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Commentary Why risk and volatility are underpriced heading into Trump’s presidency

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave

Deborah Baic/The Globe and Mail

It is inauguration day and Donald Trump is now the U.S. president.

We now confront the "first hundred days" time frame, where our heads are likely to spin as much of the Obama regime gets unwound.

I realize I have been quite harsh in my assessment of Mr. Trump, but, if you go back over the years, I was also critical of Mr. Obama and George W. Bush as well.

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My intent is going to be to figure out what all the changes are going to mean for the investing landscape. And I come to the same conclusion: we are going to be in a heightened state of uncertainty, extreme volatility and a high likelihood of over-promising turning to under-delivering.

Other presidents came in with a couple of main objectives. Dwight Eisenhower with domestic infrastructure. John F. Kennedy with the space program and the Soviet threat. Richard Nixon with detente and China relations. Ronald Reagan with tax relief and military spending. Bill Clinton with health care and the environment. George W. with deregulation and isolationism. Mr. Obama with health care reform, reregulation and race relations.

Some presidents are obviously more successful than others. But they come into office juggling a couple of balls and staying focused.

Donald Trump, instead, is juggling way too many balls at the same time: Repeal of Obamacare; a wall with Mexico; immigration reform; China-Taiwan; China in the South Sea; a free trade deal with the UK; meddling in EU politics; warmer Russian relations; infrastructure; bringing coal mining jobs back; renegotiating NAFTA; other trade and tariff changes; corporate tax reform; personal income tax relief; revamping the intelligence community; ramping out military spending; reducing commitments to global institutions like NATO and the UN.

Let me know if I've left anything out.

Let's deal with what we know. To do anything really big, he will need 60 Senate votes, and, as we are seeing in this heated-up nomination process, the Democrats seem to want to play hard ball. Relations with the House GOP (Paul Ryan, in particular) are not great.

History shows that barely half of what presidents' campaign on typically gets passed. We only don't know which of the 242 promises made during the campaign will live to see the light of day.

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We also know that Mr. Trump is thin-skinned and seems to be easily distracted.

And while he has many years of experience running a business, he will find out that governing a nation is a different experience that requires a certain personality and character — like taking the high road. This is what made Mr. Reagan so exceptional.

Unfortunately, we are coming off eight years of a president that could not reach across the aisle, as Mr. Reagan and Mr. Clinton did. I'm not saying it was all Mr. Obama's fault, but it takes two to tango and telling Eric Cantor "Eric, we won," set the stage for acrimony, as did the non-partisan push for health care reform.

So I have a concern that Mr. Trump has too ambitious an agenda. And that the large number of today's optimists will be let down.

I also have a concern that Mr. Trump has the wrong diagnosis regarding the economy's structural malaise — and we know that when you have the wrong diagnosis, we will have the wrong remedy.

This is why I strongly feel that volatility and risk are underpriced and underappreciated in today's market environment.

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The incoming president seems to have convinced many that we are overtaxed. Well, that certainly was the case when Mr. Reagan was elected in 1980, but I'm not convinced that is the case today.

It is tough for me to believe that when the government pulls in 3 per cent less from the revenue base than what it spends that we have an overtaxed situation. If we do, then we had better start cutting public services too, but when the expenditure pie is dominated by entitlements, veterans' benefits, interest costs, and the military, there is not a whole lot of wiggle room.

No doubt, we need corporate tax reform to make the system more globally competitive, but it has to be made revenue-neutral. And cutting personal income taxes at a time when net public debt is 77 per cent as a share of GDP (107 per cent on a gross basis) is just plain fiscally irresponsible.

Who wouldn't want a tax cut? But no responsible parent would ever give their overweight child another candy bar.

As a nation, we are obese from a debt perspective. The total debt-to-GDP ratio (households, businesses and governments) at 250 per cent is as high now as it was at the 2007 cycle peak.

My friends, it was not excessive regulation that caused the last recession (the opposite, in fact). It was not excessive taxation, either. It was the weight of unsustainable indebtedness — and this condition has yet to be resolved.

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In fact, it could get worse in this coming administration, and leave the economy increasingly vulnerable.

What we need are policies that will be aimed at rebooting this debt-to-GDP ratio to levels that will create a greater backdrop of financial stability.

The reason why Mr. Reagan could embark on his fiscal expansion in the 1980s, was because the federal debt-to-GDP ratio was 30 per cent — the same as it was 50 years prior (the same ratio that prevailed when FDR unveiled the New Deal).

Embarking on tax cuts and spending growth at this current debt ratio carries significant risks. This is likely one reason why the two classic hedges against uncertainty (gold and bonds) have found their legs in recent weeks.

Make no mistake, this excessive debt ratio is a simultaneous constraint on growth and on long-term interest rates.

As I look to the critical hurdles the economy has faced in recent years, what I see are a lot of structural issues surrounding aging demographics, epic skills shortages and rampant technological change creating heightened labour market angst and anxiety.

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Excessive environmental protection this cycle did not prevent U.S. energy production from soaring at over a 9-per-cent annual rate.

Reregulation of the financial sector did not stop bank credit from expanding at a 4-per-cent annual rate this cycle, right in line with nominal GDP growth. Do we really want to go back to that 2002-to-2007 bubbly era where bank lending outpaced nominal GDP by multiples?

With respect to "globalization" (and other countries allegedly manipulating their currencies and unfair trade deals everywhere you look), the reality is that net foreign trade was neutral for the U.S. economy during this business expansion — much of the reason why we didn't see a contribution has nothing to do with unfair trade and more to do with a weak global economy. Full stop.

As for capital spending, what more can be said except that when capacity utilization rates are close to 75 per cent, there is little need for the corporate sector to embark on a major plant spending expansion. ‎There simply is too much spare capacity.

Beside the fact that the economy is carrying far too much debt on its shoulders, the most acute obstacle for the economy has been an ever dysfunctional labour market.

I don't think we have a productivity problem — in fact, the demise of productivity is vastly overstated and that is because the Bureau of Labor Statistics (BLS) is likely vastly overstating labour input, and I'm talking here about how hours worked are estimated.

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But the real travesty, and what I think deserves top priority (but I don't see it), is that we have, in addition to 7.5 million officially unemployed (a number that is closer to 15 million when all the hidden unemployment is accounted for), 23.5 million Americans aged 25-to-54 who reside outside the confines of the labour force. And at a time when job openings are at record highs.

The problem is that unqualified applicants for these openings also are at a record high. The number of jobs available that are not being filled because the skill set is absent is at an unprecedented level — and this was an overriding theme in the latest edition of the Fed's Beige Book.

The question is what is in the policy playbook to redress this situation?

What we need is a policy playbook that makes education, apprenticeship and training a major priority — the one plank that I had hoped would be yanked out of Bernie Sanders's platform.

While deregulation and simplifying the tax code obviously are constructive segments of the Trump plan, they are not the most important obstacles in the way of growth. Neither is globalization.

Even the most ardent "supply-sider" would admit that labour input is key to the outlook and this should really be at the top of the agenda — closing the widening and unprecedented gap between job openings and new hiring. There simply is no replacement for excellent education achievement with respect to maximizing labour productivity.

I see scant attention being paid to this file — surely this is more important than U.S. involvement in Brexit or trying to play a role in breaking up the European Union, don't you think?

The low levels of proficiency not just in the maths and sciences but also in reading is the real travesty, far exceeding anything else that is curbing America's growth potential.

It's not currency manipulation in China that is the problem with U.S. relative competitiveness. It is that student performance in mathematics there is, on average, two years ahead of U.S. students (OECD data).

The country simply is not investing enough resources in helping workers deal with job transition, training programs and searching assistance.

Other countries are much further ahead in this respect and this will take on greater importance as we move increasingly towards an A.I.-driven world economy. We need a far greater effort in transitioning the labour market through this "Fourth Industrial Revolution" — artificial intelligence, automation, and robotics.

The future is medical imaging software, cyber security, networking architecture. And for this we need an education system that will graduate students proficient in computer science, statistics, mathematical logic, critical thinking and engineering.

Not that we don't need artists in Santa Fe — but we have a skills shortage of epic proportions that is receiving scant attention.

Meanwhile, the BLS estimates in the next few years, three-quarters of the jobs in the fastest growing parts of the economy will require a university education. The high-school diploma isn't cutting it now and it sure won't in the coming decade — and our educators are going to need ever-more support and professional development.

There is no new gas pipeline, airport improvement or improved trade deal that will remedy this greatest constraint of all on growth which is the incredibly wide and growing gap between the skills our kids have and what businesses need.

This is the infrastructure the economy urgently requires, and I do admit this is not about coal, steel, cement, concrete or shipyards.

This is not the 1970s any more, nobody is watching Happy Days any longer, and the pledge that these jobs will come back is a joke. I hope nobody truly believed that during the campaign.

What we need, in my opinion, is a commitment from the government to improve access to post-secondary education, increase affordability and create incentives for completions and for graduates in high-skilled disciplines.

If you're wondering what is happening beneath the surface, state funding for higher education is down 18 per cent in the past seven years and tuitions at public colleges have soared 33 per cent.

I don't know why it is that Mr. Trump has not added this to his "disaster" list, but this needs a remedy. Perhaps taking a feather or two out of Mr. Sanders's education‎ plank wouldn't be a bad idea.

As for the existing workforce, it would be incredible if we could somehow get these 23.5 million prime-age adults who are disengaged from the economy to re-enter the labour force.

Those who have been out of the workforce for more than two years may be permanently impaired, but there is an opportunity for Mr. Trump, assuming this is important to him, to embark on policies to make these folks employable again.

But this will take investment that does not include reopening coal mines and steel mills — it will require investment in ‎job training programs (and of the high-quality variety).

The federal government — and this is astonishing — only supports 175,000 people annually in terms of helping people navigate job transitions, which is becoming vital given this parabolic shift we are seeing on the technological front.

Public spending on job training, apprenticeships, and skills upgrades today accounts for 0.1 per cent of GDP, one-sixth the OECD average and less than half of what was being spent three decades ago when the economy was far less complex and dynamic than is the case today.

I will leave you with a ditty from Janet Yellen's speech in San Francisco on Wednesday (as an aside, she made no bones about her belief that the funds rate is heading higher):

Then there is structural unemployment — a difficult problem both for the people affected and for policymakers trying to address it. Sometimes people are ready and willing to work, but their skills, perhaps because of technological advances, are not a good fit for the jobs that are available. Or suitable jobs may be available but are not close to where they and their families live. These are factors over which monetary policy has little influence. Other measures — such as job training and other workforce development programs — are better suited to address structural unemployment.

I share her concerns and I also have little conviction that we will see policies that address the structural impediments to sustainable growth. That said, I wish the new President of the greatest country on the face of the earth success because if he succeeds the world will be a better place.

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David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

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