How will the world economy react to Trumponomics?

You can see the scale of this shift gradually dawning on the financial markets this week. To take one particular measure of the expected rise in interest rates, the yield on ten-year US Treasury securities rose from just over 1.8 per cent on Monday to nearly 2.2 per cent on Friday

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The Independent Online

Three days into the Trump election victory it is becoming clear that this is not just a seismic political shock. It is also an economic shock of equal magnitude. It signals the end of ultra-loose monetary policy but offset by looser fiscal policy. The ruling orthodoxy that has swept right across the developed world since 2009, that governments should cut their budget deficits and instead rely on cheap money to boost the economy, is in its turn being swept away.

That will happen in America and it will happen in the UK. That will put pressure on Europe. But quite what the various EU governments and European Central Bank will do in response is quite unknowable.

You can see the scale of this shift gradually dawning on the financial markets this week. To take one particular measure of the expected rise in interest rates, the yield on ten-year US Treasury securities rose from just over 1.8 per cent on Monday to nearly 2.2 per cent on Friday. Other bonds moved in much the same way. The price of bonds, which moves inversely to the yield, fell across the world, with Bloomberg calculating that $1,000bn of value was lost.

Of course it is true that interest rates, both short-term and long-term, remain extremely low by all historical standards. It is true, too, that this is just an immediate reaction and like all such reactions, it may be reversed. But it does not feel like that. The US Federal Reserve will almost certainly increase rates next month – we have just had another hint it would do so from its vice-chair, Stanley Fischer. And we here in the UK have been told by Mark Carney that the guidance that the next movement in UK rates would be down no longer holds. The outlook is now neutral.

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Our own stronger than expected growth post-Brexit, coupled with the inflationary impact of the fall in the pound, explains the shift here. But it would be consistent with the loosening of fiscal policy that we will be told about in 10 days’ time.

That is the second half of the switch. In the UK any loosening will have to be modest, because we still have a fiscal deficit of between 3 per cent and 4 per cent of GDP. It was 3.9 per cent in the last financial year and is not going to come down as fast as hoped this year. In the US however, the scope for easing policy is rather greater. It too has a deficit, 3.2 per cent of GDP last year, but has much greater freedom to borrow from abroad, witness the strong dollar through this year.

How much of a switch will the US make? Well, all we have to go on are campaign statements by Donald Trump and Congressional plans by Republican senators and representatives. There will be personal tax cuts, for that is something on which the new President and a Republican-dominated Congress will find easy to agree. The top rate of income tax comes down to 33 per cent. But quite how they will reach agreement on other changes, particularly in corporation tax, is less clear.

The US has a very high nominal rate of corporation tax, 35 per cent, but companies that earn money aboard can keep the funds offshore, only paying tax if they repatriate them. Unsurprisingly that is what large companies do, hence the “double Irish”, the balances stashed away on Caribbean islands, and all the other devices US companies have, quite legally, used to reduce their tax bill.

There is an obvious deal. It would be to cut the headline rate of company tax, maybe to the 15 per cent level proposed by Donald Trump, have fewer loopholes, and offer an amnesty of an even lower rate on foreign balances if companies bring back the money. Everyone, except the tax havens, would benefit. But it needs agreement.

Whatever happens, though, it seems pretty clear that there will be a widening budget deficit. The tax cuts may bring faster growth. That is the idea at least. But growth is unlikely to be fast enough to make up the shortfall from lower rates. Add to this the promised extra spending on infrastructure and the deficit would widen further. How much by, we have no idea. Remember that we don’t yet have a Treasury secretary, or indeed any other cabinet appointments. But we can be very sure the US will choose to have a more expansionary fiscal policy.

That will put pressure on the rest of the world. The UK is in a bind because it starts from a weaker position but several European governments could, if they wished, have wider deficits. Germany at the moment has a small surplus, for it is obliged to balance its budget by law. So no change there. But France (deficit last year of 3.3 per cent of GDP) and Italy (2.6 per cent) would dearly love to ease the squeeze. There is an irony that the country most able to boost demand won’t do so, while those that would like to do so can’t.

However when a big idea starts to move in the US, other countries do pad along behind. The big idea is the governments can do more to boost growth by fiscal policy, particularly by cutting taxes, and that this is better than trying to do so by ultra-low interest rates. Expect Europe eventually to follow America. 

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