Wednesday, November 30, 2016

World is moving away from Free trade and globalization

The stunning victory of Donald Trump over Hillary Clinton was the culmination of the voter angst in Europe and North America that I identified in my column on November 23, 2015. They are “mad as hell” because purchasing power for most people has been declining for more than a decade. So voters have rejected mainstream politicians and turned to the political fringes.

The root causes of weak incomes are financial deleveraging and globalization. In the 1980's and 1990's banks and other financial institutions worldwide borrowed heavily to finance economic-growth-propelling lending. Also, U.S. consumers ran up their debts and ran down their savings rate to finance rapid spending. But the financial crisis and pressure from regulators have forced banks to retrench, and U.S. households have switched from a borrowing-and-spending binge to a growth-retarding saving spree.

Globalization, the most significant economic phenomenon of the last three decades, has transferred manufacturing from the West to China and other developing countries, eliminating many well-paid jobs in North America and Europe.

The voting climate was ripe for demagogues who blame weak purchasing power not on its basic causes but on income polarization (in the case of Hillary) and immigration and imports (in the case of Trump).

Trump struck the chord of voter discontent. He won even though he continually got off point, had numerous detours into his history of womanizing and got into a nonstop catfight with Hillary over who was the bigger crook and moral degenerate.

What does Trump’s triumph mean for investors? After an initial drop, stocks rallied sharply, presumably in anticipation of tax cuts and massive growth-reviving fiscal stimuli.

But the euphoria is overdone. As Congress grinds through Trump’s proposals, many will likely be watered down. He ran as an outsider without the support–and, in many cases, to the disdain–of many key Republicans. Tax cuts, though not on the scale Trump proposes, are also likely, in the unjustifiable hope they’ll stimulate enough growth to finance themselves.

The Mexican peso nose-dived in line with Trump’s threats to build a wall on the Mexican border and get the Mexicans to pay for it. But the dollar is rising against most major currencies. This may be in expectation of a strengthening U.S. economy and higher interest rates but also reflects the greenback’s safe-haven status. A rising buck is probably the best, safest investment strategy at present.

The world has been moving away from free trade, but the election of Trump accelerates things. In times of domestic weakness, which is now the case, governments and central banks try to promote growth at their trading partners’ expense. The Bank of Japan, the European Central Bank and others are trying to trash their currencies to promote exports. And Obama’s tariff-cutting Trans Pacific Partnership was rejected by both candidates. Consequently, emerging-market stocks and bonds are vulnerable.

Voters are demanding economic growth and higher incomes, and both Trump and Clinton put forth plans for major fiscal stimuli. Infrastructure, much in need of upgrades, will benefit. So will the military, with the Republicans in control of Washington. Military spending is done directly by the federal government and can be increased fairly rapidly, but infrastructure outlays take several years to come to fruition. So investors may be jumping the gun there.

By calling for fiscal stimuli, the Fed and other central banks have admitted that monetary policy is impotent. They won’t allow the leaping deficits that finance the stimuli to push up interest rates and offset the positive effects. They’ll essentially buy those new sovereigns, the helicopter-money phenomenon. Also, there’s the threat that Trump and the Republican Congress will reduce the independence of the Fed and encourage central bank cooperation.

So the initial postelection jump in interest rates and the selloff of safe-haven Treasurys in anticipation of huge Treasury borrowing were probably a vast overreaction. It all may be retraced–and then some–as investors again face the stark reality of a deflationary world, with chronic price declines likely unless offset by rapid economic growth sired by massive fiscal action.