No pain no gain? America and Trump 2.0

While the press focuses on personnel and personality, the real challenge for the incoming Republican administration will be events.

Nov 26, 2024

The phrase ‘lost in translation’ reflects a deeper truth about language - that it functions by distinction, and that “Languages differ by differentiating differently”1. The Japanese for example have a word for the space between clouds. They also have a word for a woman who is attractive from afar but less so when seen close up.

With a second Trump administration a few months away, the US stock market and bitcoin in particular appear to be hot for teacher, while the US dollar has risen as the potential impact of US tariffs on developed and emerging markets alike have started to be priced in.

Given all the big talk about cutting the deficit and eliminating graft in government, the US bond market has given a decisive thumbs down to Trump as yields at the longer end of the curve have continued to rise. Perhaps this is just the market suggesting that the Federal Reserve has been too swift to cut rates with the inflation rate still above target, but it may portend an underlying ugliness in the US economy that is set to be revealed only when the life support of massive deficit spending is wound down.

So many impossible things before breakfast, more than under Obama. Tremendous things (Photo source - British Museum)

Focus in the last few weeks has been on Trump’s potential appointments to the key government offices. The FT’s Edward Luce for example has pulled no punches in a recent article suggesting that Trump is intent on “appointing charlatans to America’s great offices of state”2. He jumped the gun a little in critiquing Matt Gaetz, who was nominated as US attorney-general. The latter has since pulled out of contention, suggesting that Senate Republicans may have more of a sway over Trump than some initially thought.

Another FT article has critiqued Elon Musk and Vivek Ramaswamy and their Department of Government Efficiency3. Citing previous attempts at reforming government by Presidents Reagan (1982) and Clinton (1993), the article details the difficulties in an external advisory body reforming a bureaucratic system with ‘multiple sign-off points’.

There is little doubt there will be resistance, both from within the government system and without. Robert Kennedy Jnr is likely to come up against a solid wall of opposition from big pharma and big food, whose media and lobbying spending will test the administration’s ability not only to control the message but also swing Congress behind any controversial industry changes.

The announcement that Scott Bessent will be at Treasury has seen a more effusive article in FT. The hedge fund guy knows his stuff, understands money flows and might act as a moderating influence on Trump’s tariff policy4. The article goes on to say how Bessent may become Trump’s James Baker, sorting out an international trade and currency agreement (including China) similar to the 1985 Plaza Accord. The same article sadly fails to point out either that the Plaza Accord was between cold war allies not cold war enemies, or that the Japanese yen strengthening following the 1985 agreement led to a massive credit boom and then a crash resulting in a lost decade (or decades). Still, plenty to be positive about, Bessent is a market guy etc.

Pick the right people and success is a foregone conclusion? America has been here before with star-studded cabinets. The youthful John F. Kennedy surrounded himself with a brain trust of high-profile figures, one of whom, Robert S. McNamara, hailed from the auto industry much like Elon Musk.

Yet despite the quality of the individuals and a desire for reform, it was events in the first two years of JFK’s presidency that dictated the narrative. JFK was seen as coming off a poor second to the USSR’s Krushchev at his first summit, while the erecting of the Berlin wall and the Bay of Pigs debacle further undermined the young president’s credibility. This increasingly made Vietnam a key policy issue for JFK to show his backbone, setting the scene for the US to be dragged into what many already feared was going to be an unwinnable war.

the time for memes is over - the real work is about to start. (Photo source: ITVX)

In 1961, the US economy was still growing and debt levels were low. JFK’s challenges lay abroad in managing America’s approach to the cold war. Trump’s problem is domestic - dealing with US trade and primary deficits to the backdrop of record Federal debt levels. These issues are the end product of the problems that Trump et al have tasked themselves to fix. Everything else, including celebrity appointments, is just window dressing.

Where to start? In 2023, US GDP was $27.4b. A $2 trillion spending cut of the sort Musk and Ramaswamy have mentioned would amount to around 7% of GDP. Bear in mind that the ‘great recession’ of 2008-9 saw GDP fall by ‘only’ 4% with unemployment of 10%, then the magnitude of the task at hand is apparent. This is just the basic numbers - and doesn’t address what in fact will be cut. Given this starting point, even Bessent’s apparent target of a 3% deficit over the medium term would involve major spending cuts - or perhaps an unrealistic reliance on growth from deregulation.

Austerity is still a dirty word. Asking America to undergo severe cuts to medical and entitlement payments at a time when the stock market is at the highs and unemployment is at the lows is a near impossible task - the sort of thing doable in war time but not otherwise. Given the escalations in the war in Ukraine, the bubbling conflict in the Middle East and the great power rivalry with China, chopping the defence budget will be unpopular or at the very least perceived as unwise in the extreme.

Along with interest payments on the Federal debt, these sources of expenditure (social security, health, Medicare and defence) amount to 80% of Federal spending, and very little of it seems negotiable5.

The US economy will likely grow at around 3% in 2024 while the deficit is likely to be high single digits. The risk is that any aggressive push for radical spending cuts could hit GDP and raise unemployment, which may in itself precipitate recession and the widening rather than the shrinking of the deficit as tax receipts fall and the automatic stabilisers of unemployment payments kick in.

Tax cuts generally increase the deficit - a key observation from the cuts during the first Trump administration. The market loved them but their long-term consequences are now part of the problem. Elon Musk is right to focus on the deficit, but deficits are tricky things to manage when your boss’s natural inclination is to increase it.

Trump basically has two years until the mid-terms, so any radical moves will have to come early to ensure Congress is onside while his political capital is at its highest. Rationalising government, ending waste, reducing regulation to improve economic growth, helping to make the population more healthy and so on are all laudable goals, whatever one’s political perspective.

They are however long-term goals, and what the Trump administration appears to be setting itself up for is an assault on many of the short-termist policies that have juiced GDP and kept the markets afloat in recent years. The price of long-termist thinking replacing short-termist policy is short-to-medium term pain. This is the real problem.

The promise of mass deportations and the reshoring of business in the US, as well as what we know of tariff policy (including potentially using tariffs to replace Federal income tax) are all likely to be inflationary. With interest rates still at multi-year highs and with the Federal debt at $36 trillion, another burst of inflation is really not what America needs - particularly given voters’ clear concern for the cost of living.

This is the ugliness of reforming the US economy when viewed up close. Cutting taxes, spending and regulations while managing inflation, reshoring businesses and maintaining US presence abroad (even if this means weakening the dollar) seem to be Alice’s six impossible things to imagine before breakfast. It’s the sort of job that would require bi-partisan agreement at the deepest level and would take a few decades to implement adequately. Trump has four years max, two until voters once again get to voice their opinion at the mid-terms. It might be easier to focus on getting to Mars, Elon.

Market Depth

Discussion about this post