Hope for the best but prepare for the worst is a good motto in economics, as in much of life. It comes readily to mind when I think of what Donald Trump will do to the world economy.
If we’re lucky, the financial markets will take a Trump victory more or less in their stride. The dollar, as has been indicated for these many past weeks, will take a tumble, but otherwise the world will, hopefully, wait to find out precisely what Trump has planned. If we’re very lucky, Trumponomics – tax cuts, deregulation and protectionism – will stimulate enterprise, investment and job creation, put trade relations with the rest of the world on a fairer, more sustainable, footing, and, as they say, make America great again.
Things might not turn out like that. Perfectly plausible is that Trump's victory will instead prove the catalyst for the next financial crisis. In truth, that crisis has been in the making for many decades and it will represent the third chapter in the trilogy that has the banking crash and the great recession as its first two episodes: the great dollar crisis of 2017 will be the final reckoning of the long boom and the era of financial irresponsibility.
Trump is now in charge of nuclear weapons and the biggest armed forces in the world. Far more terrifying, though, and surprisingly little discussed, is that President Trump is in charge of economic weapons of mass destruction: the dollar, the world’s only reserve currency; the world’s largest economy (the US is about one third of global GDP), and its largest blocs of debt.
For example, the world’s investors – one third Americans, two thirds foreign – have lent the US government a colossal, unimaginable, sum: the best part of $20 trillion; some $19,809,400,298,300 last time I looked. Stacked as dollar bills it would go to the moon and back. Individuals, companies, pension funds and nations lend the US government such absurd sums because they trust the US Treasury and expect to get paid back. There is some doubt Trump will be able or willing to do so. Imagine, if you dare, what that might to do to an already overstretched Chinese commercial banking system (China holds $1.3 trillion of these US government bonds).
The most dangerous idea he has put forward as a way to deal with America’s debt is to buy it back at a discount. Some have interpreted that as an offer to pay back 85 cents in the dollar on outstanding debt, but the precise “haircut” is anyone’s guess – itself quite a cause of uncertainty. What is certain is that it would represent – in effect – the first modern default by the federal government on its debt, with, as a direct consequence, a spiralling devaluation of the world’s sole reserve currency.
To be fair, we’ve not heard much about the Trump Plan to deal with the national debt since the summer, but, if Trump takes a “businessman’s approach” to the US debt, something like that may well re-emerge in coming months. Even if he scrapped that plan, the chances are his tax-cutting would make the government deficit and the trade deficits even bigger. He would spin America into levels of indebtedness that would prove unsustainable even in a world that wished devoutly to believe in America’s essential goodness and strength. Not all wish to: think for a moment of powers such as Russia and some in the Middle East who might be tempted to start playing games with a tottering dollar.
In any case, running away from her debts won’t make America great again. It’ll turn her into the new Greece, and confirm once and for all that the modern American economy really was just the biggest Ponzi scheme in history; a confidence trick on the entire world where the last suckers in, lose their shirts. Which is really the point. For Trump wouldn’t be anything to fear if America were not so indebted (and he can hardly be blamed for that).
The fact remains, though, that America is vulnerable because neither the US nor her economic partners have sorted out the “global imbalances”, as the economists call them. Instead, for the past two decades, the US and China, and before that Japan, have indulged in an unsustainable game whereby the Americans run up huge trade deficits and the Chinese lend them the cash to keep it going. However, the mountain of dollars now held in China is so large that it cannot in reality be spent, or even managed. If they, the Chinese and Japanese, wanted to dump anything like a substantial proportion of their $2.5trn in US Treasury bonds, they would shred their wealth, their trade with the US and the wider world economy with it. The dollar in 2016, like the big Wall Street investment banks in 2009, is in that sense too big to fail. Trouble is, that didn’t prevent the banks failing, and only America saved the world from collapse.
This time, though, who will save America? The world will have lost its last lender of last resort.
If you’re a lord of finance, then, you know what to do about a Trump's victory: “short” the dollar so you at least make some money when it falls. For the rest of us, let’s just hope for the best from The Donald, eh?
Following his win, it is likely that the dollar will drop like a stone, and everyone will be poorer. Because everyone in the world, directly or indirectly, has some dollars in their pocket, their purse, their pension fund, their bank account or in their government's reserves. Everyone in the world also has an interest in the world’s largest economy being healthy and strong. It is a little surprising that more is not made of this risk. It may not be that substantial in reality, and currencies of course bounce around all the time. Yet there is some risk that things could quite easily run out of control. If so, the consequences would be truly catastrophic, for America and for the world. Yes, Donald Trump could prove the catalyst for a world economic cataclysm, one that would make the financial crisis feel like an aperitif for the main event.
From what we know about the signs are not promising. Let’s take the foreigners. The Trump effect will be truly global. A fall in the value of the dollar will affect anyone whose pension fund is invested in United States Treasury bills and bonds; anyone whose government has stored much of its national wealth in dollar assets. Pretty much anyone on the planet, in other words. Two thirds, indeed, of the US national debt is owned by foreign entities of one sort or another, with the Japanese and Chinese owning very substantial chunks of it (over a thousand billion dollars’ worth a piece), but virtually every bank, investment fund and government in the world is invested in securities issued by the US government and its agencies. Thus, if you are the lucky person in charge of the Chinese state’s holdings of US Treasury paper, you do not want to have to tell the stony-faces in the Chinese politburo why you’ve lost so much of China’s wealth, just because you sat on your hands while all around you investors were dumping their dollar assets.
Some commentators regard America’ astronomical debts as a matter of national shame or intrinsic danger. Not quite, because if the rest of the world is prepared to keep buying the IoUs the US treasury produces, then everyone is happy. Foreign banks and investors get to win dollar assets, backed by the biggest economy in the world; the Americans get to borrow to invest and, well to be honest, live a little beyond their means. In particular, the People’s Republic of China, with whom Donald Trump has an equivocal relationship, has a nice stash of about $1.3 trillion of US Treasury bonds and bills, its nest egg for a rainy day.
Ironically, richer Americans with lots of such assets won’t feel the loss so acutely, because, as we found with the effects of a weak pound on the London stock exchange, companies who earn lots abroad, but report their earnings and pay dividends in dollars, will face far more damage to their financial position on the personal “balance sheets” than any putative Trump tax cut might deliver for their incomes.
But shed few tears for them.
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