On that fateful night in November when the results of the United States presidential election started to come through, the financial markets reacted violently. The US dollar dropped quickly in Asian markets, while investors placed bets that US share prices would fall sharply in the next trading sessions. The fear was that the Trump presidency would bring big risks to the US economy.
In the meantime, president-elect Donald Trump has not signalled any U-turn in his planned economic policies. But ever since that initial, very brief, sell-off of all things American, investors have taken the exactly opposite view.
In the markets it is called the “Trumpflation” trade. Share prices have surged, fuelled by hopes that he can deliver on his promise to increase US economic growth. And the US dollar has risen on expectations of a rising economic tide, higher inflation and increasing interest rates. The risks – of trade wars, of tariffs, of the impact on the US’s public finances and of the sheer unpredictability of the new president – have been ignored.
Sooner or later this bubble will surely burst. It is impossible to say when this might happen – or what the precise trigger will be. But Trump’s economic policies are risky and in some areas clearly dangerous. By nature, he goes for the dramatic and shocking.
One of the things to watch, in the immediate wake of Friday's inauguration, will be the first moves on trade policy.Yes, Trump will surely move on tax and immigration too,and on plans to increase investment in infrastructure. But in these areas he will have to negotiate much of what he does with Congress. On trade, legal experts believe that using delegated powers which the Congress have given the president and existing US legislation he can move quickly and on his own initiative. If he wants to send a early signal on the economy, there is where it may well come.
Campaign commitments
And remember the campaign commitments. Trump has promised to renegotiate or scrap a number of trade deals. He has threatened to impose punitive tariffs on Mexico and China, effectively meaning their exports to the US would be subject to a special tax as they entered the US market. And he has even said he would consider withdrawing from the World Trade Organisation, the body which oversees world trade. Doing so would threaten to undermine the entire structure underpinning international trade, under a complex web of rules which have developed over more than half a century.
Trump’s approach is not one of incremental change. For example, he said in speeches that he would impose 35 per cent tariffs on imports from Mexico and 45 per cent from China, though presumably only if they didn’t “fall into line” with what he wanted.
As a first step, he has said that on his first day in office he would declare China to have manipulated its currency to boost its exports artificially. Trump has long argued that Beijing is getting an unfair boost selling into the US by keeping its currency weak. Ironically, while China did keep the yuan weak for many years, it is now grappling with the opposite problem – trying to stop it from falling too fast.
Trump would use this tactic of declaring China to have manipulated it currency to try to get it to the negotiating table, perhaps to agree to some restrictions on its exports. Nobody knows how Beijing would react, but few expect it to meekly fall into line. Any hint of building trade tensions between the world’s two biggest economies would hit economic confidence hard.
US recession
If tensions turned into a trade war, the threats would grow.The respected Peterson Institute for International Economics (PIIE) in the US ran the numbers. Together China and Mexico account for a quarter of US trade in goods and services. The PIIE modelled what would happen if Trump went ahead with tariffs at the levels has has threatened. Not unreasonably, it assumed that the two countries retaliated. If both imposed blanket tariffs of the same level on US products, the model predicts a US recession by 2019 and the loss of 4.8 million jobs, or more than 4 per cent of the workforce.
We don’t know that this is exactly how it would work out, of course. Events will take time to unfold. But this illustrates two points. One is that restricting trade has an immediate short-term economic cost. The second is that the cost is widespread, quickly spreading from the companies directly affected and rippling through service industries – the shops, restaurants and so on that depend on local spending power.
Unusually for a president from a Republican, business background, Trump jumped on the bandwagon of blaming free trade – and the wider trend towards globalisation of investment – for the feeling of many that they were getting a raw deal. The irony is that carrying through on his campaign promises on trade would cost jobs, not save them and many would be the middle- to low-income employees who voted in such numbers for the new president.
Maybe the optimists are right. Maybe, after a bit of sabre-rattling,the reality will not match the campaign rhetoric and Trump’s cabinet of billionaires will temper his policies. But you wouldn’t bet on it. Trump has been a consistent critic of the trade policies of countries such as China for years. He has been elected on a ticket of doing something about it. He has appointed people to senior positions – including in trade – who generally agree. He may not do everything that he promised – but if he does half of it this will quickly get rocky.