Despite a presidential campaign in which Donald Trump blasted his opponent for ties to Wall Street, financial markets seem pretty giddy about the incoming Trump administration. And in the short term, they’re not wrong for feeling that way.
The prospect of far-reaching financial deregulation seems at play. President-elect Trump’s tax plan would slash rates for those working on Wall Street. His proposed infrastructure plan, although somewhat dodgy in the details, seems like an additional Keynesian fiscal stimulus (along with any increase in defense spending). And it appears that Trump will be sprinkling his administration with plenty of Goldman Sachs alums.
As Politico’s Ben White concludes, “Christmas has arrived early for Wall Street in the early days of the Donald Trump era.” No wonder the stock market and the dollar have surged in value over the past week.
Far be it from me to throw water on any of this, but if Wall Street’s expectations do indeed come to pass, there’s a scenario that has been playing out in my head that I want to share with you. I’m a little worried that by 2018, we will see Trump announce the imposition of mass protectionism. Eventually, he would impose capital controls on the American economy — i.e., impose barriers on the movement of money in and out of the United States.
Let me stress that this is not a prediction — 2016 has taught me the folly of doing that. This is a low-probability scenario. Of course, a year ago, both Brexit and a President-elect Trump were low-probability scenarios, so maybe we should think about these contingencies more often. Hear me out:
As I noted last month, the very existence of a protectionist Trump in office will cause the dollar to appreciate against the currencies of trading partners he bashed, such as the Mexican peso. After a few months, that probably will worsen the trade deficit. So that’s not good for a president who has claimed that the trade deficit ails the American economy.
The other thing that is likely to happen over the next year — if Wall Street is correct — is that interest rates are going to go up. Indeed, Federal Reserve Chair Janet L. Yellen hinted as much the very second I was typing this sentence.
The reasons for this are pretty clear. You may not have guessed from the campaign rhetoric, but the U.S. economy has had a pretty good run as of late. Growth has ticked up, the unemployment rate is below 5 percent, and real wages and incomes are starting to rise at a rapid clip. If the Trump administration implements its planned tax cuts and fiscal expenditures, the pump will be primed even more.
Inflation hawks already want to raise rates to ward off inflation. One look at Trump’s plans will cause them to redouble their efforts, and Yellen might come around to their way of thinking.
If you combine an expansionary fiscal policy with a contractionary monetary policy, two things will shoot up dramatically: interest rates and the value of the dollar. Capital will rush into the United States because of higher interest rates. And a surging dollar will significantly worsen the trade deficit, particularly as any fiscal stimulus works its way through the U.S. economy.
Now this has happened before: see the first terms of George W. Bush and Ronald Reagan. Whopping trade deficits combined with lackluster economic growth increase protectionist pressures on the president. Bush and Reagan responded with myriad forms of ticky-tack protectionism without doing anything sweeping. Eventually both presidents engaged in efforts to try to coordinate a weakening of the dollar.
Trump is going to be a different president. He really believes in a global zero-sum economy. He will no doubt impose ticky-tack protectionism and then some when he is sworn into office. The dirty secret of protectionism, however, is that most forms of it won’t affect the trade deficit. That’s mostly a function of macroeconomic factors like domestic demand for goods, foreign demand for goods and services, and interest rates. And I’m extremely dubious of Trump’s ability to get other countries to agree to moves that would ease upward pressure on the dollar.
My concern is that there is going to come a moment when Trump’s voters will be demanding that he bring jobs back to the industrial heartland even though those jobs are gone for good. And faced with those political pressures, Trump would simply decide to impose more radical measures to lower the trade deficit and stop capital from rushing into the United States. The result would faintly echo what Richard Nixon did in 1971 when he ended the Bretton Woods system.
Will this actually happen? I have my doubts. Trump’s fiscal plans might not come to fruition. Yellen might resign and be replaced with a more pliant, Trump-friendly acolyte. Markets might correct if they think that Trump is not ready for prime time. And if I can envision this scenario, so can investors; maybe they’ll be reluctant to invest too heavily in the United States.
If this happens, however, then Wall Street is going to look back at the past week and feel very, very foolish.