Donald Trump’s surprise election as President of the United States, following on from the UK’s vote to leave the European Union, is disturbing.
For those whose job it is to interpret public opinion, and those who still listen to them, there is plenty of food for thought on the state of “modern” democracies.
Financial markets do not ask as many questions. Capitalism is amoral, and the markets apolitical. Political risk defies quantification, and hence most investors tend to exclude it from their analysis. In Trump’s election, investors see the outcome almost exclusively in economic terms, which were readily quantified during the election campaign, but are still highly uncertain. It’s hard to make assumptions on public infrastructure expenditure, welfare cuts, and lower corporation and income tax are very hard add up, unless you feel that hiking the fiscal deficit and public debt are minor inconveniences without importance.
The markets, for one, are overlooking these inconsistencies. They believe in self-regulation, so that excesses and inconsistencies will correct themselves under the influence of the markets’ restorative force. What matters to the markets is forming convictions about trends, and there are four basic convictions which are being expressed.
The first conviction is that reduced tax pressure will increase companies’ net margins. This possibility offers realistic hope that corporate America’s inclination to invest will finally pick up. At the very least, firms will have more incentive to invest on US soil, and the example of Ireland has shown that such atax strategy can be effective. Over the long run, this success could reverse the decline in US economic productivity. In the shorter term, it will draw capital to the United States and underpin the value of the dollar.
Therein lies a crucial distinction from the British project: the United States and United Kingdom both have a very large balance of payments deficit, which the former could easily cover if external capital flows in. The United Kingdom, on the other hand, is seeing capital inflows dry up due to the uncertainty of Brexit. As a result, the pound became the country’s adjustment variable and falls, whereas the dollar rises.
The second conviction is that infrastructure spending will increase. This was one thing on which the two major candidates agreed, albeit to different extents. And this is not just an American phenomenon: infrastructure spending was a key theme in Philip Hammond’s November Autumn Statement. The reason for this is that public investment has fallen massively over the last 20 years, due to a drift away from Keynesian solutions and, since 2008, due to budget constraints. It is therefore reasonable to expect the government to start pumping in investment once again.
The third conviction is that, at least initially, these ambitions will mean higher budget deficits, increased debt and greater inflation expectations. The economic policies put before the French and German electorates in 2017 should also agree on this point. This prospect suggests that interest rates can’t go on reflecting a deflationary macroeconomic outlook forever. Interest rates will necessarily have to rise off the back of this new perspective.
The markets’ fourth conviction is also the most debatable: that the transition will be smooth. In other words, fiscal slide will not fuel fears of financial instability. The inexorable increase in interest rates will be tempered by the sluggishness of central banks’ monetary policy changes. Protectionist promises will not undo the benefits of domestic stimulus packages by hitting world trade. The rise of nationalism will not push the political risk premium any higher. The contrast between populist promises and economic policies that are actually anything but social will not lead to massive disappointment.
The first three convictions require the markets to prepare for a huge macroeconomic swing. The fourth calls for eyes to be kept wide open.
Didier Saint-Georges is managing director and member of the investment committee at Carmignac.