The other strike on November 8th
Trade protectionism, criticism of the Fed and the utter disdain for regulation — Donald Trump's views are a cause for anxiety
Apologies if I disappoint you! This column is neither about the many virtues nor the myriad perils of demonetisation. Instead, I am writing on another event on November 8 that could arguably change the world forever. On that day, as Prime Minister Modi announced his decision to demonetise ~500 and ~1,000 notes, Americans voted in Donald Trump as the 45th President of the United States. If he delivers on even half of the things that he promised on the campaign trail, it could change the way the global economy has functioned and jettisoned a number of goals that policymakers have strived for over at least the last three decades.
Let me focus on the economic consequences of Trumpism although my fear that its social ramifications (not just in the US but in places such as Europe, where his victory has given the hard right wing a fillip) are possibly more alarming. Let me start with his pet project —“Making America Great Again” by effectively impeding the flow of cheaper goods and services into America.
To be fair to Mr Trump, the need for an industrial policy in the US — that is to build or rebuild industries through active government intervention — has gained support in the policy community over the last couple of decades. But, using tariff protection to boost domestic industry is the oldest and least efficient trick in the book and the USA’s experience of using import duties to block trade has been far encouraging. The infamous Smoot-Hawley tariffs of the 1930s, for instance, have been blamed by many economists for intensifying the “Great Depression”. The US steel industry, to take a more recent example, enjoyed considerable protection in the early seventies but failed to restructure itself to become globally competitive. Besides, protection is not a one way street. While economies such as Mexico that would bear the brunt of Mr Trump’s ire might not be in a position to retaliate successfully, the big “trade war” that could rock the global economy would be between the US and China. The USChina trade relation is highly asymmetric — last year the US imported three times as much from China as it exported to it. Thus, China depends far more on the US demand than the other way around. While this seems to suggest that China will be the loser in a trade war, a large hike in tariffs on imports on key imports from China such as mobile phones, laptops and tablets and network equipment would lead to a sharp rise in inflation in the US since there are really no viable domestic or import alternatives for these things. Mr Trump should also not forget the fact that the US companies have large production facilities in China that they cannot relocate immediately. The Chinese government could make things very difficult for them.
Finally, China still holds about $1.22 trillion of the US government debt. It has been selling this debt steadily and could ramp up the pace as a retaliatory move and push US yields up. The bottom line is that a trade war between the two global superpowers could make the world a more dangerous place. Spooked investors could pull capital out of China and mounting depreciation pressure on the Chinese currency could rock both emerging and developed world.
Another key change that a Trump presidency could bring would be in the way the US central bank, the Fed, functions. Remember this is not just an academic question best left to technical economists. Since the Great Financial Crisis of 2008, economies and financial markets have been kept alive by a monetary life-line and the Fed has been pivotal in this process.
Mr Trump in his public appearances has not wasted any opportunity to criticise the Fed, even calling for an “audit” of the central bank (I am not sure what that entails). If one were to read between Mr Trump’s lines, he seems to reflect what one could perhaps term the Republican view that the Fed has used too much “discretion” in policymaking and should go by rules instead. Going by the textbook, most of these rules would call for much higher interest rates that currently prevail. The current consensus in financial markets and among policymakers has been that while the US should hike rates in response to the tepid recovery, the pace of increase should be gentle.
Mr Trump could, in one stroke, do two things. He could challenge the independence of the world’s most powerful central bank. There are fears that he may replace Fed boss Janet Yellen before her term gets over. He could also send interest rate zooming in the US and lift the entire world to a high interest rate platform since the US monetary policy will have a ripple effect on all economies. These could together set the stage for a meltdown in financial markets (except perhaps the US stock-market) and trigger yet another global recession.
Mr Trump’s somewhat crude economic blueprint seeks to counter this contraction by massive debt-financed government spending and tax breaks. What he seems to forget is that he can raise more debt only at higher interest rates. Thus, what he tries to gain by way of a stimulus would be undone by private business investments being crowded out.
Finally, the President-elect’s utter disdain for the idea of regulation should be a legitimate cause for anxiety. This extends to financial regulation and he has pledged to repeal the Dodd-Frank Act, a tedious but carefully crafted piece of legislation to prevent excessive risk-taking and the use of dodgy financial instruments by major financial institutions. Wall Street, with its obsession for short-run gains and its disregard for long-term consequences, might cheer this but financial stability could be the biggest casualty. Greed might get the better of fear in the near term but reckless unregulated risk-taking could soon get its comeuppance.
There are two things that you can do at this stage. First, cross your fingers and hope that the new president will tone down his campaign rhetoric when it comes to making actual policy. Second, batten down the hatches, clean your storm shelters and brace for a long, vicious economic storm.