar is weak and American interest rates are low, companies outside America are keen to borrow dollars. Often big firms, flush with such cheap loans, will further extend credit in local currencies to smaller ones. But when the dollar goes up, the cycle goes into reverse, as corporate borrowers outside America scramble to pay down their dollar debts. That causes a more general tightening of credit.
Mexico has the most to lose from Mr Trump’s presidency, should he keep his campaign promises. So the peso plummeted in the wake of the result. But Mexico, along with Chile, Turkey, the Philippines and Russia, also has a large burden of dollar debts, which are becoming more expensive in local currency. Mr Trump’s protectionist bent may make it hard for emerging markets to trade their way out of trouble. Only a few are likely to be unharmed by his victory (see box on next page).
Where does a Trump victory leave China, the world’s second-largest economy? China accounts for roughly a half of America’s net trade-deficit, so in Mr Trump’s zero-sum reckoning, it has a lot to lose should America launch an all-out trade war. In fact, the resulting disruption to global supply-chains would badly hurt American firms, and higher prices on imported goods would squeeze American consumers, especially poorer households, which spend proportionately more on them.
Yet there are risks to China’s economy too, from even a milder form of Trumpian populism. The dollar’s weakness over the spring and summer helped stem the outflow of capital from China that had threatened to unmoor the yuan and so unsettled global financial markets at the turn of the year. A sustained dollar rally would thus mean a severe headache for China’s policymakers, as it would revive the pressure on its capital account. They might then face an unpalatable choice: let the yuan sink against the dollar or keep domestic monetary policy tighter to support it.
China is safe from the biggest indirect effect of Mr Trump’s victory: the boost it gives other populist politicians. Europe is far more vulnerable. Britain’s vote in June to leave the European Union was one early ballot-box reflection of anti-establishment sentiment. Since then, insurgent political parties in France, Germany, Italy and elsewhere have called for referendums on membership. Such parties typically favour trade barriers and limits on immigration, and are gaining in popularity.
The euro area’s economy has been faring better in recent years, but the single currency remains fragile. The kind of cross-border risk-sharing needed to put the euro on a sound footing is at odds with the rising tides of nationalism and populism. An immediate hurdle is Italy’s referendum on constitutional reform on December 4th. A defeat would weaken Matteo Renzi, the reformist prime minister, and embolden the populist Five Star Movement, which favours ditching the euro. Around 14% of the euro area’s goods exports go to America, quite a bit less than China’s 18%. But America accounts for about 40% of the currency zone’s recent export growth, according to economists at HSBC, a bank. So American protectionism is arguably a bigger threat to Europe than to China.
The whole world has much to fear from Mr Trump’s threats to tear up trade agreements and impose punitive tariffs on imports. And even if he refrains from starting a trade war, the loose-tongued, fact-lite style he cultivated during the campaign could wreak serious damage when he is president. His hyperbolic threats now carry the weight of the American presidency. His victory was enough to chill some financial markets; what he might do with it could spark full-scale panic. Even short of that, like the Brexit vote, it marks an alarming step away from a liberal, open economic order towards more isolationism and less prosperity.