Trump as Reagan Mark 2 ? It's a different time, and very different circumstances .....

Trump as Reagan Mark 2 ? It's a different time, and very different circumstances .....

ref :- "Trump takes the reins without the benefit of Reagan's timing" , John Plender in the Financial Times, Markets and Investing

Donald Trump's prospective economic policies have invited comparison with those of Ronald Reagan ever since those detailed to analyse such things realised somewhat belatedly that a Trump win was a genuine possibility. Of course, for many of them that didn't happen until victory was already in the bag, but still .....

Not everybody is happy with such comparisons. Reagan may have split opinion among his contemporaries but the passing of time colours people's memories and history tends to treat him very fondly for the most part. The Donald, on the other hand, is just at the start of what promises to be a rollercoaster ride of a presidency and he cuts a divisive figure, to say the least. But undeniably the incoming President's policies will have a good deal in common with Reaganomics, even if we don't yet know many of the important details.

Along with the likes of Britain's Margaret Thatcher, Mr Reagan was known as a champion of the free market (largely due to his own, slightly misleading rhetoric) but the fact is that he espoused protectionist policies in much the same way as Mr Trump is likely to, raising tariffs and import quotas to protect domestic producers. He was also an enthusiastic cutter of headline taxes ...... ring any bells ?

That kind of loose fiscal policy coincided with rising interest rates as that hawkish Chairman of the US Federal Reserve Paul Volcker showed his determination to defeat inflation, then considered an economic evil of the first order. The result was a strong dollar that ultimately soared to unsustainably overvalued levels.

Whether you believe that the current dollar strength will continue or not (and it doesn't look as clear-cut now as it did then), the comparisons between the two eras are obvious : Mr Trump is proposing loose fiscal policy (tax-cutting and infrastructure spending) at a time when interest rates are heading higher, resulting in a strong currency. Where the analogy falls down however is an examination of the very different circumstances facing the two Presidents upon inauguration.

In 1981 Reagan took over an economy in a recession caused largely by the second oil crisis. He was fortunate in that under his watch the economy was able to benefit from both a cyclical recovery AND a collapse in oil prices. As inflation fell so too did interest rates, encouraging growth and starting a bull run in bond markets that lasted 35 years (assuming it did indeed end after November's election).

Trump on the other hand inherits an economy that may be at the end of a long period of growth. Even if the growth has not always been terribly robust, this period of expansion has lasted seven years, much longer than the average upturn. Wages are rising, there is little slack in the economy and worryingly at a time of ultra-low interest rates there has been very little capital expenditure  --  in other words, investment  --  which means that productivity is low.

Back to 1981, and high levels of unemployment meant that the economy was able to grow faster than potential for an extended period without incurring inflation. (NOTE 1 : Potential GDP is the level of output that an economy can produce at a constant inflation rate) . Mr Trump by contrast faces an economy at or near full employment and risks both an increasing output gap and a jump in inflation. (NOTE 2 :  Output Gap  ....the difference between actual GDP and potential GDP). Nor is he likely to have the benefit of a marked fall in the price of oil, although the re-entry of his much-favoured shale companies as market players might at least keep a cap on prices.

Another issue which presents Donald Trump with a problem that his celebrated predecessor did not have to contend with is that of debt. Reaganomics will always be associated with deeply escalating levels of public debt, which in the short-term at least is surely what Mr Trump's policies will also produce. The difference is that gross public debt today is already at 105% of GDP before Mr Trump even gets started, more than double what Mr Reagan left behind in 1989. And with corporates also having gorged themselves on debt during the period of ultra-low rates to indulge in share buybacks and M & As (but crucially not in investment), the danger is that this issue of debt could blow-up in Mr Trump's face . 

What seems certain is that Mr Trump will NOT face any of the deflationary worries of recent years. The US will not be going down the Japan route. Mr Plender's question is whether  the market is taking the danger of inflation seriously enough, especially if Mr Trump implements protectionist measures to match his belligerent rhetoric. He points out that although a strong dollar does effectively tighten monetary conditions, this is offset by the fact that real interest rates remain negative and therefore add stimulus. (NOTE 3 : Real Interest Rates = Nominal interest rates minus inflation).

Bond markets will be the measure of how well the incoming administration deal with the growth / inflation / interest rate conundrum. What Mr Trump will have to encourage is a smooth transition from bull market to bear market, which is not easy at the best of times. He'll have to avoid sharp rises in interest rates and bond yields, and to do so he'll probably have to keep a lid on his more ill-considered rhetoric  --  not something he is known for. Otherwise, and with debt levels so high, any crisis in the bond markets will spell big trouble not just for market participants but the whole economy.