Monday, February 5, 2018

End Of The Obama-Yellen Economy

For the past year the US has been essentially operating on an Obama-Yellen economy, at least as far as the big macroeconomic policies have been concerned in terms of fiscal and monetary policies.  We saw basically a continuation of what had been seeing in previous years, steady growth with inflation under control.  There was some uptick in wage growth, although that had already started in the previous year.  He has supposedly engaged in a lot of deregulation, but most of it that has gotten a lot of attention has involved making it easier for firms to pollute in various ways, with squashing renewable energy projects while super encouraging fossil fuels and coal.  Indeed, about 50% of the increase in capital investment in the US last year was in the energy sector.

One area where Trump's policy, or expectation of it, has had a noticeable influence has been the expectation of his corporate tax cut on the stock market, ,which has risen a lot since his election, even after taking account of the declines in the past week (although the market rose more in percentage terms in Obama's first year than it did in Trump's first year).  But, of course, stock markets are famous for buying on the rumor and selling on the news.  Now the market continued to zoom after the tax cut passed for awhile, but now some realities may be kicking in regarding the full implications of it.  The Obama fiscal policy is over, and Janet Yellen officially went out the door at the Fed at 9 AM this morning when her successor was sworn in as the new Fed Chair.

So why is the realization of the end of the Obama-Yellen economy downing the market so hard?  One side item that has probably exacerbated things and has little to do with Trump or the rest has been the more dramatic collapse of the cryptocurrency markets, now down well over 50% from its November high. I shall not get into the details of that or where I think it is going, but I suspect the sharper plunging those markets were doing this past week have spilled over to some extent into the stock market.

That said, it has been noted by a wide range of people, with Robert Shiller perhaps the most prominent, that the US stock market appeared to have become somewhat overvalued, with Shiller claiming it has had the highest ratios of prices to recent trends of earnings of any major national stock market.  Many have been warning of an impending correction, and it looks like it is here.  If it does not go down too much more, it will not in the end be a big deal, a merely useful correction.

That said, and along with the caveat regarding the drag coming from the epiphenomenon of the crytpocurrency crash, there is reason to believe that this recent market drop may well reflect some realizations about the implications of Trump policies, along with perhaps jut a bit of confidence loss due to the departure of the incredibly calming and reliable Janet Yellen from the Fed.  A lot of talk has been that with wage pressures rising, inflation expectations may be rising, and with that that interest rates may be pushed up by the Fed.  On top of that there was the realization a week ago that Treasury borrowing is really up thanks to the Trump tax cut, estimated to be up 84%, and we have a debt ceiling increase needed in probably a month, not to mention another possible government shutdown looming this week (probably to be put off for another month).  In any case the unexpectedly high increase in borrowing will put upward pressure on interest rates, irrespective of inflation or Fed policies affecting short term interest rates.  I suspect this matter is what has really gotten the stock market spooked.  They spent all last year capitalizing in their higher after tax profits, but had failed to capitalize in the higher interest rates to accompany the higher budget deficits.

I think the market is paying less attention to these, but Trump's policies also have some negative implications for growth, although less upward pressure on growth might actually help right now (and the rest of the world economy is now officially growing well, thank you Obama-Yellen).  So we have his anti-immigration policy, which most of his supporters do not understand will slow growth.  There is also the threat of a trade war.  Of course simply engaging in protectionism is a mixed bag, with import competing industries gaining as other parts of the economy lose.  But the losses become more serious when foreigners retaliate against our exports, as China did today against US wheat exports in response to our tariffs on solar cells and air conditioners. Again, most Trump supporters are under the delusion that all this is just a big plus for the US economy.

I am not forecasting a near term recession for the US economy, although one could happen at any time.  The general boom in the world economy will help prop us up,  and some of the financial problems we are looking at may further depress the dollar, thus boosting US exports.  But it would seem that markets have now realized that we are in the Trump economy, and that means much higher budget deficits with likely upward pressure on interest rates, and those are indeed not good for the stock market, which even Trump knows.  But given how much he has bragged about the stock market performance in the last year, he is in he situation where having lived by the stock market he can die by the stock market as well.

Barkley Rosser

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