Trump: What the Market Is Really Saying

The Frankfurt stock exchange the day after the US election, Frankfurt, Germany, November 9, 2016
Kai Pfaffenbach/Reuters
The Frankfurt stock exchange the day after the US election, Frankfurt, Germany, November 9, 2016

There are so many parts, often extreme, in Donald Trump’s proposed economic plans that it is impossible to get an early fix on them. These include raising tariffs on imports sharply, deporting millions of immigrants, deregulating finance, a large-scale return to fossil fuels, repealing much of Obamacare, and tax cuts mostly for the rich that would send budget deficits by some estimates (including Mark Zandi’s) back to 10 percent of the GDP. But these did not stop the stock market from soaring over the two days following the election to new highs, gains it has held and improved since then. Why did this happen?

Election night, all indications were just the opposite. When I looked at a TV screen at about 9 PM, the Dow Jones Industrial Futures, an indication of what will happen when markets reopened the next day, were down 600 points. Pre-election, investment firm after investment firm had been predicting a market slide if the real-estate magnate was elected because the mix of policies would create so much uncertainty. When the polls showed former Secretary of State Hillary Clinton was likely to win, for example, the stock market often rose. 

But Trump’s surprisingly conciliatory acceptance speech, and the cordial ninety-minute meeting between President Obama and the president-elect, temporarily calmed the jitters, and the markets have focused instead on the stimulative aspects of one of the centerpieces of the incoming administration: big tax cuts. And what’s interesting about this is that the market response contradicts much recent economic policy thinking, at least among the mainstream.

The economy had been growing since 2009 but not as strongly as many had hoped. Yet by the election, unemployment had fallen below 5 percent, an indicator claimed by many economists as evidence that we were at last near full employment: the unemployment rate could not drop further without generating inflation as workers asked for higher wages. And according to much recent economic orthodoxy, inflation must be kept below the longstanding target of 2 percent. So there was little room for the US economy to grow much faster.

But now the stock market seems to be saying something very different. The ultra-low interest rate policy of the Federal Reserve cannot alone support growth at the rate needed. Rather, investors apparently have concluded that the economy can grow faster if the deficit grows, even if it leads to higher inflation and interest rates, and even the likelihood of higher rates from the Fed. This is exactly the fiscal medicine many liberals had been advocating.

But let’s be clear. Trump is not a Keynesian. He is taking a page straight out of Reaganomics. When Reagan came to office, he embarked on a huge tax cut. At the same time, finance was given a free hand and business was deregulated aggressively. As Reagan’s advisers argued, lower tax rates and fewer regulations would create more incentives for business to invest and consumers to spend, and therefore the federal budget deficit will not rise significantly as incomes and tax receipts grow. But while GDP grew under Reagan, unions were undermined and the minimum wage, adjusted for inflation, was mostly allowed to sink. Above all, incomes became much more unequal, the beginning of an income gap, that has continued growing, with only a couple of interruptions until recently, and that has specifically hurt the white working class. The top 1 percent now earns 18 percent of all income—double what it did when Reagan entered office.

Like Reagan, Trump says he will undertake large tax cuts for businesses and individuals. According to the Tax Policy Center, these cuts could reduce tax revenues by $7 trillion over the next ten years. Yet he has offered few plans about how he might cut the budget to reduce the flow of red ink. To the contrary, he plans to raise military spending (like Reagan did), embark on a huge infrastructure program, and—encouragingly—promises not to cut Medicare or Social Security. Instead Trump—supported by one of his main economic advisers, Peter Navarro of the University of California at Irvine—is claiming, like Reagan before him, that the tax cuts will produce a huge pop in economic growth, and therefore that tax revenues will rise rapidly.

But Republicans rarely if ever acknowledge, or even understand, that Reaganomics didn’t work. Paradoxically, it was the long-term effects of Reagan’s programs that contributed greatly to the to stagnating wages for the working class that in turn contributed to Trump’s victory. In fact, Reagan was forced to raise taxes significantly a couple of years later, as the persistently high federal budget deficit alarmed business and investors, as it likely will under Trump, according to almost all economic projections.

So what might happen to a Trump economy? To begin with, the composition of Trump’s proposed tax cuts is deeply unfair. According to the Tax Policy Center, under Trump’s plan, the top 0.1 percent of the population would get a tax cut of $1.1 million, or 14 percent of their after-tax income. Middle–income earners would get a tax cut of less than 2 percent of income or an average of about $1,010. Those in the bottom fifth would get a tax cut on average of $110 or less than 1 percent of after-tax earnings. But almost as important, this plan is not the ideal way to maximize growth: middle-income and poor households (who get only marginal benefit from the Trump plan) tend to spend tax cuts, while the rich often save them.

Trump has also blamed trade agreements for the stagnating wages and lack of jobs for the working class. We don’t know how serious he is about raising tariffs on trading partners. It is not a one-way street; they will retaliate. Moreover, their currencies will fall—Mexico’s peso is already sharply down in value—which will raise the cost of exports and reduce the cost to Americans of imports. A trade war could lead to global recession.

Carl Icahn, the corporate takeover tycoon and close Trump supporter, says Trump’s plan will improve productivity in America—the output per hour of work that enables incomes to rise. Rapid growth could stoke the investment needed, but under a tax-cutting Reagan, productivity did not rise at historical rates, partly because fears about the rapidly growing deficit pushed up interest rates. Reagan’s wide-ranging deregulation did not help. Only after the tax hike under Bill Clinton did the high-tech revolution help re-launch productivity in America. Tax cuts alone under George W. Bush twenty years later also failed to stimulate productivity growth, with much investment simply going to support the housing bubble. Job creation itself remained slow for eight years, only to collapse in the Bush recession of 2008.

Trump’s plans will be softened as he seeks Congressional approval. But even so, they are the wrong policies. The many unknowns—and Trump’s almost uniquely unpredictable behavior—could themselves be enough to inhibit consumers and business spending and lead to global recession. Battles over immigration will be anxiety-inducing, both at home and abroad, as will Trump’s stubborn denial of climate change. Any repeal of Obamacare will meet with at least some public anger, given that 20 million people now have insurance who didn’t before. Some stock investors are also placing bets on financial deregulation, unshackling oil and gas from requirements that slow climate warming, the reduced threat to control drug prices, and other anti-regulation scenarios, giving business a much freer hand. But there will also be considerable civic backlash to such deregulatory intentions, also reducing national and international confidence.

The better, truly Keynesian way to achieve a growth-inducing deficit is through government spending programs. Trump promises up to $1 trillion in infrastructure spending financed by public-private partnerships. If implemented, this is a useful Keynesian policy, but not many believe such an investment can be easily financed privately. Nevertheless, it is probably one of the best ideas we now have for creating decent jobs, and there would be bipartisan support for a program if reduced in size.

But a truly sustainable approach to economic growth will also require a stronger safety net, featuring more generous unemployment insurance, especially for those hurt by trade, enhanced human capital programs for the young and the poor, retirement security, and maybe even some adventurous efforts towards jobs creation for those lacking a college education. Dollar for dollar, most economists agree these kinds of programs boost the economy more than tax cuts. Keynes believed deficient demand was the cause of weak economies, not taxes. A smart business tax reform that repatriates funds buried in foreign countries without giving away tax revenue through excessive business tax cuts will also help. Trump’s proposal along these lines is far too generous to business.

Still, the big, and surprising, lesson of the market reaction to the election is that investors are starting to agree with liberal economists that fiscal policy is the way to get more growth, even if it brings somewhat higher inflation and interest rates. This is a sharp turnaround from the austerity-driven arguments long propounded by Republicans, and also some Democrats.  

There is plenty to be afraid of about Trump’s economic plans. It could well be that the new administration, backed by a Republican-controlled Congress, will start cutting needed social services to the bone—even attacking bedrock programs like Medicare and Social Security despite Trump’s promise to keep them—to compensate for the lost revenue from Trump’s tax cuts. House Speaker Paul Ryan has favored privatizing Social Security, for example. But for the moment, investors are throwing off their long-misplaced fear of rising inflation, or a bulging budget deficit.