December 12, 2016
The soaring Wall Street is a tough short. In the course of November, the Fed put back in $58 billion of high-powered money, after a huge liquidity withdrawal of $245 billion in the previous two months.
And don't even think that the President-elect Donald Trump will offer easy puts and a coddling forward guidance.
If that's not enough of a hint, the brave souls contemplating a stab at markets' collective wisdom could also think of this.
Mr. Trump's America First policy is a corollary to Tip O'Neill's (the late, long-serving House speaker and a venerated Boston politician) maxim that "all politics is local."
That should be clear enough. A much more disconcerting is the habit of America's new chief executive of holding cards close to his vest. During his long election campaign, Mr. Trump always refused to give detailed accounts of his policy designs. As he put it, he was not going to tell his adversaries what he intended to do.
Both strategic principles served him well all the way to a convincing election victory.
They still work. Mr. Trump is still hard to read. To see that, the would-be short artists just have to look at some overseas reactions of people America used to spoon-feed with forward guidance.
Our European lecturers are utterly confused and dismayed. They are profoundly aggrieved by the demise of "America's 911 global military service" – an expression coined by Leon Panetta, the former defense secretary, during his Congressional testimony in February 2013. Germans are adding an angry rejoinder that Mr. Trump is a godsend to despots and tyrants around the world, but they refuse to buy spare parts for their grounded Luftwaffe (air force). They would rather use their riches to fund Germany's outstanding public services while America bleeds to defend them.
The Chinese are not so surefooted either. During a recent visit to Beijing of America's oldest and most famous sinologist, President Xi Jinping was quoted by Chinese media as saying: "Please tell me what is going on. I am all ears." And he apparently was for more than an hour-and-a-half. It seems that Mr. Trump has turned tables on those famously inscrutable Oriental sages.
Short On Superior Knowledge, Not Instincts
Shorts are hard work. During a presentation I gave some years ago to a group of Hong Kong investment managers, a youthful Chinese participant asked me a very pointed question about dissensions within the then governing Spanish Socialist Party (PSOE). Since he seemed satisfied with my answer, I asked him why he was so deeply interested in Spanish politics. And this is what he said: "I want to know everything about my shorts."
The Wall Street bull-run is a tempting contrarian play, especially for people who made a mint on Germany's failed attempts to throw Greece out of the euro area, and on similar "sure thing" sovereign defaults in a number of highly indebted EU countries.
And then they seem to think that there are some easy sitting-ducks: America's mature bull market, "excessive" valuations and, allegedly, a host of long-overdue, revert-to-mean, "imperatives."
That may be fair targets, but the massive bets are placed elsewhere. Indeed, people are betting on heroic assumptions that Mr. Trump's team will succeed in propping up the sagging U.S. economy.
Hopefully, these investors realize a tough slog that lies ahead. America's current growth dynamics (1.5 percent in the first nine months of this year) are not good. They are held back by tight physical limits to potential growth, estimated at about 1.6 percent, and the fact that the monetary policy, acting alone, cannot remove the cyclical and structural obstacles clogging up the way to faster and broader output gains.
It will take time to change that. A stronger consumer confidence and a traditionally buoyant retail business during the fourth quarter could have revved up demand in the past few months, but that would probably be a flash in the pan because jobs and incomes are still a problem.
Investments Hop Over Trade Barriers
The growth of the real disposable household income has slowed to 2.9 percent in the first three quarters of this year from 3.6 percent a year before. The jobless rate is down to 4.6 percent, but the actual number of people out of work – 15 million – is more than double the officially reported 7.4 million, and the long-term unemployed still account for a quarter of the total number of job seekers.
And here is how big a drag on growth that could be: In addition to credit costs, jobs and incomes are the key variables driving about 80 percent of U.S. economy.
The monetary policy has done a great deal in reversing the damage done by its serious mistakes in the run-up to the 2008 financial crisis and the ensuing Great Recession. But, from now on, the Fed's solo play should be over; the new role should be to work in concert with more active fiscal, trade and structural policies to gradually lift the economy to the 3-4 percent growth path.
A growth-oriented fiscal policy could get a significant room to operate, without compromising public finances, by rearranging national priorities and maintaining an iron-clad discipline on how public money is managed and spent. You can call that a waste control. Think of how many roads could be repaved, bridges reinforced, airports modernized, school lunches served and healthcare services provided for those $125 billion that were unforgivably wasted by just one segment of the public sector administration. Reassuringly, the uproar about the $4 billion Air Force One plane is a signal that Mr. Trump is likely to keep an eye on where the taxpayers' money is going.
The bond market would like that. A commitment to keep public finances in good order is particularly important at a time when a discretionary fiscal policy is expected to play a bigger role in demand management. A good housekeeping rule would be to hold budget deficits below 3 percent of GDP, and to aim for rising primary budget surpluses to stop and reverse the increase in the $19 trillion of public debt.
Fiscal, trade and structural policies are closely intertwined. Their proper coordination is essential for efficient resource allocation, reaching particular growth objectives and expanding the economy's noninflationary growth potential.
Bilateral and multilateral (G20) forums must be used to reduce unsustainable global trade imbalances by insisting on policy changes in countries pushing large and systematic trade surpluses instead of growing on their own savings. Mr. Trump should ignore the squeals about trade wars. So far, his folksy "they-are-eating-our-lunch" scream is eliciting exactly what the trade theory says: If you (threaten to) limit trade, factors of production (i.e., investments) will come in.
The hugs and beaming photo-ops last week at the Trump Tower with Japan's Masayoshi Son (the SoftBank CEO) are a case in point. The pledge of a $50 billion investment had nothing to do with the European put-down nonsense about the Donald and Masa "billionaires' show." The Japanese simply saw a new writing on the wall, and rushed in to get a good slot at the ground floor of the emerging trade policy. The Chinese won't be far behind.
The U.S. economy needs a lot of support to expand its productive potential, and to get back to a sustainable noninflationary growth path of 3 percent (from 1.6 percent at the moment). Such a growth objective requires a properly calibrated mix of monetary, fiscal, trade and structural policies.
Mr. Trump and the Congressional leadership have an opportunity to redesign a supportive fiscal policy, without destabilizing cyclically and structurally fragile public finances. The payoff for that would be stable bond markets to benchmark attractive prices for consumer credit and mortgage finance, which drive three-quarters of the U.S. economy.
The Fed seems ready to cooperate. The management of money market operations and of its own balance sheet since early November shows that the Fed may be prepared to play an appropriate role in maintaining price stability and a sound dollar within a broader, growth-oriented policy mix.
The jawboning of American businesses to pause their off-shoring activities is apparently just an interim step until a new policy package emerges that should keep jobs at home in a sustainably profitable operational environment.
Investors are facing a swift transition to an activist and all-business American government. The new markers are set with a firm focus on jobs, incomes, infrastructure, and an apparent determination to put an end to humiliating declines of our education and healthcare to third-world levels.
These are the things that markets are betting on. Rest assured that Mr. Trump and his Wall Street appointees fully understand the conditionality of that welcome mat.
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