No one is quite certain what will happen when Donald Trump takes over as U.S. President on Jan. 20. So far, stock market investors have convinced themselves that the overall thrust of his administration will be positive for business.
This initial response is premature and may be dead wrong. Investors appear to have assumed that the President-elect will implement all the business-friendly policies he favours (e.g. lower taxes, less regulation, more infrastructure spending) and none of the negative positions he outlined (e.g. trade wars).
That strikes me as an overly rose-coloured view of where the new regime is likely to take the country. But at this point we have very little to go on in trying to discern what lies ahead, beyond reanalyzing campaign rhetoric. So it is impossible to predict exactly where Mr. Trump will take the U.S., and the global economy, when he takes office. But we can identify some of the major issues we should watch closely in the coming months for indications of how the next four years will unfold. Here are five of them.
China. The President-elect blasted China on many occasions during the campaign as being a currency manipulator, to the detriment of U.S. trade. Accordingly, he must be aware of the sharp decline in the value of the yuan this month, dragging the currency to its lowest level against the U.S. dollar since December 2008.
Economists believe the decline was triggered by the rise in the U.S. dollar that followed the election, pointing out that yuan has remained stable against the Japanese yen and the euro. Internal problems within China have also been blamed for the currency's fall.
But if Mr. Trump wants to trigger a trade war with China, he may seize on the yuan's retreat to escalate his manipulation accusations and ask Congress to approve the introduction of tough new tariffs against that country. The result could be a disruptive trade war that would likely inflict harm on both countries.
Dodd-Frank. The Dodd-Frank Act of 2010 was designed to rein in what Washington saw as the greedy excesses of Wall Street that resulted in the sub-prime mortgage crash and the Great Recession of 2008. The Act, which The Wall Street Journal has called "the most restrictive financial legislation since the New Deal", imposed sweeping new regulations on banks and other financial companies, brought in more stringent capital requirements, and created a top-level Financial Stability Oversight Council to promote market discipline and identify major risks to the U.S. economy.
Since its passage, opponents have blamed it for stifling new business growth, discouraging bank lending, and smothering new initiatives under piles of red tape. Proponents say the strict measures were necessary to prevent the U.S. from repeating the blungers that led to the 2008 crash.
As a candidate, Donald Trump was highly critical of Dodd-Frank, although he didn't provide much detail about how to fix it. A repeal of the bill, or a significant loosening of its restrictions, would be seen as a huge plus by Wall Street and have a positive effect on the markets. The downside is that going forward, any relaxation of the rules could lead to a new round of excesses that could end badly.
The Federal Reserve Board. Donald Trump made it clear on several occasions during the campaign that he has no use for the Federal Reserve Board and that he is not happy with chair Janet Yellen. On at least one occasion in September, he accused the Fed of keeping interest rates artificially low to support the Obama administration and, by extension, the campaign of Hillary Clinton.
Ms. Yellen fired back that politics are never a consideration when policy decisions are made but some people saw Mr. Trump's accusations as undermining the Fed's independent authority. If he continues to take this position while in office, it could set up a major crisis in Washington that could lead to Ms. Yellen's resignation before her term as chair is up in 2018. Central banks (which the Fed is) have traditionally operated independently of government interference. If Mr. Trump tries to change that, all hell will break loose.
Tax cuts. Mr. Trump has proposed massive tax cuts for both business and individuals. Everyone taxpayer in the U.S. would benefit if the plan is enacted. Businesses would see their federal tax rate drop from 35 per cent at present to 15 per cent (the same rate as Canada). Individuals would have their marginal rates cut across the board. The Washington D.C.-based Tax Policy Center (TPC) estimates the average saving would be $5,100 but points out that high-income people would enjoy the greatest benefits.
The thrust of the plan is to stimulate business and spending activity, boosting economic growth in the process. The problem, says the TPC, is the cost. It estimates the plan would reduce U.S. federal government revenue by $9.5-trillion over the first 10 years and another $15-trillion over the next decade. The U.S. is already running a huge deficit, projected to be $587-billion this year. The TPC says that without massive spending cuts, the Trump tax plan could increase the national debt by nearly 80 per cent of GDP by 2036.
Many Republican legislators support the idea of tax cuts, but there is a faction that wants a return to a balanced budget. They are likely to fight tooth and nail against a plan that would swell the deficit dramatically, push interest rates much higher, and bring back inflation to levels not seen since the 1980s.
NAFTA. The Trudeau government has moved quickly to reduce public anxiety over Mr. Trump's threat to "tear up NAFTA", saying it is open to negotiating a few tweaks in the plan to bring it up to date. But Mr. Trump will need more than a few tweaks as far as Mexico is concerned to appease his base. A big part of his campaign message was a pledge to bring back jobs to middle America that he says were lost to Mexico and China. That's probably impossible – a lot of those jobs went to states in the low-wage, anti-union South or were lost to automation. But the incoming President will need to put on a strong show and end up with some gains he can boast about to his supporters. The NAFTA talks will not be easy and the result could be harmful to Canada.
How these issues unfold will have a significant impact on stock markets, interest rates, bond yields, and economic growth. I'll be keeping a close watch on all of them in the coming months.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.