In the lead-up to Jan. 20, when Trump assumes the US Presidency, Asians are all guessing on what the outlook will be for their savings.
Trump is particularly difficult to read because he has made so many wild statements during the campaign trail. Everyone accepts that campaigners promise heaven and deliver mostly hell, but when they win the election, they should become much more sober. So far, it looks like policy will follow his campaign threats.
The Trump presidency will be bi-polar -- either highly successful if he re-boots American dynamism, or one that may bankrupt the country trying, including getting involved in another war.
These wild swings in investor mood can be read from the way the markets have yoyo’d from hesitation to rally, with the Dow showing another peak.
Disappointingly, if the treasury secretary is another ex-Goldman Sachs man, Wall Street appears to have another insider running the status quo. It remains to be seen if the new treasury secretary can manage simultaneously the promised spending on infrastructure, cutting taxes for the rich and containing the effects of a stronger dollar.
All signs are that the dollar will become stronger, repeating the famous phrase – my dollar, your problem. The latest (June 2016) International Monetary Fund health check on the US economy remarked that “the current level of the US dollar is assessed to be overvalued by 10-20 percent and the current account deficit is around 1.5-2 percent larger than the level implied by medium term fundamentals and desirable policies.” The IMF thinks that the risk of a dollar surge in value is high, with a 10 percent appreciation reducing gross domestic profit by 0.5 percent in the first year and 0.5-0.8 percent in the second year.
Trump is likely to be highly expansionary in his first year because the Republicans, having control of the Congress, Senate and presidency, must demonstrate that they will revive growth and jobs to ensure a second term. Note carefully that Trump’s election promises of stopping immigration, cutting the Trans-Pacific Partnership, imposing sanctions on China and canceling the North American Free Trade Agreement are all inflationary in nature.
This is why if the Fed does not raise interest rates in December this year, it may be under pressure next year not to take any action to slow a Trump economic recovery. Independence of the Fed will be called into question, since Trump’s expansionary policy will put pressure on his budget deficit and national debt, already running at 3 percent and 76 percent of GDP respectively. An increase of 1 percent in nominal interest rates would add roughly 0.7 percent to the fiscal deficit, making it unsustainable in the long-run.
Those who think that recovery in US growth would be good for trade are likely to be disappointed. So far, the US recovery (which is stronger than either Europe or Japan) had not led to much increase in imports, due to three effects -- lower oil prices, the increase in domestic shale oil production and more on-shoring of manufacturing. The US current account deficit may worsen somewhat to around 4 percent of GDP, but this will not improve unless sanctions are imposed on both China and Mexico, which will in turn hurt global trade.
Why is a strong dollar risky for the global economy going forward?
The answer is that the global growth model would be too dependent on the US, whilst the other economies are still struggling. Europe used to be broadly balanced in terms of its current account, but has moved to become a major surplus zone of around 3.4 percent of GDP as a whole. Germany alone is running a current account surplus of 8.6 percent of GDP in 2016, benefiting hugely from the weak euro.
Japan has moved back again to a current surplus of 3.7 percent of GDP, but the Yen remains weak at current levels of 107 to the dollar. I interpreted the Bank of Japan’s qualitative and quantitative easing as both a financial stability tool and also to ensure that the capital outflows by Japanese funds would outweigh the inflows from foreigners punting a yen appreciation. The Bank of Japan’s unlimited buying of Japanese government bonds at fixed rates would put a cap on losses for pension and insurance funds holding long-term bonds if the yield curve were to steepen (bond prices fall when interest rates rise). Japanese pension and insurance funds have been large investors in US Treasuries and securities for the higher yield and possible currency appreciation.
In short, the capital outflow from Japan to the dollar is helpful to US-Japan relations. Prime Minister Shinzo Abe, being the first foreign leader to call on Trump, is dangling a carrot that Japan can fund Trump’s expansionary policies, so long as Japan is allowed to re-arm.
Between June 2007 and June 2015, US Treasury data showed that the total amount of US securities held by foreigners increased by $7.3 trillion to $17.1 trillion, bringing its gross amount to 94 percent of GDP. Japan already holds just under $2 trillion of US securities and as a surplus saver, has lots of room to buy more.
The bottom line for Asia is not to expect great trade recovery from any US expansion. On the other hand, Asian investors will continue to buy US dollars on the back of the prospect of higher interest rates and better recovery. This puts pressure on Asian exchange rates.
Of course, it is possible that the US fund managers will start investing back in Asia, but with trade sanctions and frosty relations between US-China in the short-term, US investors will stay home. If interest rates do go up in Asia in response to Fed rate increases, don‘t expect the bond markets to improve. The equity outlook would depend on individual country responses to these global uncertainty threats.
In short, expect more Trump tantrums in financial markets.
By Andrew Sheng
Andrew Sheng comments on global issues from an Asian perspective. –Ed.
(Asia News Network)
