Trump’s ill-timed revival of Reaganomics
Emerging markets could be in for a bumpy road
by John Mourmouras in London
Tue 28 Feb 2017
Financial markets responded positively to Donald Trump’s election, as commentators expected they would. The president-elect’s policy announcements on deregulation, tax reform and spending on infrastructure were interpreted as raising prospects for higher growth, inflation and market inflows.
On Trumponomics, investors will be particularly interested in two things: the transition from announcements to detailed design, and the relationship between higher growth and inflation. The anticipation of a more active fiscal strategy assumes that Trump will revive the package of policies known as Reaganomics.
During much of Ronald Reagan’s first administration, loose fiscal policy collided with a tight monetary stance as Paul Volcker, chair of the Federal Reserve in 1979-87, sought to squeeze inflation out of the system. This resulted in a seriously overvalued dollar. The strength of the dollar since Trump’s election is justifiably based on that historical analogy. However, there are two chief differences between the Reagan and Trump administrations.
First, Reagan was fortunate in taking office in 1981, just after the 1979 oil shock tipped the US economy into recession. In addition to a strong cyclical recovery, the US economy benefited as the oil price collapsed. As inflation came under control, policy interest rates came down. This produced a 35-year bond bull market. Trump, by contrast, enters the White House near the end of a mature, if fragile, expansion. Wages are rising and there is little slack in the economy. On some estimates, the potential growth rate is as low as 1.5%, and there is a risk of inflation exceeding growth.
Second, there is the issue of debt levels. Reagan presided over the start of a long surge in US public sector debt. At nearly 105% of GDP, gross US public debt today is more than twice the size it was when Reagan left office in 1989. These levels are unprecedented in peacetime.
Then there is the question of foreign policy on trade and geopolitics. For economies with strong trade ties to the US, such as Canada and Mexico, as well as many emerging markets, open borders and mutually beneficial free trade agreements are paramount. The implementation of ‘America First’ unilateralist measures by the Trump administration would undermine the recovery in global trade and disrupt international supply chains. The potential for protectionist reprisals by other economies would have an adverse short-term cyclical impact, and a negative structural impact on potential growth in the long term.
Underlying vulnerabilities remain for some large emerging markets. High corporate debt, weak bank balance sheets and thin policy buffers mean that these economies are exposed to tighter global financial conditions, capital flow reversals, and the implications of sharp currency depreciations, especially as a result of the unprecedented strength of the dollar. This heightens their exposure to severe external shocks. When emerging economies last faced monetary tightening and fiscal loosening in the US, in the early 1980s, many sank into a decade of stagnation.
John Mourmouras is Deputy Governor of the Bank of Greece and a former Deputy Finance Minister.
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