Trump’s Policies and the Law of Unintended Consequences

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Nov 15, 2016 10:44:04 AM

and tagged Politics and the Economy

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trump's policiesAs I mentioned last week, Donald Trump’s administration could have a number of positive effects on the U.S. economy. With government spending growth set to ramp up—and taxes and regulations set to be cut—you can almost see a potential boom forming. It could be a good couple of years to come.

At the same time, we have to consider what else might come along with those policies, as there will certainly be costs. A useful example is the George W. Bush administration, which pursued similar policies with great success—for a while. Let’s consider the potential downsides of Trump's expected policies and consequent faster growth, some of which we are already seeing.

Along with potential benefits, costs

Tax cuts and the deficit. Cutting taxes helps grow the economy but also costs the government money. If Trump follows through on his proposed tax cuts, the deficit will increase substantially. U.S. government debt will grow faster, making debt service more burdensome. In fact, this is only the first part of the problem, as we will see in the next section.

Higher interest rates. Rates are moving higher on expectations of faster growth and faster inflation. Higher interest rates, though in many ways a sign of economic success, are also a brake on growth. With more expensive borrowing, houses and cars cost more on a monthly basis, hurting consumer spending, which is a major source of growth. Higher interest rates might also hurt business investment. Finally, given the very large and growing stock of government debt, U.S. government debt service also stands to rise substantially. This is the double whammy of higher spending growth, with both more debt and higher interest rates further impairing the U.S. government’s fiscal position.

Tariffs and the strong dollar. With U.S. growth up and rates rising, the dollar is also strengthening, which makes U.S. exports less competitive. This is part of what hit the stock market in early 2016, and the Chinese currency continues to drop against the dollar. This trend has damaged both the economy and the markets and will likely get worse. One of the policies Trump has proposed, however, is designed to avert some of the effects of a stronger dollar.

Tariffs are essentially a tax on imports, making them more expensive relative to American-made goods. The intent in imposing tariffs is to help U.S. manufacturers, but there are a couple of problems:

  • In our globalized world, tariffs will hurt manufacturers who buy parts abroad, which is everyone.
  • Consumers will get hit in the wallet. Consider, for example, Walmart, which imports about $50 billion in goods from China every year. A 35-percent tariff would add $17.5 billion in costs to those imports. That $17.5 billion would come either from Walmart’s profits or from consumers’ pockets in the form of higher prices. Either way, it would essentially be a tax hike, offsetting the first policy we talked about.
The intricate weave of the economy

There are other concerns as well, but these are the most immediate. None of this, by the way, is meant to dispute or minimize the possible positive effects of some of Trump’s economic policies. My point is that we also need to weigh the risks associated with the opportunities.

The economy is like a sweater; if you pull one thread too hard, the whole thing can unravel. As investors, we need to keep an eye on the threads that various policies are pulling, to avoid getting caught in the unraveling.

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