Thursday, 27 December 2018

Review of 2018 Predictions - Part 2

“Trump Sends the US Into The Twin Deficits Crisis 2.0” 

Well, not quite yet. But, Trump's tax cuts for the rich have seen US interest rates rise, to cover the additional borrowing, and whilst those tax cuts for the rich initially fuelled additional speculation in financial assets, the rising interest rates have caused bond, share and property prices to fall. Of course, Trump being Trump, he does not blame his own policies, including the inflationary effects of his own global trade war, for those higher interest rates, and falls in asset prices, but has focussed his attacks on J. Powell, the Chairman of the Federal Reserve, who Trump appointed to the job. 

US Bond prices have continued to fall throughout the year, sending bond yields higher. Necessarily, that has also led to share prices falling, and higher interest rates have also impacted the US property market. Share prices fell sharply at the start of the year, and then slowly climbed higher, but have since been falling steadily again, with some large points falls, on individual days. The financial markets are now generally lower than they started the year. The only salvation for them, towards the end of the year, has been that as stock markets sold off, they were used to pressure the Federal Reserve, with Trump's help, to moderate its language about future rises in its official rates. That has caused shorter term rates to rise relative to the longer-term rates – known as curve flattening. That in turn has been used to warn that a recession may be ahead, and that to avoid it, the Federal Reserve should hold back on any further rate hikes. But, the curve flattening is only a necessary consequence of QE, and the fact that the Federal Reserve holds vast amounts of longer dated bonds itself. Were that not the case, these longer dated bonds would also have sold off, causing the yields on them to rise, and so causing yield spreads to widen. 

A major reason for Trump's tax cuts not resulting in a Twin Deficits Crisis, just yet, is that he has not yet embarked on the large-scale infrastructure spending he promised, and which the US economy requires in order to raise its efficiency. A second reason is that Trump has also embarked on his global trade war, which has reduced US imports, and encouraged import substitution. A third reason is that this is not the 1980's.  Despite Trump's trade war, the US trade deficit has continued to widen, as during the 1980's, it continues to suck in imports.  And, under Trump, the budget deficit has grown from 2.4% of GDP under Obama, to 3.5% under Trump.

The US will have to undertake large-scale infrastructure spending, and as the US working-class strengthens, spending in other areas to raise the social wage. As the spending rises, the US state will have to borrow more, and that will put significant pressure on the budget deficit, with Trump already in conflict with Congress over the budget, leading to a partial government shutdown. Trump's global trade war has reduced global growth, by restricting trade. As a result, the US trade deficit has not risen as much as it would have done. But, at the same time, the imposition of 25% tariffs on a range of US imports has both caused an inflationary impact on prices, and a lower level of US growth than would otherwise have occurred. 

A larger US trade deficit would have caused the Dollar to fall, further pushing up US import costs, and inflation, with a consequent effect on US interest rates. But, the US has not escaped that by introducing a wide range of tariffs. It simply sees the effect via a different channel. The tariffs directly raise US prices, and thereby inflation, and interest rates. In the 1980's, a period of long-wave stagnation, Reagan's Voodoo Economics caused the budget deficit to spiral, because it did not lead to sufficiently rapid growth to create the tax revenues to compensate. But, today, we are in a period of long-wave uptrend. That uptrend has been deliberately subdued for the last ten years, in order to hold back pressure on interest rates, so as to reflate asset prices, and try to avoid another financial crash. But, despite that, growth has continued to rise, employment has continued to rise, and it is again now beginning to cause wages, and interest rates to rise. So, the US has been able to increase its tax revenues from this higher level of growth, not because of Trump's tax cuts, but despite them. 

In the 1980's, tariffs would simply have caused economic growth to falter, but, today, in a climate of global upswing, although they reduce growth, and do so noticeably in the short-term, as global trade is restricted, and is being seen in global growth figures, they tend instead to simply redirect the growth into import substitution. China, faced with restrictions on its exports, to the US, due to the imposition of tariffs, will be incentivised to more quickly develop its own domestic market, as the destination for its production; the US, will engage in import substitution, producing goods formerly imported from China itself, just as it has developed shale oil and gas production, to substitute for its imports of foreign oil and gas. If Brexit occurs, and the EU then imposes tariffs on UK exports, it will simply lead to the EU producing those commodities itself, rather than importing them from the UK, probably with UK based production shifting to the EU, and that applies to things such as financial services and other service industries too. The UK, will be unable to follow that pattern, because unlike the US, China, or the EU, it is simply too small to follow that model. 

We are, therefore, seeing a short-term reduction in global growth, in addition to that caused by the usual three-year cycle, as a result of Trump's global trade war, and Brexit etc. Longer term growth will be lower than it otherwise would have been, as a result of these restrictions on trade, but in the medium term, the consequence of the long-wave uptrend will be that trade restrictions will lead to import substitution, and a shift in global production and trade, so that growth will continue to rise. The consequence of that will be that productivity will be lower than it would have been causing prices to rise faster, putting further pressure on interest rates, which in turn presses down on asset prices. 

My assessment of this prediction, therefore, is that it has simply been deferred.

Back To Prediction 1

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