Steve Forbes once joked that if you ever find yourself in a middle seat on a plane and want to create some elbow room, try starting a conversation about U.S. monetary policy. It is a subject whose power to bore the pants off fellow passengers may diminish in coming years.
Of dozens of potentially explosive problems the new Washington administration faces, not the least is monetary policy. A key dilemma is how to keep interest rates low while pursuing a tough trade policy. As we will see, the two objectives seem mutually incompatible.
Of course, all this presupposes that Trump will get a chance to reshape the economy in the first place. That is far from certain. He runs the gauntlet of open hostility not only from almost every rival centre of power in Washington, but from many of his own nominal allies and supporters in the Republican Party.
Thus although the Republicans enjoy majorities in both House and Senate, this will count for little in pursuing his more controversial policies. Indeed, as the author and policy analyst Pat Choate points out, Trump has little sense of how treacherous the Washington waters truly are.
One big concern is a possible impeachment. “Any issue will do for his opponents, so long as it can be sold to a solid majority of the populace,” Choate says. “Most Republicans in Washington would prefer Pence. Thus, there will not be a hard defence of Trump by the party.”
Choate, who ran for Vice President on Ross Perot’s ticket in 1996, adds: “Obama had solid control of the government when he took office in 2009. But within two years, he had lost the House and had only a thin majority in the Senate. He lost both in the 2012 elections. The Republicans know the same can happen to them with Trump at the helm. So they would be willing to allow Democrats to take the point of spear in the battle and then, if the public is willing, they would ‘reluctantly’ replace Trump with Pence. Trump has no idea what hardball politics is like at this level, but will soon learn.”
In common with many observers, Choate believes Trump’s greatest vulnerability is the so-called emoluments provision of the U.S. Constitution. This prohibits Presidents from taking anything whatever from foreign sources. The Brookings Institute did a study in December and provided what is considered a definitive case that Trump’s overseas businesses have put him on the wrong side of the Constitution from Day One.
What we know for sure is that bookmakers are already horning in on the emerging crisis. The Irish gambling chain Paddy Power, for instance, is offering odds of six to one against an impeachment in Trump’s first six months.
Even if Trump manages to duck the impeachment bullet, he seems extraordinarily tightly boxed in on economic policy. A fundamental concern is a Gordian Knot involving major exporting nations. For more than forty years it had been precisely these nations that Washington has relied on to buy vast tranches of U.S. Treasury bonds. Their purchases have not only financed both the fiscal and trade deficits but maintained both interest rates and the dollar’s foreign exchange value on an even keel.
Japan and China now rank broadly equal as the world’s largest foreign holders, and Germany is not far behind. Trump’s problem is that to deliver on his promise to rein in America’s huge trade deficits, he must prevail on these nations massively to increase their purchases of America’s manufactured exports. By a variety of stratagems they have successfully resisted doing so for decades. If Trump now tries to paint them into a corner, he will discover they don’t lack for ways to fight back. By selling just a fraction of its Treasury bond holdings, any one of these nations can cause a painful blip in U.S. interest rates. The knock-on effect on American stock markets could be disproportionate (it doesn’t help the Trump White House that U.S. price/earnings ratios are at an all-time high). The American tendency to think short term and a collective inability to bear pain should clinch the matter. Suddenly both the Wall Street and Washington establishments would be on Trump’s case like never before.
Although a cheap dollar would in the long run pay dividends by helping restore U.S. industrial competitiveness (and this seems understood not only by Trump himself but by some of his key people), the most visible immediate effect would be to raise U.S. consumer prices. Thus any dollar setback could greatly exacerbate a sudden sense of malaise caused by falling stocks.
For now let’s note a few numbers. The Standard & Poor’s 500 index (the benchmark for all serious discussions of American stock market trends) closed at 2,294.69 on Friday (January 27). That was a sliver below an all-time high reached the previous day and means U.S. stocks now stand more than 60 percent higher than their already seemingly overvalued level of late 2013.
As for the dollar, it reached more than 96 Euro cents in the last week of 2016. That was its highest showing since before the invasion of Iraq in 2003. Although it has dropped back a little since, it seems remarkably overvalued given that the U.S. current account deficit at last count totalled $469 billion (and Germany’s current account surplus hit $301 billion).
That said, both U.S. stocks and the U.S. dollar could well continue to edge higher in the short term. It is the longer term that matters. Assuming the Trump administration possesses the intestinal fortitude to stand by its vitally needed tough stance on trade in the years ahead, we should brace ourselves for a big setback in stock prices, a much lower dollar and a big hike in interest rates.