It is not just the fear that the investigations into Russia’s attempt to
influence the US election will distract
from the Trump Administration’s economic program. It is also that the
economic agenda itself seems is less clear.
That China was not cited as a
currency manipulator is no major surprise. Bush and Obama also made
the threat on the campaign trail over
jettison it when the were in office. China has not been cited since 1994. Although we argue
the designation is not as onerous as it is frequently made to be, lack of use
appears to have increased its symbolic importance.
During the campaign and as recently as a fortnight ago, President Trump
was talking about his willingness to address to “too big to fail”
problem in the US financial sector. There was explicit support for
some kind of new Glass-Steagall which
forced a separation between deposit-taking institutions and investment
banks. However, in recent testimony before the Senate, Mnuchin
played this down and denied a commitment
to support a “full separation” of commercial and investment
banks.
There was much debate in the primaries a year ago about how fast the US
economy can grow. Trump has talked about 5% and sometimes 4%.
The budget presented assumes 3% growth. The Federal Reserve estimates
that trend growth in the US is a little below 2.0%. Obama was
the first President since the end of WWII that did not record a single year of
growth above 3.0%. The last year that such growth was reported was 2005, and the last four-quarter period that
averaged at least 3% was mid-2006.
Fed Chair Yellen recognizes that some supply-side
reforms can boost growth potential. However, in the long run, growth is a function of hours worked and
productivity. Slower growth of the pool of available workers and weak
productivity growth limits the growth potential of the economy. There
appears to be little thought given to boosting productivity, though the right
kind of infrastructure investment can
help.
Judging from the budget proposal, the Administration seems to be banking
on boosting the labor force by making draconian cuts in the social safety
net. As if fewer life choices, greater susceptibility to illnesses,
experience greater hardships, and reduced longevity is not a sufficient
disincentive of poverty, the budget proposals won’t
raise the cost of being poor.
Mnuchin previously said that high income earners would not be beneficiaries of tax reform. This has become known as the “Mnuchin Rule,” which appears to have been repealed. The Treasury
Secretary softened his commitment by saying that the necessary compromises with
Congress may violate his rule. This
seems disingenuous, as the budget proposals, first for the remainder of this year, and then for next year that
came from the White House, before Congress even touched it, seemed to
contradict the rule.
El-Erian has argued that the problem is the sequencing of the President’s economic agenda. He says
the health care out not to have been the starting point. Yet that seems to be politically naive.
Given the desire to exploit the Republican majority in both houses of Congress,
then getting rid of the Affordable Care Act, which the GOP had harangued
against for years, must be the centerpiece. This has to do with repealing the tax cuts associated with the ACA
that would free up funds to pay for broader tax reform, in a way that can be achieved through the reconciliation process
of the legislative branch.
Moreover, when Trump was elected, the US was near full employment, the
Fed’s inflation target and trend growth. Many economists argued that
economic stimulus risks accelerating inflation and forcing the Fed to move
faster. Simply put, health care reform was needed to tax reform.
However, the CBO says that rather than free up $1 trillion that was initially expected, the House version of
the healthcare reform would only save
$119 bln over a decade. Also,
the White House has become less sympathetic to the House’s border adjustment
tax, which was to raise another $1 trillion that could have been used for tax reform.
Some observers argued that the rally in US stocks (exemplified by the Nov
2016-Feb 2017 10% rally in the S&P 500) was in anticipation of Trump’s
three-prong economic strategy of deregulation, tax reform, and stimulus spending. If the economic program is challenged by distraction and
incoherence, then why, they ask, is the market making new highs? It seems that one of the factors that make
equities appear attractive, despite arguably stretched valuations, low interest
rates. Low interest rates are not only an under-appreciated boost to many
corporate earnings, but also makes the alternative to equities less
attractive.
The uncertainty over the trajectory of US economic policy is likely to
continue at least for the next several months. There is some hope
that the Senate can do its version of health care reform before the summer
recess. Ironically, Trump’s budget proposals assume the initial House
health care bill ($150 mln deficit reduction). Mnuchin initially
suggested tax reform could be complete by the August recess but has conceded that year-end may be more
likely. And of course, this assumes that the political
maelstrom is not a significant distraction from the economic agenda.