In this report, we focus on the unexpected political ascendancy of Donald Trump, the economic framework that may be derived from his senior policy advisers, and the impact that Trumpian policies might have on the global economy, specifically asset markets.
Our current analysis has two parts: first, we examine the origins of Trump’s base of popular support; second, we use the writings of his economic advisory team, particularly Peter Navarro, to unearth a likely three-point plan for a Trump Administration’s foreign and domestic policies.
THE MANDATE: STAGNANT WAGES AND DISILLUSIONMENT
Donald Trump’s campaign represents the mobilization of populist anger and frustration regarding the difficulties that many voters — particularly male blue-collar workers in the vulnerable lower-middle class — face in the global economy. These voters have become disillusioned with current institutions and with the “politically correct” views of the liberal elite, and agitate for a more nationalistic set of policy prescriptions. Trump’s brand of brash, stark, tough language and policies have harnessed this anger and created a true upheaval in contemporary American politics.
The first thing analysts should realize is that, regardless of the practicality of the policy measures being discussed, the underlying grievances regarding wage stagnation are very real. From the McKinsey Global Institute:
“The real incomes of about two-thirds of households in 25 advanced economies were flat or fell between 2005 and 2014. Without action, this phenomenon could have corrosive economic and social consequences. …A survey we conducted as part of our research found that a significant number of those whose incomes have not been advancing said they think their children will also advance more slowly in the future, and they expressed negative opinions about free trade and immigration.”
A sizeable fraction of the populations of advanced economies in North America and Europe feel they have been left behind by globalization. Since the Great Recession, their plight has been masked by political machinations that obfuscate the true labor market picture. The end result is a deeply confusing macroeconomic situation in which the recovery appears to rest on questionable foundations. Some measures of economic growth — such as stock and bond market performance — are the result of unprecedented levels of monetary intervention. At the same time that asset prices have been stimulated by a series of liquidity floods, the unemployment rate may have been manipulated downwards.
For a sense of how a new calculation format used by the Bureau of Labor Statistics (BLS) puts an overwhelmingly positive spin on headline unemployment, consider this observation by analyst Dan Amerman:
“A detailed look at the government’s own database shows that about nine million people without jobs have been removed from the labor force simply by the government defining them as not being in the labor force anymore. Effectively all of the decreases in unemployment rate percentages since 2009 have come not from new jobs but through reducing the workforce participation rate so that millions of jobless people are removed from the labor force…when we pierce through the statistical smoke and mirrors and factor back in those nine million jobless…the true unemployment rate is 19.9% and rising not 8.3% and falling.”
Donald Trump has stated that the true unemployment rate is even higher than Ammerman’s startling and controversial assessment. Trump evidently believes that the U.S. has entered into the beginning of a crisis period; he claims to have joined the race because the acceleration of America’s decline into a dystopia has forced his hand. In a nutshell, Trump’s specific mandate is to deploy the full powers of the executive office to prevent the further erosion of blue-collar jobs in the former-manufacturing hotbed states. To pull this off, he would have to do three things:
- Stop the Hemorrhaging. Before a Trump administration does anything else, it must use tools at its disposal to attempt to prevent further loss of jobs to outsourcing. His rhetoric suggests that he will look to do this via punitive regulatory changes, perhaps involving changes to corporate taxes or to import/export licensing.
- Bring the Jobs Back. After deploying measures to close the spigot on the outsourcing flow, Trump claims he will create a business climate in the United States so dynamic that manufacturers who had previously moved to China will repatriate their factories back to the U.S. This is probably the least realistic of the scenarios.
- Create New Jobs. The most promising component of Trump’s platform might be the initiation of a new entrepreneurial and diversified manufacturing renaissance within the United States. This would mean a combination of A) lower taxes and B) a much simpler, clearer regulatory burden placed on U.S. companies (regulatory compliance costs in America are currently estimated by analysts at National Affairs to run between $1.5 and $2 trillion, and they are increasing dramatically as the full impacts of the Affordable Care Act of 2010, the Dodd-Frank Wall Street Reform Act and Consumer Protection Act of 2010, and the Food Safety Modernization Act of 2011 are felt throughout the business sector). If Trump could, in the words of a staffer, create a “giant version of Hong Kong” via tax and regulatory reform, he might achieve his target goals via dynamic new job growth and small business creation.
THE POLICY PRESCRIPTIONS: TRUMP’S THREE-POINT PLAN
Trump’s wild card status makes policy forecasts difficult; in fact, he has said that unpredictability and a potential for radical, “irrational” strategic options should be part of the president’s mystique. It is not clear which pronouncements accurately reflect legitimate political goals and which ones are designed to be provocative, to capture the media’s imagination, to create an enjoyable and celebratory “winner” ambiance at his events, etc. Trump himself may not know which elements of his agenda he will actually attempt to execute, and which are mainly useful for motivating his core audience.
However, it may be possible to peek behind the curtain in order to make some informed predictions about the actionable policy goals that are being quietly assembled in the background. Trump’s impractical rhetorical flourishes about walls, mass deportations, and Muslim immigration freezes are the objects of media attention; beneath the campaign’s aggressive bluster and bombast are a small team of policy advisors who have thought deeply about the state of the American economy, and written extensively about their goals.
At the turn of the century, the plans of Neoconservative elements of the George W. Bush administration could be unpacked via the more academic writings of men like Leo Strauss and Paul Wolfowitz. In a similar way, the theoretical frameworks on which Trump’s campaign rests may be best understood by first developing an understanding of the intellectual foundations of his more academically-inclined senior policy team.
Peter Navarro, an economics professor at UC Irvine with a PhD from Harvard, has been an outspoken critic of America’s current trade deal with China. We have been following his writing since 2001, when he released his theory of “global macro wave” investing for private investors and hedge funds (his approach could be considered a fundamentalist version of the systematic trend-following strategy that Bastiat employs). At the time, Navarro positioned himself as a moderate, pro-free trade/ pro-free markets advocate in the Glenn Hubbard tradition.
Navarro appears to have been quasi-radicalized by China’s entry into the WTO. Since 2006, he has concentrated his research and writing efforts on articulating the threat he believes China poses to the U.S. both economically and militarily. This has been maintained through three books —The Coming China Wars, Death by China, and Crouching Tiger: What China’s Militarism Means for the World.
In other words, Navarro is neither a ‘hired gun’ academic mercenary nor speechwriter who has been retained to provide a veneer of academic respectability to Trump’s anti-China populism. His prognostications regarding the threat of China precede Trump’s candidacy by more than a decade: Navarro should not be classified as a neo-protectionist dilettante. He is a true believer, a sophisticated economic mind extremely well-versed in the arguments for free trade, but nonetheless dedicated to the cause of protecting America’s manufacturing base from what he sees as predatory and destructive Chinese practices.
When we dissect Navarro’s general recommendations to Donald Trump, a potential three-point policy plan emerges. The policies are an unusual mix of ideas from both the left and right sides of the political spectrum, and combine a protectionist, pro-union working class sensibility one might expect from a Marxist rally with an equally fervent belief in supply-side tax relief that could have come from the lips of Arthur Laffer himself. The policies are:
- Supply-Side Economics at Home
- Protectionist Policies Abroad
- New Controls on the Federal Reserve
Point #1: Supply-Side Economics at Home
In a paper he released this year entitled “An Analysis of Moody’s Analytics: The Macroeconomic Consequences of Mr. Trump’s Economic Policies”, Navarro provided very useful insight into the thinking behind Trump’s tax plan. The paper, which was motivated by a Moody’s commentary that was very critical of Trump’s economic platform, probably provides the single best source for understanding the ideological assumptions and practical positions that undergird Trump’s views on the future of the U.S. economy. One of Navarro’s attacks on a Moody’s analyst proved very telling:
“On its face, the Moody’s report lacks credibility. Its lead author Mark Zandi is a registered Democrat and a major contributor to Democratic presidential candidate Hillary Clinton. Over the last eight years, Mr. Zandi has also been an instigator of, and chief apologist for, the failed Keynesian fiscal and monetary policies of the Obama presidency (emphasis added)—a presidency marked by slow growth, stagnant wages, a near doubling of government debt, and likely recession as Obama leaves office.”
In other words, we should expect a Trump presidency to be hostile to continuation of the pro-Keynesian combination of fiscal deficits and monetary policy accommodation techniques used in a particularly aggressive manner since 2008. We also know that Trump has claimed that he will both cut taxes and balance the federal budget by the end of his first term. This would mean that he expects one of two things to occur: either he expects tax revenues to decline with tax cuts, and intends to make up for the shortfall with dramatic cuts in government spending (essentially impossible to do given that the major expenditures are now remarkably cut-resistant), or he expects the tax cuts to trigger a tremendous uptick in GDP growth, and thus to raise tax revenues enough to cover fiscal spending.
The latter position — the supply-side argument — is the one Trump is betting on. Navarro:
“Moody’s Keynesian and partisan analysis also deeply discounts the supply-side stimulus effects associated with tax cuts themselves. In reality, Trump’s tax package will significantly stimulate GDP growth, the rate of job creation, and tax revenues raised much as the Reagan supply side tax reforms did in the 1980s. “
Point #2: Protectionist Policies Abroad
Trump has made his intentions to renegotiate trade deals with China a keystone of his economic recovery plan. For the Trump team, the results of China’s entrance into the World Trade Organization (WTO) in 2001 are best summarized by Navarro:
“(Describing Bill Clinton)…Perhaps no American president has been more wrong about so much with such devastating economic consequences. In the wake of China’s joining the World Trade Organization, Clinton’s corporate backers would begin a massive offshoring exodus to China that would help lead to the closing of over seventy thousand American factories; the number of unemployed and underemployed workers would eventually swell to over twenty-five million; and America’s massive trade deficit would swell to over $300 billion, leaving America in debt to China to the tune of trillions of dollars.”
What happened? To Trump’s economic policy advisory group, the problem was that the negotiated deal mandated that the United States open its borders to free trade while allowing the Chinese to practice a turbo-charged version of the export-driven mercantilism the Japanese used in the 70s and 80s. Dan Slane, a member of the U.S.-China Commission, explains:
“When the United States allowed China to enter the World Trade Organization in 2001 and opened up its markets without any corresponding opening up of the Chinese markets, we knew we would take a huge economic hit. However, many of our leaders thought that hit would be worth it because increased trade would take China and turn it into a democracy. As it turned out, that never happened. Instead, China has taken advantage of every opportunity to game the free trade system, maximize their own trade to build up their economy, and, in the process, they’ve done severe damage to our own economy.”
Once again, Navarro’s paper provides a very clear exposition on how Trump and his team believe a tough-trade position with China will work out to America’s benefit:
“The Moody’s report does not properly account for the fact that roughly half of the U.S. trade deficit in goods is with a mercantilist and predatory China. Reducing America’s Chinese import dependence by getting a fair deal from China as Trump’s trade policy is intended to do would significantly boost U.S. growth and create millions of jobs.
“Instead, the Moody’s report simply slaps a 45% tariff on Chinese exports and then assumes that China retaliates with its own tariffs, causing consumer prices to rise. The far more likely Trump presidency scenario is that Chinese leaders realize they no longer have a weak leader in the White House, China ceases its unfair trade practices, America’s massive deficit with China comes peacefully and prosperously back into balance, and both the U.S. and Chinese economies benefit from trade.”
While Navarro speaks here of a peaceful resolution to the de facto trade war between the United States and China (a war which, in his view, China has declared on a hapless America), he does feel that the U.S. must prepare for the possibility of a military collision in the South China Sea. This frightening possibility has been largely absent from the debates regarding a more belligerent U.S. attitude towards Chinese trade, but defense analysts looking to predict the national security and defense procurement components of a Trump presidency should potentially focus on the geopolitical situation within the South China Sea.
Areas of particular interest would include China’s interpretation of laws regarding Economic Exclusion Zones (EEZs) surrounding the many small island chains in the region, and the country’s development of an “area denial” naval capability that specifically targets the ability of U.S. carrier battle groups to freely traverse these waters as part of America’s traditional open sea lanes military mission.
It is unclear how far a Trump administration would attempt to push trade relations with China, and if it would risk a military confrontation in the South China Sea. Some of Navarro’s writings make such a confrontation appear almost inevitable, the result of an eternal, recurring competitive dynamic between established and rising great powers that was documented as far back as Thucydides.
One last side note on the Chinese trade issue: the theoretical foundation for Trump’s form of protectionism (or at least what we know of it) has been chiefly articulated by economists Ian Fletcher and Erik Reinert. While many of us wince at some of the anti-intellectual, populist statements issued during the course of the campaign, it is important to note that beneath the crude and simplistic accusations and anti-globalist rhetoric actually lies an interesting and subtle critique of “free trade” as it is being currently practiced. Even avowed free-traders will find that Fletcher and Reinert are well worth reading.
The core of their argument is the common finding that diversified manufacturing is an industry with exceptional, unique, and irreplaceable characteristics, including a tight link to research and development capability and to economies of scale that are unavailable in most service sector jobs. Fletcher and Reinert would caution us against believing that a post-manufacturing economy will be a vibrant source of wage growth; they warn that the loss of manufacturing jobs will be followed, over time, by a loss of white-collar managerial/R&D jobs (manufacturing exerts a type of gravitational pull on R&D — they will eventually be co-located). Firms that attempt to retain design work in the United States while off-shoring production to China will, ultimately, find their design work flowing across the Pacific as well.
Point #3: New Controls on the Federal Reserve
In February of this year, Trump tweeted:
“It is so important to audit The Federal Reserve, and yet Ted Cruz missed the vote on the bill that would allow this to be done” (the “Audit the Fed” bill was proposed by libertarian Rand Paul).
We previously mentioned that adviser Peter Navarro explicitly states the view that quantitative easing, zero interest rates, and so on are part of a “failed Keynesian policy”, but Trump’s direct views on the matter have been less forcefully delivered. We know the following:
- Trump favors a Congressional audit of the Federal Reserve
- Trump has stated that he would replace Janet Yellen as Fed Chair:
“Janet Yellen for political reasons is keeping interest rates so low that the next guy or person who takes over as president could have a real problem.”
- Trump has voiced concerns about low interest rates:
“In terms of real estate, if I want to develop…from that standpoint I like low interest rates. From the country’s standpoint, I’m just not sure that it’s a very good thing, because I really do believe we’re creating a bubble.”
We also know how another outspoken Trump policy adviser, Larry Kudlow, feels about current fiscal and monetary policy measures:
“We need a different model. In other words, zero interest rates, or negative interest rates, and tons and tons of government spending for all of these G-7 countries have not worked. We have global stagnation, a virtual global recession. And we have virtually no inflation… I recommend an across-the-board slashing of corporate taxes for large and small businesses in the U.S. I would start right there to reignite growth and then give the Fed a chance to normalize their interest rates…I do not approve of what the Fed or these other central banks are doing. I have never favored it, QE, negative rates even worse. The trick is how to get out of this with minimal damage.”
In short, we would expect a Trump administration to attempt to use immediate tax cuts as a stimulus measure. This would, notionally, provide a covering fire behind which the Fed could begin to return to a conventional monetary policy stance. Janet Yellen’s position at the Fed could be in jeopardy; Trump has already stated a desire to replace her when the opportunity for re-appointment rises in 2018. Given his stated predilection for crafting a deliberately unpredictable persona, he may attempt to dangle reappointment as a leverage point with which to gain Yellen’s support for his new program.
Trump appears to be aware that the incoming president will probably have to deal with the popping of huge asset bubbles in stock and bond markets; according to comments from Kudlow and Navarro, he looks to head this off with the various structural pro-business measures he claims he would deploy within his first hundred days in office. Thus we find that Trump’s team looks to pull off something of a “great switcheroo” caper — to stimulate the economy with tax and regulation relief while simultaneously hoping to enable the Fed’s exit from eight years of extraordinary monetary policy accommodation. The short-term risks in this plan hinge on the level of sensitivity that the markets have developed in regards to a continuation of existing, emergency-levels of liquidity provision. Can we safely exit from the QE era?
In conclusion, Donald Trump’s economic policy proposals, stripped of their distracting and entertaining “bread and circus” excesses, are essentially a directional bet that supply-side Reaganomics, combined with a mercantilist/protectionist posture towards trade (normally associated with anti-WTO , pro-union agitators on the far Left), will serve to usher in a new era of greatly improved American GDP growth. His most specific economic target is to generate wage improvements for members of the lower middle class who have been made most vulnerable to offshoring.
In addition, Trump’s entire economic policy team appears to be deeply skeptical regarding the efficacy of continued use of Keynesian fiscal and monetary policy measures, and investors should anticipate that a Trump administration would attempt to use various techniques of political pressure to push the Fed into normalizing its policy accommodation stance and balance sheet as soon as possible.
The views and opinions expressed herein are those of the author and do not reflect the views of BASTIAT CAPITAL, LLC, its affiliates, or its employees and should not be regarded as an offer to sell or a solicitation of an offer to buy any financial product. Bastiat Think Tank does not provide information on any of the Bastiat investment programs.