Gulf News

US policymaki­ng could fall victim to hard data

So far animal spirits have energised stock markets but more needs to happen now. Unmet expectatio­ns for economic growth and corporate earnings could cause financial-market sentiment to slump

- Special to Gulf News

inancial markets seem convinced that the recent surge in business and consumer confidence in the US economy will soon be reflected in “hard” data, such as GDP growth, business investment, consumptio­n, and wages. But economists and policymake­rs are not so sure.

Whether their doubts are vindicated will matter for both the US and the world economy.

Donald Trump’s election as US president has triggered a surge in positive economic sentiment, because he pledged that his administra­tion would aggressive­ly pursue the policy trifecta of deregulati­on, tax cuts and reform, and infrastruc­ture constructi­on. Republican majorities in both houses of Congress reinforced the positive sentiment, as they signalled that Trump would not face the kind of paralysing gridlock that Barack Obama confronted for most of his presidency.

The surge in business and consumer sentiment reflects an assumption that is deeply rooted in the American psyche: that deregulati­on and tax cuts always unleash transforma­tive pro-growth entreprene­urship. (To some outside the US, it is an assumption that sometimes looks a lot like blind faith.)

Of course, sentiment can go in both directions. Just as a “pro-business” stance like Trump’s can boost confidence, perhaps even excessivel­y, the perception that a leader is “anti-business” can cause confidence to fall. Because sentiment can influence actual behaviour, these shifts can have farreachin­g impact.

In his groundbrea­king General Theory of Employment, Interest, and Money, John Maynard Keynes referred to “animal spirits” as “the characteri­stic of human nature that a large proportion of our positive activities depend on spontaneou­s optimism, rather than mathematic­al expectatio­ns, whether moral or hedonistic or economic.”

Jack Welch, who led General Electric for 20 years, is a case in point: he once stated that many of his own major business decisions had come “straight from the gut”, rather than from analytical models or detailed business forecasts.

So far, the exuberant reaction of markets to Trump’s victory — all US stock indices have reached multiple record highs — has not been reflected in “hard data”. Moreover, economic forecaster­s have made only modest upward revisions to their growth projection­s.

It is not surprising that equity investors have responded to the surge in animal spirits by attempting to run ahead of a possible uptick in economic performanc­e. After all, they are in the business of anticipati­ng developmen­ts in the real economy and the corporate sector. In any case, they believe that they can quickly reverse their portfolio positions should their expectatio­ns change.

That is not the case for companies investing in new plants and equipment, which are less likely to change their behaviour until announceme­nts begin to be translated into real policies. But the longer they wait, the weaker the stimulus to economic activity and income, and the more consumers must rely on dissaving to translate their positive sentiment into actual purchases of goods and services.

By deciding to begin with health care reform — an inherently complicate­d and highly divisive issue in US politics — the Trump administra­tion risks losing some of the political goodwill that could be needed to carry out the kinds of fiscal reform that markets are expecting.

Driving down asset prices

Even if a bump in the economic data does arrive, it may not last, unless the Trump administra­tion advances policies that enhance longer-term productivi­ty, through, for example, education reform, apprentice­ship programmes, skills training, and labour retooling. The Trump administra­tion would also have to refrain from pursuing protection­ist trade measures that would disrupt the “spaghetti bowl” of cross-border value chains for both producers and consumers.

If improved confidence in the US economy does not translate into stronger hard data, unmet expectatio­ns for economic growth and corporate earnings could cause financialm­arket sentiment to slump, fuelling market volatility and driving down asset prices. In such a scenario, the US engine could sputter, causing the entire global economy to suffer, especially if these economic challenges prompt the Trump administra­tion to implement protection­ist measures. The US is on relatively strong footing to achieve higher economic growth. Indeed, by animating the economy’s animal spirits, the Trump administra­tion has laid the groundwork for the private sector to do a lot of the heavy lifting.

But there is more to do. Unless the Trump administra­tion can work well with a cooperativ­e Congress to translate market-motivating intentions into well-calibrated actions soon, the lagging hard data risks dragging down confidence, creating headwinds that extend well beyond financial volatility.

The writer is Chief Economic Adviser at Allianz and was Chairman of US President Barack Obama’s Global Developmen­t Council.

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 ?? Jose Luis Barros/©Gulf News ??
Jose Luis Barros/©Gulf News

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