Bill Evans gauges Donald Trump

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From Bill Evans at Westpac today:

I have spent some time over the first week of my trip to the US with economists, officials and investors.

The general view is that growth in the US will gradually build through 2017; 2018 and 2019. That will be supported by easing financial conditions (tighter credit spreads and a rising share market to more than offset higher rates and a rising USD); rising business confidence; a lift in wages to reflect the fact that the labour market is at full capacity; and expansionary fiscal policy.

Rising wages, full employment and stronger growth will boost interest rates, with the FED tightening 2–3 times in 2017 and then 2–4 times in both 2018 and 2019. The peak in growth and interest rates is expected sometime in 2019, with the real Federal Funds Rate peaking around 1% (a zero real rate is seen as neutral).

After piecing together that profile, discussions usually shifted to the huge unknown – the policies of President Trump.

Despite my personal urging that infrastructure policy should be at the forefront of any initiatives, it was generally dismissed as being highly unpopular, with Republican senators seeing it as being too difficult to implement without a huge negative impact on the budget.

Early readings of Trump’s priorities indicate that health care; trade; tax and regulation are the focus. Personally I am attracted to the concept of an infrastructure bank, capitalised by a Federal Government guarantee.

That would seem to be a more practical approach than privatisation, where the complex relationships between Federal; state and local authorities vis a vis infrastructure assets means the time required to release funds through privatisation would be extremely long – i.e. many years.

Of course, privatisation policies should be embraced anyway, but doing so should not delay infrastructure initiatives.

All policy discussion was dominated by tax and trade. The base case on tax is taken to be the Ryan Plan which was released in June 2016 and contains some truly bold initiatives, including: cutting the corporate tax rate from 35% to 20%; and consolidating personal tax rates into three brackets, 12%; 25% and 33%.

These policies are broadly in line with Trump’s less detailed assertions.

However, to make the package “saleable”, Ryan includes some radical changes in approach. Corporates are to be taxed on sales rather than earnings, with standard deductions such as depreciation; interest; state taxes; and advertising no longer deductible. Meanwhile, capital investment would be deductible in full in the year it occurred.

Of most controversy is the Border Adjustment Tax. Under this tax, companies would be exempt from tax on revenue from sales outside of the US. On the other hand, companies which purchase goods or services from outside the US would not be able to claim a deduction on those costs.

Effectively, the US, which runs a massive trade deficit, would be taxing that trade deficit at 20%. Importers would be under huge pressure, while exporters would be given a massive subsidy.

Implications for inflation; the USD; and the trade policy responses of other countries would be significant.

For example, some argued that the USD would appreciate by 20% to reflect an improved trade position, protecting the margins of importers. That would also contain inflation pressures and help dilute the opposition from other trading partners, especially China.

My discussions concluded that there is only around a 20–30% chance of such an arrangement being implemented. However, in recent days Mr Trump appears to have moved from a detractor of the policy to a supporter. Of course, all that can change again.

Such a policy, while hugely disruptive, would certainly be in line with his approach on trade, and could possibly have the support of Republican senators.

For markets, the implications for currencies; rates and equities would be profound.

These types of uncertainties complicate the central views on the economy and markets set out above. In particular, the impact on confidence of possible policy gridlock and speculation around developments such as the Border Tax will be central.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.