Nouriel Roubini is professor of economics at the Stern School of Business, New York University, and CEO of Roubini Macro Associates.
Financial markets have finally awoken to the fact that Donald Trump is U.S. President. Given that the world has endured two years of reckless tweets and public statements by the world’s most powerful man, the obvious question is: What took so long?
For one thing, until now, investors had bought into the argument that Mr. Trump is all bark and no bite. They were willing to give him the benefit of the doubt as long as he pursued tax cuts, deregulation and other policies beneficial to the corporate sector and shareholders. And many trusted that, at the end of the day, the “adults in the room” would restrain Mr. Trump and ensure that the U.S. administration’s policies didn’t jump the guardrails of orthodoxy.
These assumptions were more or less vindicated during Mr. Trump’s first year in office, when economic growth and an expected increase in corporate profits – owing to forthcoming tax cuts and deregulation – resulted in strong stock-market performance. In 2017, U.S. stock indices rose more than 20 per cent.
But things changed radically in 2018, especially in the past few months. Despite corporate earnings growing by more than 20 per cent (thanks to the tax cuts), U.S. equity markets moved sideways for most of the year, and have now taken a sharp turn south. At this point, broad indices are in correction territory (meaning a 10-per-cent drop from the recent peak), and indices of tech stocks, such as the Nasdaq, are in bear-market territory (a drop of 20 per cent or more).
Although financial markets’ higher volatility reflects concerns about China, Italy and other euro zone economies, and key emerging economies, most of the recent turmoil is due to Mr. Trump. The year started with the enactment of a reckless tax cut that pushed up long-term interest rates and created a sugar high in an economy already close to full employment. As early as February, growing concerns about inflation rising above the U.S. Federal Reserve’s 2-per-cent target led to the year’s first risk-off.
Then came Mr. Trump’s trade wars with China and other key U.S. trade partners. Market worries about the administration’s protectionist policies have waxed and waned throughout the year, but they are now reaching a new peak. The latest U.S. actions against China seem to auger a broader trade, economic and geopolitical cold war.
An additional worry is that Mr. Trump’s other policies will have stagflationary effects (reduced growth alongside higher inflation). After all, Mr. Trump is planning to limit inward foreign direct investment, and has already implemented broad restrictions on immigration, which will reduce labour-supply growth at a time when workforce aging and skills mismatches are already a growing problem.
Moreover, the administration has yet to propose an infrastructure plan to spur private-sector productivity or hasten the transition to a green economy. And on Twitter and elsewhere, Mr. Trump has continued to bash corporations for their hiring, production, investment and pricing practices, singling out tech firms just when they are already facing a wider backlash and increased competition from their Chinese counterparts.
Emerging markets have also been shaken by U.S. policies. Fiscal stimulus and monetary-policy tightening have pushed up short- and long-term interest rates and strengthened the U.S. dollar. As a result, emerging economies have experienced capital flight and rising dollar-denominated debt. Those that rely heavily on exports have suffered the effects of lower commodity prices, and all that trade even indirectly with China have felt the effects of the trade war.
Even Mr. Trump’s oil policies have created volatility. After the resumption of U.S. sanctions against Iran pushed up oil prices, the administration’s efforts to carve out exemptions and bully Saudi Arabia into increasing its own production led to a sharp price drop. Although U.S. consumers benefit from lower oil prices, U.S. energy firms’ stock prices do not. Besides, excessive oil-price volatility is bad for producers and consumers alike, because it hinders sensible investment and consumption decisions.
Making matters worse, it is now clear that the benefits of last year’s tax cuts have accrued almost entirely to the corporate sector, rather than to households in the form of higher real (inflation-adjusted) wages. That means household consumption could soon slow down, further undercutting the economy.
More than anything else, though, the sharp fall in U.S. and global equities during the past quarter is a response to Mr. Trump’s own utterances and actions. Even worse than the heightened risk of a full-scale trade war with China (despite the recent “truce” agreed with Chinese President Xi Jinping) are Mr. Trump’s public attacks on the Fed, which began as early as the spring of 2018, when the U.S. economy was growing at more than 4 per cent.
Given these earlier attacks, markets were spooked this month when the Fed correctly decided to hike interest rates while also signalling a more gradual pace of rate increases in 2019. Most likely, the Fed’s relative hawkishness is a reaction to Mr. Trump’s threats against it. In the face of hostile presidential tweets, Fed chair Jerome Powell needed to signal that the central bank remains politically independent.
But then came Mr. Trump’s decision to shut down large segments of the federal government over Congress’s refusal to fund his useless Mexican border wall. That sent markets into a near-panic, and the government shutdown was soon followed by reports that Mr. Trump wants to fire Mr. Powell – a move that could turn a correction into a crash. Just before the Christmas holiday, U.S. Treasury Secretary Steven Mnuchin was forced to issue a public statement to placate the markets. He announced that Mr. Trump was not planning to fire Mr. Powell after all, and that U.S. banks’ finances are sound, effectively highlighting the question of whether they really are.
Recent changes within the administration that do not necessarily affect economic policy-making are also rattling the markets. The impending departures of White House Chief of Staff John Kelly and Secretary of Defence James Mattis will leave the room devoid of adults. The coterie of economic nationalists and foreign-policy hawks who remain will cater to Mr. Trump’s every whim.
As matters stand, the risk of a full-scale geopolitical conflagration with China cannot be ruled out. A new cold war would effectively lead to deglobalization, disrupting supply chains everywhere, but particularly in the tech sector, as the recent ZTE and Huawei cases signal. At the same time, Mr. Trump seems to be hell-bent on undermining the cohesion of the European Union and NATO at a time when Europe is economically and politically fragile. And special counsel Robert Mueller’s investigation into Mr. Trump’s 2016 election campaign’s ties to Russia hangs like a Sword of Damocles over his presidency.
Mr. Trump is now the Dr. Strangelove of financial markets. Like the paranoid madman in Stanley Kubrick’s classic film, he is flirting with mutually assured economic destruction. Now that markets see the danger, the risk of a financial crisis and global recession has grown.