Rewiring Chaos

What does the Trump2 message mean? Wailing is useless

President-elect Trump’s command of both houses and Supreme Court mean he is better prepared and more determined to radically remake America and the world. He has nominated committed loyalists to key positions. An appropriate reaction would be “what will this mean?”

Instead there is tantrum! A selection of today’s Financial Times headlines suggest a kindergarten having its break time interrupted. "The Republican War on Science" "Trump's demolition of the US state" "Why Trump's trade war will cause chaos" "Trump's attack on the enemy within will delight America's real foes". A universal wail that 'everything about Trump2 is wrong'.

This is hubristic personal opinion, not journalism. All the stories are versions of the same article covering ostensibly different areas of policy. Each of them say "we hate it, we are frightened and where here to tell you". Little serious consideration of enactment process, path dependency, likely reactions from other policymakers, other countries. As a consequence, all these articles are worse than wrong, they’re useless. The concerted howl postulates nothing other than that the status quo ante is self-evidently better than anything Trump is proposing. That is obviously incorrect and it is childish. The bleating doesn’t help understanding one bit. Certainly it doesn’t help justify the status quo.

Photo by Terence Starkey on Unsplash

A constructive approach would involve critical analysis, and conscious restraint of learned reactions. Perhaps follow a list of questions such as the following: ‘What does Trump say he will do? What does that actually mean? What are the impediments to enactment? Which bits may lead to benefits for society? How may existing institutions adapt?

These prompt further questions. Which parts of our ‘rules based system’ reflects Trump’s concerns? Which parts of Trump’s proposed reforms may change in the inactment process? What are the likely reactions? How may this look in 6 months time? How may this look in 4 years time? What are the benefits that will inevitably accompany the purported costs? Where will those benefits most accrue? How will the costs be distributed? Yet so far all we hear (and of course it is not just the FT) is the collective howl of rejected hubris.

Tariffs are coming. What does that mean? Well, it means the contradictions of the dollar’s ‘Exorbitant Privilege’ will enter America’s political arena explicitly . How these contradictions are tackled will determine economic outcomes for the entire planet, perhaps for generations. Despite the FT’s complaints, there’s a chance the outcome will offer more equitable global trade arrangements. It is certainly not possible to discern how it will settle. But it is possible to frame important questions.

As Trump2 enters government, a growing theoretical body of work is willing to frame and justify radical change. It is still a fair bet that opportunities will be squandered for short-term political advantage. Or squashed or distorted by vested interests. For these interests are among the most powerful of all including global institutions, central banks, Wall Street and China. It will upset allies. It will require long-term focus. The obstacles are daunting. But to shirk reform simply adds to already huge problems, especially that of US fiscal unsustainability. By all means highlight the risks and downsides, but try to discern (and guide) opportunity as well as negatives.

A great paper by Michael Pettis and Erica Hogan of Carnegie Endowment lays out a coherent shape for trade reform. They show how reserve status and mercantilism directs foreign investment into America, undermine manufacturing at the expense of consumption while bolstering debt and financial market bubbles. It is also terrible for consumption in surplus countries like China - with political implications within China that all Americans (and Europeans) should favour.

The paper outlines the disasterous imbalances of the current global trading system which accompany dollar dominance; how they arose, their costs on households and industry, and what can be done about it. Pettis/Hogan consider Trump campaign ambitions on tariffs but prefer controls on capital flows, preferrably multi-laterally, but if necessary unilaterally by America. Let that sink in for a few minutes. The global investment destination of first resort has a serious economist advocating restricting incoming capital. What does that mean for the S&P500?

To say the paper’s ambition is huge is true, but insufficient. The author’s entirely reimagine a replacement for the post-Nixon trading framework. It is a remarkable work that starkly, and concisely, shows the dilemmas with which the new administration is attempting to grapple - something I alluded to here. Think of the paper as a benchmark for coming policy - what ‘should’ happen if rational policy actors were in charge.

Another outline for reform, more closely aligned to Trump campaign promises, comes from Stephen Miran at Hudson Bay Capital. In the paper, Miran argues we are ‘on the cusp of generational change in the international trade and financial systems.’ Yes, it may be that big. There is a good YouTube interview with Stephen here.

Miran, Pettis and Hogan openly refute the accepted wisdom of self-regulating free-trade. This refutation will now be tried and serious thinkers will try to work out how it can best deliver favourable outcomes. They advocate deliberate intervention to correct the massive trade imbalances. This is economist heresy. Or was.

But just as the Global Financial Crisis destroyed political consensus around laissez-faire financial markets, the relentless accumulation of dollar financial power has undermined, possibly fatally, orthodox assumptions of free trade. Benefits for both Americans and Chinese citizens have been redirected into financial markets, international corporations and mercantilist state actors (i.e. political insiders). The remedy, the paper argues, is to reassert comparative advantage by deliberately subverting the centrality of the dollar - including the use of tariffs and capital controls. If a concise and convincing theoretical justifcation for reform accords with political will it is not likely to stay private.

The paper describes what ‘should’ be done to correct a dangerously unstable status quo. Should happen is, of course, different to what ‘could happen’ and both are different to what ‘will’ happen. Yet almost any long-term remedy to the current dystopian trade system raises questions about the dollar’s current central role. The political tension those questions raise will define how asset markets perform and whether the gambles of Trump2 lead to gains or chaos, or both.

In coming pieces I’ll consider some of the obvious questions these policies pose for asset markets.