Peter Thiel, the billionaire who became Donald Trump’s most prominent backer in Silicon Valley, made a critical distinction last week. He complained that the media tended to take the man literally, but not seriously.
Now that Mr Trump is the president-elect of the US, everyone takes him seriously. And hence it becomes vital to work out whether we should take what he has been saying literally. After two days when markets leapt to assume that Mr Trump means growth, higher interest rates and inflation, and allocated their money accordingly, it is imperative to work out whether the market has taken him too literally.
Markets assume President Trump will mean stimulus at last. In some form, this is correct. That explains the explosive rise in bond yields, and the steepening of the yield curve, with longer-term interest rates rising further, to signal inflation ahead. Even Henry Kaufman, known as Dr Doom for his gloomy prognoses on interest rates as a Wall Street economist in the 1970s, this week told the Financial Times that a secular rise in bond yields had begun, after a decline of more than three decades.
But how exactly will the stimulus happen? Many in Wall Street are already drawing a comparison with Ronald Reagan (who, like Mr Trump, was a Republican who arrived in Washington as an outsider, with many doubting that he was up to the job). He cut taxes, did not cut spending, and merrily allowed the deficit to rise. A boom resulted, accompanied by the beginning of long bull markets in both stocks and bonds.
One rather big problem with staging a repeat is the bond market itself — Reagan arrived with rates sky-high, while President Trump will arrive as companies have been bingeing for years on cheap debt. Meanwhile, the aggressive Fed under Paul Volcker, with interest rates of 20 per cent at one point, made the world safe for expansive fiscal policy. The Fed is now aiming to raise rates, and may have to do so rapidly. Corporate America’s indebtedness could put a limit on deficit-driven expansion.
An alternative is to be FDR, or maybe Eisenhower, and boost spending on infrastructure. This is after all an area in which Mr Trump has undoubted experience. The reasons to do this are manifold. But could it survive the inevitable principled opposition from the many Republicans in Congress who want a smaller role for government? Pulling off a trick like this eluded Barack Obama, and would require great political skill, which Mr Trump may well not have.
Emerging market currencies have taken a dive since Tuesday night. This is not just about Mexico, which obviously stands to be grievously hurt in any trade war with its vast neighbour to the north. Turkey’s lira, like the Mexican peso, dropped to an all-time low against the dollar on Thursday. Many other emerging market currencies dropped, while the Chinese renminbi, a far more managed currency, dropped to a point where it had erased almost all its gains versus the dollar since the authorities embarked on a managed appreciation in 2010.
Some of this follows the script from the “taper tantrum” of 2013, when higher US yields in response to talk that the Fed would taper off its support for the market, led to a sharp sell-off for straitened emerging market currencies and briefly threatened a true emerging market crisis. With China awkwardly trying to manage an economic transition, even the biggest emerging economy could be involved this time.
That incident, though, was easier to manage than this one might be. The Fed slowed down before tapering, and the market calmed down. What is different this time is that markets are not just bothered about rising yields, but also about Mr Trump’s threats of new tariffs. These are very threatening to emerging markets, and lie to a great extent within presidential discretion. A few more days of declining currencies like this, and their ability to repay their dollar-denominated debts will begin to come into question — and Mr Trump could face his first governing dilemma before he even takes office. Would he backtrack on his talk of tariffs to avert an international crisis? If there is one president who is remembered for tariffs, after all, it is Herbert Hoover, who presided over the Great Depression. It is not an encouraging parallel.
Does Mr Trump mean what he has said about breaking up concentrated oligopolies on the campaign trail, and does he follow through when he bears a grudge? Growing industry concentration, allowing companies to increase profits and lay off workers while increasing prices, goes a long way to explain the disjunction between increasing profits and stagnating living standards. Attacking trusts and monopolies, like a latter-day Teddy Roosevelt has great appeal. Nowhere is power more concentrated than in Silicon Valley.
Hence the stocks that roared ahead last year, and came to be known as the ‘Fangs’ (Facebook, Amazon, Netflix and Google) all tumbled precipitously. So did stocks involved in big planned mergers, such as AT&T and Time Warner, and which might benefit most from lighter regulations, such as pharmaceuticals. There are plenty of other stocks with far further to fall should Mr Trump is going to pursue a rigorous antitrust agenda; some clear signal on whether he is to be taken literally on this would help.
Too Big To Regulate
Bank shares have rallied phenomenally this week, even though Mr Trump railed against the insidious power of Wall Street in his final campaign ad. Beyond the effects of higher yields, which make it easier for banks to make a profit, this has been driven by a belief in Mr Trump’s anti-regulatory zeal, which he shares with Republicans in Congress.
Banks feel thoroughly set upon, and resent many of the measures imposed on them by Dodd-Frank legislation, which they now hope that Mr Trump will repeal. But here is the problem. US banks are highly concentrated, with several huge banks that could not possibly be allowed to collapse without inflicting terrible damage on the economy. If they remain that size, intrusive Dodd Frank-style regulation is necessary. It could doubtless be improved, but outright repeal could be disastrous. Mr Trump’s base is (rightly) furious at the role banks played in the 2008 financial crisis, and in the lack of accountability for them afterwards. And his own party’s platform calls for reinstating the strict Glass-Steagall separation between commercial and investment banking.
At the moment, the market seems to assume that Mr Trump will — rather ironically — be a second Bill Clinton, slashing bank regulations and putting little in their place. That analogy is unlikely to appeal to him, and bank investors should bear that in mind. They may be setting themselves up for disappointment.
Fighting the Fed
For many good reasons, the Fed’s loose monetary policy of the last eight years is deeply reviled, and Mr Trump has already said that he intends to replace chair Janet Yellen when her term expires. Taking on the central bank directly like a latter-day Andrew Jackson, would be a stupendously dangerous political gambit.
The arguments in favour. There is a long and respectable intellectual tradition that dislikes the current role of the Fed, and the role of fiat money. And arguably no issue more deeply divides the capital markets and economic elite from the populace who revolted this week. And with several governorships open, there are opportunities to alter it already, or try something radical.
Its mandate could be revised, along with the balance between its different branches. There are plenty of opportunities to turn the Fed into a more relevant institution for a 21st century economy. But this is a technical task of the highest difficulty, where small mis-steps would be magnified many times over by markets. Most presidents have understandably feared to tread there. Will President Trump really be different?
The possibilities are close to endless and the race to price in a positive outcome for the Trump presidency is premature. He has no precedents and many potential role models. He will give markets the chance to swing wildly just in the next few weeks, let alone the next four years, as we learn which of his pronouncements to take literally.