Analysis

Bracing for the Big Trump Recession

It is pretty much a foregone conclusion that next year would be a lousy one, and that's without considering Trump's policies.

In this Dec. 6, 2016, photo, President-elect Donald Trump speaks to supporters during a rally in Fayetteville, N.C.
Gerry Broome, AP

The American economy clearly slowed in the last year. The industrial sector, especially capital-intesnsive sectors, is already in recession, and other leading sectors of the American economy are demonstrating real strain.

The car industry has suffered throughout 2016 from record inventory levels, combined with stagnating sales. After a protracted period of incline, used car prices are declining anew. New housing sales are down and mortgage lending is slowing fast. Prime real estate markets like New York, Miami, Chicago and the San Francisco area are seeing prices plunge and foreclosures rise.

Retail sales are approaching recession levels. Businesses related to transport and catering are especially hurting. In fact, many of the six drivers of a growth economy are either grinding to a halt or retreating.

There have been signs ostensibly indicative of recovery in recent months – an increase in exports and in inventories – but neither stem from sustainable elements. A more stable indicator is the stark decline in domestic consumption.

Exporters are a point of light but there are towering obstacles to true recovery, one being the weakness of the global economy, another, the strong dollar, and a third, the inevitable decline of competitiveness.

Accommodative monetary policy around the world is winding down, because of its high cost and side effects, which is weighing on the global economy. The process is gaining momentum and causing damage to the global economy. Against the Asian currencies, including the Chinese yuan, the dollar has returned to heights last seen in 2009. It has also appreciated against the Canadian dollar, the Mexican peso, and the currencies of Europe and South America – all of which spells trouble for American exports, an increase in imports, and deflationary pressures on America.

Long-term interest rates have already risen by almost 1% in recent months and the Fed has just begun the process of raising interest rates. As it does, borrowers – mortgage, student loans, whatever - will hurt. Yields on U.S. government bonds (10-year treasuries) have already risen to 2.4%, which will weigh on equities, particularly dividend stocks; it will render mergers and acquisitions, and stock buybacks, costlier to effect - and those are the three main elements supporting American shares in recent years.

This trend has been exacerbated by people withdrawing from shares, and by government investment funds and oil producers spending less on shares, too. Oil prices are likely to stay steady, or won’t rise much in the foreseeable future. The accrued influence – mainly negative – of the decrease in energy prices will continue to impede the economy and markets.

Lousy year ahead

It is pretty much a foregone conclusion that next year would be a lousy one anyway, economically speaking, and that’s even before factoring in the economic policy presented by Donald Trump in his campaign.

The main points of Trump’s plan are tax cuts for individuals and companies, a huge boost to investment in infrastructure, a significant change in international trading agreements and possibly an American retreat from them, imposing tariffs on imports and giving a lift to corporate profits through a one-time tax cut (maybe 10%).

The implications for the markets and economy are clear.

1. Long-term interest rates will continue to rise. The present level (10-year treasuries are at about 2.5%) is already hurting the economy, which had become addicted to lower levels.

2. The appreciation of the dollar has serious implications for imports and exports. In dollar terms, the U.S. is the biggest exporter in the world – about $2 trillion a year. It is commensurately vulnerable. Politically and economically, clearly imposing tariffs on imports will spur reactions in other countries, inevitably causing prices to rise and hurting household income. Imports can be supplanted by domestic production but these are long-term processes, and we haven’t even touched on the damage caused by systems that depend on imports from the United States.

3. Corporate tax cut: It is unthinkable for a weakening economy to invest more just because companies get tax breaks. It makes more sense to assume that the corporate bonds bubble of recent years, which served mainly to buy back shares and effect mergers and acquisitions, will serve to improve cash flow and repay debt. Regarding household tax cuts, it will take a very long time for enough money to accrue to affect middle-class consumption.

4. Constraints on immigration and working visas will also impact growth at a very time that U.S. growth per capita is low. That will mainly hurt retail sales, building starts and housing prices.

The startling news that Trump had won sent the business and financial community into euphoria, with some even comparing him with Ronald Reagan. The comparison is wrong, and misleading.

Reagan entered the White House in 1981. The U.S. at the time was mired in recession. Inflation was high, albeit trending down. Interest rates, real and nominal, were at record heights. The American national debt was negligible in the early 1980s, today it exceeds 100% of GDP. The dollar was strong but began to decline, which spurred exports.

Today, year-end 2016, the dollar is strong and Trump is likely to strengthen it further, hurting American exports. The deflationary process is nearing its end, interest rates are rising and the debt burden, government and household, is onerous.

In Reagan’s time, the threat posed by Russia enabled the U.S. to dictate policy to the G7, including on financial matters, such as joint intervention in the currency markets, and regarding monetary and budget policies. When the U.S. wanted to stop the dollar from appreciating, it had economic and diplomatic tools to make it so.

Post-Brexit and with the euro bloc under terrific pressure, that isn’t true any more.

People look back at the Reagan era fondly because the recession ended because of the aggressive monetary expansion, centered on a sharp rate cut (from levels of over 20%), which sent stocks climbing 300% from their low of 800 points.

Then came Black Friday, October 19, 1987, when the Dow Jones tumbled 23 percent in a day and 40 percent over three weeks. But Washington had the political and diplomatic tools to cope. Stabilitization, at some cost to the G7 but with their consent, was achievable, and was achieved. The ensuing collapse of the Soviet Union and the high-tech revolution helped the U.S. and the rest of the world recover as well.

Today the U.S. does not have such tools. It took six years for stocks to crash in the Reagan era. If Donald Trump sticks to the policies he listed in his campaign, it won’t take that long. And his social domestic and policies, as stated, are unlikely to help.