by Hubert Marleau, Market Economist, Palos Management
State Capitalism
In a truly remarkable comeback and an estimated $16 billion dumped into the electoral process, Trump and his allies totally won the election, gaining ground in almost every demographic category, including a significant chunk of young Americans, Muslims and black men. The only 2 exceptions were people over 65 and white college women. He did not waste time on social crusading; on the contrary, he connected with the basic instincts of the working class, winning all 7 of the so-called swing states, while his party gained control of Congress as well: a rare opportunity to install policies he cares about, with no ifs or buts.
A Republican regime will likely promote supply side economic policies, such as dialling back Biden's antitrust policies, lowering individual and corporate taxes, and reducing regulations. There is no doubt that investors love these incentives, and they seem to be coming at the right time. The big reason for the outstanding subsequent performance of the stock market was the lack of legal issues, public demonstrations and political disputes about who had ultimately won. Put simply, a big uncertainty was eliminated, meaning the transition of power looks normal. As a result, the VIX - the classic gauge of fear - plunged on Wednesday.
Powell, meanwhile, remains dovish: “We don’t guess, we don't speculate and we don't assume.” Productivity is the secret sauce: the magic elixir that allows him to follow the course toward a more neutral stance over time that he set for himself last September. Q3 nonfarm labour productivity rose at a brisk 2.2% annual rate, keeping the increase in unit labour cost below 2.0%. In this regard, the Fed decided to cut interest rates on Thursday by another 25bps to 4.625%, on the basis that inflation was receding and that the policy rate remained high enough to dampen economic activity. Powell may be right in his assessment: the policy rate is still 50 bps higher than the mystical neutral rate, which I clock at 4.125%. It’s getting close, and he’s therefore in no rush to push the envelope too fast.
In the end, the combination of 2 institutional guardrails - Biden's promise of a smooth transition and Powell's avoidance of political entanglements - released anxiety, which helped to drive the S&P 500 to a new all-time of 5996 without much retail involvement. By the end of the week it was up 267 points for a weekly gain of 4.7 %.
The Advent of Isolation
While the aforementioned points are pretty much in the bag, Trump’s proposed mass deportation of 11 million illegal immigrants is far from an accomplishable solution. It would be an administrative nightmare - detention centres, control agents, courts, disruption of families, civil conflict, etc. For the most part, such immigrants work in health care, agriculture and construction - the very jobs that Americans do not want to do themselves. Businesses are not in favour of this approach.
The one thing that I’m the most concerned with is the imposition of tariffs in an indiscriminate manner, as President Trump can do right off the bat without Congressional approval. This course of action could upset the comparative advantage that free trade brings, but it may not lead to the inflation expectations that the bond vigilantes adhere to. In this regard, the American experience with tariffs has been mixed. Most of the time, they have resulted in dislocations that have led to dire domestic consequences for both the economy and the stock market, but on a few occasions they were associated with prosperity. President-electTrump has proposed a 10% tariff on all goods and services entering the US as well as 60% on China’s. Whether this anticipated move is going to be good or bad no one knows for sure. It is a complex issue because it is hard to figure out what is the real cause of the chronic trade deficit.
Here is my quick take on this perplexing phenomenon. The United States has a large trade deficit because it spends more on imports than it earns from exports. The question is why. There are 2 theoretical explanations. It could be because Americans earned more income than the national economy can actually produce in the form of goods and services or because foreign capital is pouring into the country in amounts that exceed considerably domestic investment needs.
If the first thesis is correct, then the idea of tariffs to protect domestic industry and to lure foreign direct investments make some sense. Advocates of this idea believe that such a policy would raise domestic output to meet domestic demand. Unfortunately, this thesis appears weak, although not entirely impossible. The fact that personal savings are generally always positive and that inventory levels tend to rise more often than they fall weakens the proposition. Nonetheless, some pundits are willing to take the gamble on the grounds that the US would likely benefit more or be bruised less than the rest of the world would, even under massive retaliation, trusting that the U.S. is more insulated and has lower tariff rates than most countries. The latter point is not the reality. On a trade-weighted basis, the WSJ reported that the U.K., Canada, and Europe all imposed lower taxes on American manufactured goods than the U.S. imposes on comparable imports.
The second thesis makes more sense to me. It is based on the observation that America attracts an exorbitant amount of foreign capital beyond its domestic needs because its markets for debt, private equity and stocks are liquid, deep and diversified. Put simply, the excess capital is spent on services and goods, some of which is in the form of imports. Thus I fail to see how tariffs would correct the trade deficit, given the fact that the U.S. market for securities is an implicit part of the world’s financial contract.
In my humble estimation, the idea of tariffs has appeal, if - and only if -it’s strictly based on trade-rules reciprocity. Squaring this circle through equal tariffs for all is something that the whole world, including the U.S., should aspire to. Zero trade restrictions with allies is the economically optimal arrangement.
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