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Is Trump Magic Making America Great Again?

Avinash Persaud (apersaud@me.com) is chairman of Elara Capital Limited and emeritus professor of Gresham College, London.

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It was uncharacteristically in the early afternoon, and not in the early hours of 31 July 2017, when Donald Trump, the 44th President of the United States (US), tweeted: “Highest Stock Market EVER, best economic numbers in years, unemployment lowest in 17 years, wages raising, border secure, S.C.: No WH chaos!” Could it be that while the Democrat opposition was obsessing over whether the Russians helped steal last November’s presidential election from under them, Trump had unexpectedly, perhaps unintentionally, delivered? Could it be that without passing any legislation and despite having a backlog of critical unfilled executive appointments, he had sprinkled some of the now familiar if irritating Trump magic and made the American economy great again?

To Dismiss or Not to Dismiss?

There are many, who, on past evidence, have come to dismiss every Trump utterance as laughably false. The problem for them is that the July payrolls report showed that the US created 2,09,000 new jobs in July, beating Wall Street’s forecasts of 1,75,000. Separately, the unemployment rate dropped from 4.4% to 4.3%, matching a low 16 years ago if not actually 17 years ago. In response, the Dow Jones Industrial Average hit 22,092.81, a new all-time high.

Practitioners of the dismal science, like myself, love to stamp on all indications of optimism and will rush to tell you that unemployment is a lagging indicator of the economy. Hence, what we are seeing is a measure of the last President’s handiwork, not the new. Many economists recall that George H W Bush’s 1992 economic stimulus package worked, but recovery came so late that Bill Clinton was able to defeat Bush Senior in November 1992 with the campaign cry of “it’s the economy stupid!” It is the kind of bitter thing that economists easily remember.

However, while unemployment is a backward-looking indicator, the stock market is forward looking. And the stock market’s response to the payrolls report was not a one-day wonder. The day of the payroll report was the ninth straight day of stock market gains and the 34th record high for the year so far. Stock market performance is important to the psychology of ordinary US consumers and rising stocks have fed US consumer confidence. This has in turn supported domestic sales which has boosted US stock prices. Maybe, however unlikely, Trump has the right stuff after all?

Unsustainable Rally

The first bucketful of cold water to pour on this fantasy is that what is good for the stock market is not always good for the economy. It depends on what is driving the stock market higher. The four factors that explain the current stock market performance are not the right stuff for US productivity. Trump remains firmly in a self-destructive arc and the more he tries to claim credit without doing anything, the more he will end up getting blamed in the future.

The performance of the US dollar and US bond markets tells you that part of what is going on in US stocks is lower expectations of higher US interest rates. This is partly the result of still subdued inflationary pressures, but whatever it is, it is not a sign of a rapidly strengthening economy. Lower interest rates boost stock prices, first by reducing the cost of leverage and secondly, through lower discount rates, by boosting the current value of future earnings.

A more relaxed Federal Reserve has hit the dollar. Since last year’s presidential election, the dollar has fallen 12% versus the euro, 6% versus the rupee, and 3% versus the renminbi. In response to a cheaper dollar, exports have risen to $192 bn, the highest since April 2015, and the US deficit in the trade of goods with China has slimmed 6.2% to $30.1 bn. Exporters are disproportionately represented in the US stock markets. While currency depreciation can boost economic activity, it effectively does so by reducing real wages versus those in the rest of the world and so this is not the basis for a country to get richer relative to the rest of the world.

Another important driver of stock market performance has been share buy-backs. Although the rate of buybacks has slipped slightly, the quantum is still running at around $135 bn per quarter. Moreover, what matters is the cumulative impact of buy-backs over time rather than one quarter’s size and there have been as much buy-backs in the last five years as there was in the five years before the 2007–08 crash. Buy-backs createa disconnect between the growth of earnings per share and economic activity and explain the stock market’s rosier perspective than most economists.

In sum, lower-than-expected interest rates, a weaker dollar and share buy-backs are the foundations of the Trump rally. While these factors can cause a temporary boost to the markets, they do not raise long-term productivity without which the stock market’s performance and faster economic activity cannot be sustained. Another, less tangible factor, in the Trump rally is expectations of lower taxes and deregulation. But measures of monopoly power and the share of income in the form of wages suggest that this
is not what the US economy needs today. Worse, there is a dangerous whiff of déjà vu about the current combination of loose monetary, regulatory, and fiscal policy. US is stuck in boom–bust, and the recent stock market performance is a false prophet of a new dawn.

 

 

Updated On : 16th Aug, 2017

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