Wednesday, 20 of June of 2018

Economics. Explained.  

Dampening Expectations

August 18, 2017

The economy is chugging along nicely.  But non-economic events like the North Korean crisis and Charlottesville, and disquieting tweets from President Trump, are causing business leaders and politicians to wonder if he can accomplish his political agenda.  If it ever becomes clear that tax cuts are not going to happen, the stock market is going to pull back sharply.  Investment spending will be curtailed, and GDP forecasts will be trimmed.  Rather than having a legitimate hope that GDP growth could quicken from its current 2.0% pace to 2.8% or so by the end of the decade, forecasts would revert to the same slow growth rate we have seen for the past several years.

GDP growth was 1.2% in the first quarter and 2.6% in the second.  Third quarter growth is likely to be about 3.0%.  Consumer spending is holding steady at about 2.5%.  What gives us hope for faster growth ahead is the fact that investment spending surged in the first half of this year.  Nonresidential investment jumped 7.0% in the first quarter followed by 5.1% growth in the second quarter and is on track for a 4.0% increase in the third quarter.  Keep in mind that business spending was largely unchanged in 2015 and 2016.

There can be little doubt that this acceleration is due in large part to President Trump.  He came into office advocating significant health care reform, lower individual and corporate income taxes, relief from a stifling regulatory environment, and an opportunity for business leaders to repatriate overseas earnings at a favorable tax rate.  That is a very pro-business agenda.  It would enhance corporate earnings, boost growth in productivity, and trigger faster GDP growth both near-term and in the years beyond.

In response to Trump’s proposed agenda the stock market climbed 18% between the election and mid-August.  The dollar jumped 4.0%.  Both domestic and foreign investors were encouraged.  But now all are beginning to question Trump’s ability to actually implement his agenda.  He promised to quickly repeal and replace Obamacare.  That did not happen.

His steady diet of disturbing tweets is bringing further into question his ability to pass his agenda.  For example, his extraordinary warning that any further threats by North Korea against the United States would result in “fire and fury like the world has never seen” brought the U.S. the closest it has been to a nuclear confrontation since the Cuban missile crisis in the 1960’s.  Those statements were scary and drew widespread criticism.  However, they sent a strong signal to both North Korea and China that the U.S. treated those threats seriously.  For now Kim Jong-Un has backed off his threat to fire missiles at Guam and said instead that he wanted to monitor the “reckless Yankees” but left open the door for a strike later.  While the crisis is far from over it has abated for now.

Following the attack in Charlottesville Trump initially said, “We condemn in the strongest possible terms this egregious display of hatred, bigotry and violence on many sides”.  That seemed to suggest that both groups were at fault.  A day later he said “Racism is evil.  And those who cause violence in its name are criminals and thugs, including the KKK, neo-Nazis, white supremacists and other hate groups that are repugnant to everything we hold dear as Americans.”   A day later he recanted that statement and said “I think there is blame on both sides.”  His unwillingness to explicitly and consistently attribute blame to the far-right extremists has cost him the support of many business leaders as one after another chose to resign from his business councils and he was eventually forced to dissolve them.  Republican leaders like John McCain, Lindsey Graham, and Marco Rubio strongly denounced his comments.

What does all of this mean from an economic viewpoint?  It suggests that both U.S. and foreign investors are becoming increasingly nervous and concerned that Trump will be unable to accomplish what he had hoped to do.  The dollar rose sharply between the time of the election and the end of January.  It has since fallen 6.5%.  Earlier this year the Euro cost $1.06.  Today it costs $1.18.  Earlier this year one U.S. dollar bought 115 yen.  Today it purchases 110 yen.  Admittedly, not all of the drop can be attributed to a lack of faith in President Trump.  In the past several months GDP growth in Europe and Asia has gathered some momentum which enhanced the desire by foreign investors to pull back from dollar-denominated investments.

The S&P 500 index rose 18% from the time of the election through mid-August, but it has contracted by 2% in the past few days.  That is another hint that U.S. investors are beginning to question Trump’s ability to achieve tax cuts and health care reform.  We share that concern but are unwilling to abandon the idea that a diluted version of tax cuts and health care reform will pass at some point.

If it becomes increasingly apparent that Trump will have neither the legislative nor business support to pass his agenda, the markets will make the requisite adjustment.  The stock market will encounter a correction and give back much of its run-up since the election.  Business leaders will experience a renewal of uncertainty and curtail investment spending.  Economists will have to trim their expectations for GDP growth and give up on the notion of a pickup in potential growth to 2.8% by the end of the decade.  GDP forecasts will, instead, revert to the 2.0% mark for the foreseeable future with little hope of breaking out of the slump.  Let’s hope we do not have to go there.

Stephen Slifer


Charleston, S.C.

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