Trump’s Economy: The Best Ever!?

10 September 2020

With Labour Day celebrations marking the unofficial end of summer, the US electoral race now will enter its final (and likely most brutal) phase. We do not need President Clinton’s 1992 campaign strategist James Carville, who famously coined the phrase “it’s the economy, stupid”, to remind us of the role the economy will play in the upcoming election. Indeed, given the severe disruptions caused by the Covid pandemic, the American electorate is likely to give even greater consideration to the candidates’ ability to competently manage the economy during this health emergency.

The Trump campaign is attempting to walk a fine line. On the one hand, the President enjoys portraying himself as a political outsider who can (single-handedly) solve the nation’s numerous, deep-seated problems brought on by his predecessors. In 2020, however, President Trump is the incumbent…..with his own record to defend. He describes repeatedly that as a result of his policies, the performance of the US economy is “the best in the history of the country”! The President’s use of superlatives is not suprising at this stage. But, how accurate is his assertion? My concern is not to fact-check political rhetoric. Rather, investors need to assess the impact of the Trump Administration’s economic program in order to gauge correctly what to expect after polling day, regardless of the outcome of the election.

Tax Cuts and Deregulation: An Economic Renaissance?

The President claims often that the US economy is booming, as a result of corporate tax cuts and sweeping deregulation. Given the economic dislocations stemming from the Coronavirus crisis, I will limit my discussion to the the first three years of the Trump presidency (I will assess the US Covid response in a future essay). To be sure, the Chart above illustrates US GDP has advanced at a healthy 2.4% rate since President Trump took office. However, despite the enormous fiscal stimulus provided by the 2017 Tax Cut and Jobs Act (TCJA), this growth rate simply mirrors the rate of expansion experienced since the end of the Global Financial Crisis (GFC). Indeed, it still is not even certain that secular slowdown the United States has experienced in recent decades has been reversed.

The Chart reveals also a similar pattern in US employment. By the end of 2019, the US unemployment rate had declined to an enviably low 3.5% level. Again, however, the healthy 1.6% annual pace of job creation is similar to the long-term trend for the US economy, and similar to the experience since the end of the Great Recession.

These trends should not be too surprising. If the United States was undergoing a supply-side renaissance, this would be reflected in accelerating growth in productivity and business investment. The Chart above illustrates America (as well as other advanced economies) has experienced a dramatic deceleration in productivity growth in the wake of the GFC. During the 2017-19 interval, American efficency has grown at a 1.4% annual rate — exactly in line with slower post-GFC pace.

To be sure, US capital spending did accelerate immediately following the corporate tax cuts and generous treatment of depreciation expenses included in the TCJA. However, even before the sharp cyclical decline in business investment this year, corporate spending had cooled significantly — advancing only 1.3% in Q4 2109. The Chart above illustrates that US capex growth during the Trump presidency is at best in line with the long-term average, and arguably slower than the the post-GFC recovery.

Who’s Benefiting from Rising Incomes?

The Chart above reveals inflation-adjusted household incomes declined consistently between 1998 and 2012; with the sharpest falls coming in following the GFC. The Trump Administration deserves praise for continuing the recovery in real incomes, which began during the Obama years.

To be sure, the Chart above illustrates that all income groups have enjoyed real income gains in recent years. However, inflation-adjusted compensation during the Trump years has been more modest than during the overall post-GFC period in all income groups. Perhaps more worrisome, the wealthiest quintile of the US population has enjoyed the largest real income growth: with particularly out-sized gains amongst the top 5%. As a result, the widening disparity in income distribution occurring since 1980 has continued during the current Administration. For instance, the share of income for the richest quintile, which rose from 44% to 51.5% between 1980 and 2016, rose further and now stands at 52%. The skew in wealth distribution is even greater.

While the issue of US racial relations is beyond the scope of this blog, the Trump team often extols the benefits of its economic program for minority groups. To be sure, black and Hispanic minorities have enjoyed meaningful employment growth in recent years. And, while unemployment rates amongst ethnic minorities remains higher than for white workers, all racial groups enjoyed historically low levels of joblessness prior to the pandemic (standing at 5.6%, 4.1%, and 3% for Black, Hispanic, and White members of the labour force at the end of last year).

Again, however, the Chart reveals that these highly favourable patterns represent a continuation of trends in place since the end of the Great Recession. In fact, minority job growth actually has cooled in recent years (not surprising so late in an economic cycle), and the pace of recent gains are in line with the long-term historical trend.

Trade Policy: Expanding or Diverting Opportunities?

The objective of the Trump Administration’s confrontational approach to trade has never been clearly established. If the aim, for example, is to reduce America’s global trade deficit, and its reliance on foreign capital inflows, the Chart above illustrates the policy has failed. Indeed, the overall trade deficit (on goods) has risen from $735 billion in 2016 to $854 billion last year (massive disruptions to supply chains may lead to a small reduction in 2020). Similarly, if the hope is to boost American export opportunities, sadly that has not happened either. Sales abroad advanced a relatively modest 15% during the past three years, suggesting exports as a share of GDP have remained roughly stable. Indeed, foreign sales may decline 15% or more in 2020: back to 2016 levels.

On the other hand, aggressive tactics with China do appear to be paying off. After peaking at $419 billion in 2018, the bilateral deficit declined to $345 billion last year. Unfortunately, the reduction was not the result of stronger US exports, which actually declined 12%. Rather, the imposition of higher tariffs on Chinese goods led to a 16% slump in imports in 2019. While the targets of Phase 1 of this year’s Sino-US trade agreement may not be achieved, another meaningful reduction in the bilateral deficit is likely in 2020. However, in addition to another double-digit contraction in purchases of Chinese goods, the trade deal should lead to the first increase in exports to China since 2017.

What lessons can we learn? First of all, focusing on bilateral trade imbalances will never produce a reduction in America’s global external deficit. The earlier Chart demonstates that despite a smaller gap with China, the world-wide shortfall continues to widen, as the imbalance with the rest of the world balloons further. Focusing solely on China has simply diverted America’s insatiable appetite for foreign-made products to other countries. Since 2016, for example, while US purchases of Chinese goods have declined 2%, imports from the rest of the world swelled by 15%. Until the US savings rate rises (curbing imports), America dependency on foreign capital will persist. Taking aim at China may serve broader geo-political objectives, but will not curb mounting US external indebtedness.

Furthermore, President Trump often boasts that US firms are bringing capital and jobs back home. To the contrary, America’s foreign direct investment position has risen an additional $450 billion during the Trump presidency. Meanwhile, FDI inflows into the United States have surged by $900 billion, with Europe being the largest partner. Even US manufacturers have increased external investments by over $200 billion, while foreign penetration of America’s factory sector continues to expand (reflecting in part concerns about additional US tariffs on foreign goods). I, for one, consider the continuation of FDI a good thing. President Trump’s political base, however, may not!

Fragile Budgetary Position Limits Fiscal Options

Even prior to the Covid crisis, the Trump Administration’s tax cuts had produced additional budgetary red ink (Chart above). For example, following the huge post-GFC fiscal stimulus, budgetary consolidation sliced the US public sector deficit from 13.3% to 4.7% of GDP between 2009 and 2015. The impact of the TCJA expanded the shortfall to 7.5% in 2019 — so much for the tax cuts paying for themselves! The Chart below illustrates that American public sector debt levels were on an unsustainable trajectory even prior to the impact of the pandemic. While Federal government liabilities will soon top 100% of GDP, broader measures of public sector indebtedness are already above 130% of output.

With the OECD projecting deficits of 17% and 12% of GDP in 2020 and 2021 respectively, any new American government’s budgetary options will be limited. With interest rates low, the immediate priority must be to provide additional targeted support for sectors hard hit by the pandemic. However, with fiscal consolidation likely over the medium term, President Trump’s pledge to reduce payroll taxes significantly lacks credibility.

Once the pandemic passes, the manner in which America deals with its budget deficit will define the nation’s future (and reflect its values) for decades to come. Therefore, there is much at stake in the coming election. Former VP Biden indicates he would hike corporate taxes from 21% to 28%. While I supported the TCJA’s reduction of business’ marginal tax rates, the overall level of corporate taxation is low (Chart above). Higher business levies should not overtly harm US competitiveness. Nevertheless, financial markets should anticipate a higher corporate sector tax burden (as a percent of GDP) under a Biden government.

Trump’s Stock Market Rally, or No?

Unlike previous residents of the White House, President Trump regularly points to the rising stock market as a real-time assessment of his Administration’s achievements. But, how much credit does the President deserve for the 50% rise in equity values during his time in office?

The Chart above (provided by Morgan Stanley) helps answer this question. In simple terms, the S&P 500’s level reflects the valuation (P/E ratio) investors attach to current and future earnings (EPS). To be sure, earnings per share have risen sharply. However, as the US economy does not appear to have experienced a supply-side miracle (the pace of GDP growth is in line with historical patterns), it is hard to attibute directly the recent EPS growth to the Trump policies. Indeed, part of the surge in corporate earnings following the TCJA simply reflects reconition of profits accruing in years prior to President Trump’s electoral victory.

But surely, the P/E ratio’s expansion from 17X to 21X EPS growth reflects an optimistic appraisal of the Aministration’s sweeping dereguatory program. The Chart compares the S&P 500’s earnings yield (the inverse of the P/E ratio) to the level of US interest rates. Currently, the gap between the yield on US equities and bonds is at roughly the same level as at the end of 2016. This suggests the US Federal Reserve’s massive monetary stimulus is largely responsible for the recent P/E expansion, not President Trump’s policies.

Strategic Considerations

  • The United States has enjoyed three additional years of healthy economic expansion under President Trump’s tutelage. This reflects the continuation of prior trends, not an economic renaissance.
  • If President Trump sought my advice (he has not!), I would ask the public for 4 more years to complete what he has started. It is fair to suggest that the benefits of the TCJA’s corporate tax cuts and the concessions gained in negotiations with China take time to emerge fully.
  • The Federal Reserve and the industriousness of American workers and firms are largely responsible for high US equity valuations. Consequently, despite some near-term volatility, the election result should not be overly disruptive to financial markets unless macroeconomic policies change direction radically.
  • Even though US firms are not overly taxed, Joe Biden’s plans on corporate taxation are a potential source of concern.
  • The continuation of large twin deficits will be a headwind for the US dollar.