The Independent Market Observer

Saudi Arabia and the Republican Tax Plan: Will the Markets React?

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Nov 7, 2017 12:19:50 PM

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Saudi ArabiaIt has been a busy couple of days in the news. So, while I don’t ordinarily quote Lenin, his statement that “there are decades where nothing happens; and there are weeks when decades happen” is just too applicable to ignore. The events in Saudi Arabia and, to a lesser extent, in Washington are potentially changing the range of reasonable future outcomes—to a degree that markets are not fully discounting.

Let’s start with Saudi Arabia

The move to arrest multiple princes, as well as economic and political actors, is a play to centralize power and secure the succession for the current crown prince of Saudi Arabia, Mohammed bin Salman. By neutralizing the potential opposition while King Salman is firmly in control, the crown prince can reduce uncertainty and create a defined political path forward for the Kingdom of Saudi Arabia. This is clearly in line with the major changes he has proposed. The intent—to create clarity about who is in charge and where Saudi Arabia is going—would be beneficial and allow the country to move forward and deal with its very real challenges. But will it actually work out that way?

Why did the arrests happen now? What made a gamble like this necessary? Regardless of the answer, the follow-up question is, what happens if the arrests fail to accomplish the objective, for whatever reason? The only reason to make the arrests was to isolate and neutralize other power centers. But that same move has now forced those power centers to mobilize against the crown prince. It will either work or make the problem much larger and more immediate.

The Saudi system has been based on consensus, carefully designed to manage the competing power centers among the princes. The recent appointment by King Salman of his son as crown prince disrupted that system, and the arrests have broken the system further—quite possibly beyond repair. In other words, the internal implicit political struggle between factions within the royal family has now become external and explicit, and the stakes have been dialed up significantly. What might have simmered along for years now has a chance of blowing up in a big way.

Markets are noticing. Oil prices are up, and the Saudi stock market is down. The problem with a move like the arrests is that by raising the stakes, it also raises the chance for significant changes, positive or negative. If it does not work, the Saudi state will become even more destabilized, with consequences for the oil markets and the world economy.

So, do we care? Not yet, according to the financial markets. Will we care? Quite possibly, if the downside risks come true. Saudi Arabia is still a major oil supplier, and an oil shock is now more likely, although still not a central case. This will be something to keep a close eye on in coming months.

The Republican tax plan

The other significant potential change is the Republican tax plan. I have purposely not commented on this to date, as the proposal is a moving target and passage, at this point, is hypothetical. Once we get an actual set of bills (and remember the Senate bill will be different from and have to be reconciled with the House bill), then we can start to consider the effects. Right now, it’s too soon. The change I want to highlight here is in the political effects of passage of anything.

The Republicans are on the back foot. With the failure of health care and basically every other legislative initiative, their ability to govern is still very much in question. A failure on tax reform, which seems close to the default assumption among many, would just give an answer of “no” to that question. Taking that into the 2018 midterms would certainly raise the chances of losing the House and possibly the Senate. It would also poison the well for the next crisis in Washington, which is the debt ceiling debate next month. Failure here would almost guarantee even more political disruption.

On the other hand, passing a tax bill—any tax bill—would change that narrative completely. Just as with the Saudi arrests, there is a real binary outcome. If it works, there is a much clearer future. If not? There is a real likelihood of chaos.

Things are just getting interesting

We should have at least some initial indicators in the next couple of weeks regarding both of these issues. As such, it is very likely things will get even more interesting, in the sense of the Chinese curse “may you live in interesting times.” Real changes are afoot.

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