The world economy

Our election, your problema

A Trump presidency will be bad for the world economy and worse for places outside America
           


IT IS not clear precisely how Donald Trump will govern, the extent to which he will carry out some of his scarier promises on trade and immigration, and who will be his economics top brass at the Treasury and in the White House. But a decent first guess is that President Trump will be bad for the world economy in aggregate; and a second is that his actions are likely to do more harm, in the short term at least, to economies outside America.

When America has in the past stepped aside from its role at the centre of the global economic system, the damage has spread well beyond its borders. In 1971, when Richard Nixon ended the post-war system of fixed exchange-rates that had America at its centre, his Treasury secretary, John Connally, told European leaders, “The dollar is our currency, but your problem.” This election result, to paraphrase Connally, belongs to America but is potentially a bigger economic problem for everyone else. 

The scale and nature of that problem depend on the interplay of the two main elements of Mr Trump’s economic populism. The first is action to boost aggregate demand. Mr Trump favours tax cuts and extra public spending on infrastructure. The second element is trade protectionism. He has pledged to slap tariffs on Chinese imports and to renegotiate the North American Free-Trade Agreement (NAFTA) with Mexico and Canada. To the extent that he leans more on the first element and less on the second, the immediate damage to America’s economy will be limited. But even in that event, the net effect of a Trump presidency on economies outside America is still likely to be harmful.

To understand why, go back to the subject of Connally’s gibe: the dollar. As it became clear that Mr Trump would win the election, the greenback fell against rich-country currencies, such as the euro, yen, Swiss franc and pound, as investors sought a haven from policy uncertainty in America. An index of its value against major currencies dropped by 2% in early trading on November 9th. Within hours it had regained almost all the lost ground, as investors pieced together a positive story for the dollar, based on the prospects of a boost to demand in America’s economy and an inflow of capital from abroad.

Bringing it all back home
 
A deal between Mr Trump and Congress to cut corporate taxes, goes the logic, would spur flush American companies to repatriate retained profits held offshore. It would also allow them to increase capital spending in America, because they would have more ready cash; and consequent profits would be taxed more lightly. The larger budget deficits entailed by tax reform, along with more public spending on infrastructure, would underpin yields on long-term Treasury bonds. Indeed, after falling in the initial aftermath of Mr Trump’s victory, yields on 10- and 30-year Treasuries are on the rise again (see chart). Add the potential for higher inflation from the stimulus and the likelier use of some protectionist tariffs, plus a Federal Reserve with a more hawkish tilt, as Mr Trump’s appointees alter the complexion of its interest-rate-setting committee, and you have the makings of a renewed dollar rally.
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A fiscal stimulus coupled with an investment splurge in the world’s largest economy should, all else equal, also be good for global aggregate demand. And if this kind of “reflation populism” improves the near-term prospects for America’s economy, it may dissuade Mr Trump from resorting to full-strength “anti-trade populism”. Well, perhaps. But given his leanings, it is easy to imagine him resorting to soft protectionism that keeps much of the additional demand within America’s borders.

He might for instance lean on companies to favour domestic suppliers, or attach local-content conditions to publicly funded infrastructure projects. What is more, the repatriation of profits by American firms would draw resources away from their subsidiaries abroad.

In 1971 the world feared dollar weakness. These days, dollar strength tends to have a tightening effect on global financial conditions. The waxing and waning of the dollar is strongly linked to the ups and downs of the credit cycle. When the dollar is weak and American interest rates are low, companies outside America are keen to borrow dollars. Often big firms, flush with such cheap loans, will further extend credit in local currencies to smaller ones. But when the dollar goes up, the cycle goes into reverse, as corporate borrowers outside America scramble to pay down their dollar debts. That causes a more general tightening of credit.

Mexico has the most to lose from Mr Trump’s presidency, should he keep his campaign promises. So the peso plummeted in the wake of the result. But Mexico, along with Chile, Turkey, the Philippines and Russia, also has a large burden of dollar debts, which are becoming more expensive in local currency. Mr Trump’s protectionist bent may make it hard for emerging markets to trade their way out of trouble. Only a few are likely to be unharmed by his victory.
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Where does a Trump victory leave China, the world’s second-largest economy? China accounts for roughly a half of America’s net trade-deficit, so in Mr Trump’s zero-sum reckoning, it has a lot to lose should America launch an all-out trade war. In fact, the resulting disruption to global supply-chains would badly hurt American firms, and higher prices on imported goods would squeeze American consumers, especially poorer households, which spend proportionately more on them.

Yet there are risks to China’s economy too, from even a milder form of Trumpian populism.

The dollar’s weakness over the spring and summer helped stem the outflow of capital from China that had threatened to unmoor the yuan and so unsettled global financial markets at the turn of the year. A sustained dollar rally would thus mean a severe headache for China’s policymakers, as it would revive the pressure on its capital account. They might then face an unpalatable choice: let the yuan sink against the dollar or keep domestic monetary policy tighter to support it.

China is safe from the biggest indirect effect of Mr Trump’s victory: the boost it gives other populist politicians. Europe is far more vulnerable. Britain’s vote in June to leave the European Union was one early ballot-box reflection of anti-establishment sentiment. Since then, insurgent political parties in France, Germany, Italy and elsewhere have called for referendums on membership. Such parties typically favour trade barriers and limits on immigration, and are gaining in popularity.
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The euro area’s economy has been faring better in recent years, but the single currency remains fragile. The kind of cross-border risk-sharing needed to put the euro on a sound footing is at odds with the rising tides of nationalism and populism. An immediate hurdle is Italy’s referendum on constitutional reform on December 4th. A defeat would weaken Matteo Renzi, the reformist prime minister, and embolden the populist Five Star Movement, which favours ditching the euro. Around 14% of the euro area’s goods exports go to America, quite a bit less than China’s 18%. But America accounts for about 40% of the currency zone’s recent export growth, according to economists at HSBC, a bank. So American protectionism is arguably a bigger threat to Europe than to China.

The whole world has much to fear from Mr Trump’s threats to tear up trade agreements and impose punitive tariffs on imports. And even if he refrains from starting a trade war, the loose-tongued, fact-lite style he cultivated during the campaign could wreak serious damage when he is president. His hyperbolic threats now carry the weight of the American presidency. His victory was enough to chill some financial markets; what he might do with it could spark full-scale panic. Even short of that, like the Brexit vote, it marks an alarming step away from a liberal, open economic order towards more isolationism and less prosperity.


Donald Trump’s false promises to his supporters

Some will benefit from his plans, but the white working class will not be among them

by: Martin Wolf



Will Donald Trump benefit the enraged white working class that brought him into the White House?

To answer this, one must examine his plans and the desires of congressional Republicans. One must also consider how these plans might affect the world economy. The conclusion is straightforward: some people will indeed benefit but the white working class will not be among them. Republicans have long stoked rage they do not assuage. Mr Trump has taken this approach in new directions.

Huge, permanent and regressive tax cuts seem the one certainty. It is something on which Mr Trump and congressional Republicans agree. The revised Trump plan would reduce the top individual income tax rate to 33 per cent and the corporate tax rate to 15 per cent. It would also eliminate the estate tax. The highest-income taxpayers — 0.1 per cent of the population, those with incomes over $3.7m in 2016 dollars — would receive an average cut of more than 14 per cent of after-tax income. The poorest fifth’s taxes would fall by an average of 0.8 per cent of taxed income. To those who hath, it shall be given.

Mr Trump (much less so the congressional Republicans) plans to increase infrastructure spending.

This is desirable, though it would have made even more sense if Republicans had supported such a programme in the midst of the Great Recession. But as noted by Lawrence Summers, former US Treasury secretary, the Trump plan relies mainly on private investment. Experience elsewhere suggests this often leads to exploitation of taxpayers and a failure to put into effect public investments that deliver high social benefits but have limited commercial returns.
The net effect of these plans would be a large rise in fiscal deficits. Calculations by the Tax Policy Center at the Brookings think-tank suggest that by 2020 the deficit would increase by 3 per cent of gross domestic product. With current forecasts as the baseline and ignoring any additional spending, this would mean a deficit of around 5.5 per cent of GDP in 2020.

Cumulatively, the increase in federal debt by 2026 might be 25 per cent of GDP.

Congressional Republicans such as Paul Ryan would surely demand matching cuts in spending.

Annual federal outlays are close to 20 per cent of GDP. Spending on health, income support, social security, defence and net interest absorbed 88 per cent of this in 2015. Elimination of spending on all else (a catastrophic mistake) would merely halve the prospective deficit. In sum, the plan’s logic leads towards either big increases in federal debt relative to GDP or sharp cuts in spending on programmes on which Mr Trump’s supporters depend.

The envisaged rise in US fiscal deficits would however be expansionary, even though the concentration of the cuts on the wealthiest would limit this effect. Still, a jump in US fiscal deficits would accelerate rises in US short-term interest rates. Mr Trump could hardly complain since he has attacked the Federal Reserve’s low rates. Yet, as Desmond Lachman of the American Enterprise Institute notes, the world economy is fragile. A swift rise in US interest rates might destabilise it.

Furthermore, the combination of fiscal loosening with monetary tightening would mean a stronger dollar and a rising current account deficit in the medium term. The US would re-emerge as the global buyer of last resort, so helping the world’s structural mercantilists: China, Germany and Japan. A strong dollar and rising external deficits would, as in the early 1980s, increase protectionist pressures — Ronald Reagan’s administration was quite protectionist in its first term. The decision to launch the Uruguay round of multilateral trade negotiations to liberalise world trade was then the response.

This time, however, a strong dollar would reinforce the bias towards protectionism of the Trump administration. But protection against imports would raise the currency’s value further, shifting the adjustment on to unprotected sectors — above all, on to competitive exporters. In all, a strong dollar must weaken the manufacturing Mr Trump seeks to help.
A likely response would be to cajole the Fed into slowing monetary tightening. Janet Yellen’s term as Fed chair expires in 2018. Her successor could be told that the 4 per cent growth mentioned by Mr Trump has to be attained. The last time such growth was achieved over a five-year period was before the crash of 2000 — an ominous warning. If the Fed tried to achieve this goal, it might trigger inflation, financial instability or, more likely, both. In all this there seem to be few, if any, gains for Mr Trump’s working-class supporters.

The president-elect has also promised to eliminate Obamacare and most environmental and financial regulations. It is hard to believe any of this would succour the prospects of the working class. They are more likely to suffer from even worse health cover, a dirtier environment, more predatory behaviour by financial institutions and, at worst, even another financial crisis. Protectionism, too, will fail to help most of his supporters. Many depend on cheap imported goods. Many would be badly hurt by the dire results of a tit-for-tat global trade war. Meanwhile, rapidly rising productivity would still ensure a steady fall in the share of manufacturing in US employment, despite protection.

Mr Trump promises a burst of infrastructure spending, regressive tax cuts, protectionism, cuts in federal spending and radical deregulation. A big rise in infrastructure spending would indeed help construction workers. But little else in these plans would help the working class.

Overall, his plans might indeed generate a brief economic surge. But the longer-term consequences are likely to be grim, not least for his angry, but fooled, supporters. Next time, they might be even angrier. Where that might lead is terrifying.

The End of Power

What Will Remain of Obama's Legacy?

By Klaus Brinkbäumer and Holger Stark

 German Chancellor Angela Merkel and US President Barack Obama in Berlin

Barack Obama is eager to define his legacy before "turning over the keys" to Donald Trump.

This week, in his final trip abroad as president, he was in Berlin to visit his close ally Angela Merkel. But what will remain of his tenure in the White House?

He loves Berlin, he says. And he would like to return again soon with Michelle and his daughters, but without all of the fuss that severely limits what a sitting US president can see and do. He was likely referring to the sniffer dogs, the security personnel and all of the other staff who make sure that overseas visits go according to plan.

Next time, he said, he'll come in disguise, wearing a hat and glasses. "Maybe I'll grow a beard or something." Barack Obama laughed as he considered the possibility on Thursday morning in the US Embassy in Berlin while microphone was being affixed to his lapel. It was just seconds before the real interview was to begin.

Obama's visit to Berlin this week was full of messages. First and foremost, he wanted to show his support for German Chancellor Angela Merkel, an intention that was clear throughout his Wednesday-to-Friday stopover. He also wanted to promote democracy in the form of open debate and political engagement. He wanted to express his concerns that Western societies are becoming increasingly unjust, leading populist political movements to gain in strength. And he of course wanted to promote his own legacy so that he doesn't go down in history as a failure once he is replaced on January 20 by Donald Trump, who will likely revise signature pieces of Obama's domestic legislation in addition to revisiting key foreign policy achievements such as the Iran deal and the rapprochement with Cuba.

But his greatest success as president, Obama said during his Thursday interview with German public broadcaster ARD and SPIEGEL, is that the global economy didn't slide off the cliff in 2008. "I think people don't fully appreciate how severe the economic crisis was."

It has been an eventful eight years. Back in November 2008, on a cool, gray evening in Chicago, people in the crowd cried and even journalists shed tears when Obama took to the stage following his election victory. It was a touching moment, or perhaps kitschy, depending on how unemotionally you choose to view the world. A young Obama, with his campaign slogan "Yes We Can" and rousing speeches, managed to beat out the Democratic field, led by favorite Hillary Clinton, and then defeat Republican candidate John McCain. He came to the victory party in Hyde Park with his wife Michelle and daughters Malia and Sasha in tow -- and even cynics were aware at the time that it was an historic moment: the first black president of the United States.

His tenure did not begin with the same energy as his campaign and there have been several phases of weakness during his eight years in the White House. Climate policy, which had been a linchpin of his campaign, disappeared from his agenda for a few years only to make a late reappearance, just barely in time for the 2015 Paris Agreement. He announced his intention to close the Guantanamo prison, but then did little to deliver on that pledge. He also drew a red line in Syria, warning President Bashar Assad not to use chemical weapons against his own populace. But when Assad did just that, the US shied away from intervention, partly because Obama thought the rebels would topple Assad anyway. As such, the 2016 Aleppo disaster and the refugee crisis are also partly the results of Obama's eight years at the helm.

The Better President

But he became more resolute after his re-election and knew that once his second term began, so too did the countdown. If he wanted to take action, he had to do it soon -- and he made his move. The treaties with Iran and Cuba changed the geopolitical map. Obama also became tired of a Congress that sought to block his every move, and of the racism harbored by a significant group of Americans who never wanted to accept him as president. So he began issuing Executive Orders and stopped wasting time.

When the campaign for his successor began in 2015, Obama was asked if he would have liked to run again, barring term limitations, to complete his project. He hesitated, perhaps thinking that it might sound too vain, but after a brief pause he answered in the affirmative.

Did he really think that he would be able to win people over to support him for a third term?

Again, his answer was yes.

He likely considers himself to be the better president. Better than Trump, to be sure, but also better than Hillary Clinton might have been. He doesn't say so publicly, of course, but in smaller groups he hints at it. The mistakes, the weaknesses, they are always those of others.

Those close to him say that Obama's self-confidence hasn't suffered. And it became clear early on in his first campaign that charisma and arrogance went hand-in-hand, presumably axiomatically. He knew he was a good speaker, a gifted writer and had an air of cool -- one that became even cooler when he gazed into the middle-distance with eyes half closed. And if someone knows all that about himself -- and one constantly reads and hears about it -- then arrogance isn't far away.

To take a more positive view, however, it is also true that aura is another outcome -- the aura of an American president. It is a position that almost demands arrogance, as demonstrated by many of his predecessors, like Lincoln, Eisenhower, Kennedy and Clinton. The position demands leadership and not tenderness or kindness.

In Obama's case, all of that comes together to create a strange sort of distance.

A Fighting Mood

Obama, of course, can be passionate, and even heated -- as he was in Athens earlier this week just prior to his trip to Berlin. Once again, he delivered a speech that stayed in one's thoughts even hours after it was over. But one has to wonder: Is he using the final weeks of his presidency to revisit the consequences of the decisions he made: the mistakes, the children killed by yet another imperfect drone strike? Or is this somehow all part of the movie called "Obama's Presidency"?

It was certainly striking how quickly Obama was able to come to terms with Donald Trump's election victory. Prior to the election, he had said that Trump was dangerous and "unfit" to be the president.

"If somebody can't handle a Twitter account, they can't handle the nuclear codes," he said. After the election, Obama received Trump in the White House and said the transition would be seamless -- as though nothing had happened.

Trump a demagogue? A racist? Nope. It was business as usual. Just one president passing the baton to the next. All of which wouldn't matter much if the questions at stake this year weren't so fundamental: credibility, integrity, the elite versus the people. Is Obama interested in the consequences of his policies or is he only interested in his own legacy? Does he really want to improve the lives of his voters -- or is he merely after the praise that comes along with doing so?

During this week's brief visit to Europe, Obama was in a fighting mood. He fought for his legacy but also for democracy as such. He sees dark clouds on the horizon and believes that it is time for the battle to start -- and that it can only be won with justice and equal opportunity.

But the fact that Trump became possible as his successor also has to do with Obama, and that is a thought that has to make him unhappy. Part of it has to do with racism: After a black president, conservative, white America has struck back and elected the only white man on the ballot. But it is also true that Obama advised Joe Biden and others against running because he wanted to clear the path for Hillary Clinton -- partly because he wanted to help her fulfill her dream of becoming president. He ignored the fact that she had too many blemishes from the very beginning. The Democratic Party's choice of a candidate was anything but democratic and Obama allowed it to be so.

That was an enormous mistake.
A Tight Trans-Atlantic Bond

Now, in Europe, Obama presented himself as the great protector of democracy, but also as one who is aloof from the daily battles of politics. Of course he is interested in saving as much as he can of his legacy. But he was at pains to avoid the impression that it will be difficult to "turn over the keys" to Trump, as he put it. In his interview with SPIEGEL and ARD, it was only apparent for a brief moment in the way he almost spit out his successor's name: "Trump."

Suddenly, he no longer followed the well-worn American protocol of referring to him as "president-elect," "Mister," or even "Donald."

Apart from that, though, he sought to maintain distance and discretion. It was how he has always reacted when provoked by all manner of world leaders: Russian President Vladimir Putin, Iranian Supreme Leader Ali Khamenei or, on occasion, Israeli Prime Minister Benjamin Netanyahu. Obama always remains calm. It is a characteristic that drove many Americans crazy -- those who would prefer to have reacted with missiles and force, anything for the US to retain its world power status.

Despite their many differences, this discretion was something that bound him to Merkel and grew over eight years into what was, for Obama, an unusually deep sense of trust.

It is true what Ben Rhodes, Obama's deputy national security advisor, says: namely that Merkel has been "the president's closest partner over the course of his entire presidency."

Perhaps most important was his emphasis on the fact that she was German chancellor during his entire tenure. Merkel remained a reliable partner even in those moments when Obama was deeply alone. The two never developed the warmth in their relationship that Helmut Kohl and Bill Clinton enjoyed. Or even the kind of manly friendship that initially characterized Gerhard Schröder's relationship with George W. Bush prior to Schröder's polemic rejection of Bush's Iraq invasion plans during his 2002 campaign for re-election to the Chancellery.

The relationship between Obama and Merkel was always respectful, rational and professional in nature.

But perhaps it was exactly that sort of relationship that allowed an element of emancipation to creep into the German-American relationship of a kind rarely seen since World War II. America had always seen Germany as being reliant on its trans-Atlantic big brother. The NSA spying scandal contributed to the new distance, along with the SPIEGEL disclosure that the Americans had eavesdropped on Merkel's mobile phone. Obama, it is said in Washington, cursed when he learned about it and publicly promised that something like that would never happen again, at least not involving Merkel. In May 2014, during her first visit to Washington after the affair, Merkel told Obama exactly what she thought. On a sunny day in the White House Rose Garden, she delivered a sharp rebuke.

Trust in Merkel

To those close to her, she even compared the NSA with the East German secret police, the Stasi. Her comments were leaked and Americans were not amused. Obama, though, accepted it. That, in fact, is another way in which he differs from his predecessors: In addition to hubris, Obama is also capable of humility. Following the dust-up, cooperation between their two governments became more antiseptic and mistrustful, but also more grown up. And paradoxically, the relationship between the two leaders became closer as a result of the affair.

To the chagrin of conservatives in Congress, Obama initiated an orderly retreat from the world stage, in part because of his trust in Merkel. In the Ukraine crisis, she grew into her role as mediator and, more recently, as Obama's surrogate. In conversations with Putin, she translated Obama's positions into a language that the Russian leader could understand -- and the US president was happy for the help. With Syria, Cuba, Iran and domestic issues, he had enough on his plate.

That's why this trip was so important to him. First, to Athens, the birthplace of democracy, for a speech about the dismal present and the future of democracy, which, he said, can only work if executives don't earn as much in a single day as their employees do in an entire year. He also went for a walk on the Acropolis looking like a completely normal tourist in his beige pants, blue shirt, brown shoes and sunglasses. He visited the Odeon of Herodes Atticus, built in A.D. 161, and then the Parthenon, constructed in the golden era of Greek democracy. As if he couldn't get enough, he also agreed to a visit to the Belvedere Tower. It almost seemed as though visiting these ancient structures was a way to convince himself that these symbols of democracy were still there -- and that they had withstood greater crises than the one we are facing today.

He then continued on to Berlin, landing on Wednesday evening at 5:51 p.m. at Berlin's Tegel Airport, greeted there in drizzling rain by US Ambassador John Emerson, his wife Kimberly and German head of protocol Jürgen Mertens. It took Obama until 6:07 p.m. to finally emerge from Air Force One, walk down the red carpet and jump into his waiting vehicle for the drive to the Adlon Hotel in the heart of Berlin.

He and Merkel spent three hours together on Wednesday evening in the Adlon. They had dinner and talked, informally and privately just as the White House had requested. Ben Rhodes said that he couldn't remember Obama ever sitting down with someone for so long during his entire eight years as president.

Obama began Thursday morning in his Adlon suite. He had no appointments and he prepared for his meeting with Chancellor Merkel and subsequent press conference that afternoon as well as for his interview with ARD and SPIEGEL.

Proud of His Accomplishments

The conversation took place in a conference room at the US Embassy, located just two buildings away from the Adlon at the Brandenburg Gate. He walked into the room at 11:37 a.m., immediately uttering the kind of wonderfully meaningless greeting that only Americans can make sound sincere.

In speaking with Obama, it immediately becomes clear that he is proud of what he has accomplished as president. When he talks about Donald Trump, he smiles slightly, knowing full well that a majority of Americans still approve of the job he is doing; most recently his approval rating stood at 55 percent. He also mentioned that only 27 percent of all American voters cast their ballots for Trump.

His message was clear: I am the real president of the country. And during the interview, his answers were expansive and comprehensive, even responding to the brief closing question about Edward Snowden with a mini-speech about the responsibility of a state ruled by law.

The interview came to an end at 12:07 p.m., after exactly 29 minutes and 45 seconds. Obama took a few more seconds for a group photo and then disappeared for lunch in the embassy with John Emerson. Afterwards, he headed over to the Chancellery first for a one-on-one with Merkel and then for a larger meeting with her entire cabinet. A press conference followed.

Then came something that rarely happens in the life of an American president: The entire evening was free -- to spend with Merkel.

The two had a second dinner together, this time in the Chancellery surrounded by guests. They reminisced about years passed, but there were no speeches and no cameras. With Americans, who are constantly full of praise and who claim everyone is a good friend even if they aren't always sincere, real emotion isn't measured in words, but in time. As such, Thursday evening was a rare display of affection, almost tenderness, between two heads of government.

Largely Alone

What, though, will remain of this president? Obama's legacy seems all the more respectable in light of Donald Trump's victory. For now, at least. By introducing health insurance available to all, he brought a sense of warmth to an America that often seems cold and hard, a project that Democrats have been trying in vain to implement since Harry Truman's times. Obama also paved the road for the equal rights of gays and lesbians in the military and appointed the first Hispanic justice to the Supreme Court.

In foreign policy, he revised the image of a bellicose, imperialistic America that George W. Bush had left behind. Yet the weaknesses of his foreign policy convictions -- which will go down in history as the "Obama Doctrine" -- also became abundantly apparent in Syria. It is a doctrine in which the use of force is an exception, the last resort -- against terrorists, for example, when they threaten access to oil or attack allies. Foreign policy, says Obama, must reflect America's highest ideals and convictions.

But in a civil war like the one raging in Syria, where there is no clear dividing line between good and evil and thus no clear allies, this principle reaches its limits. Obama, the most powerful man in the world for the last eight years, seemed impotent in the Middle East. The strength of his brand of politics is that it defines which lines it will not cross, but it has found little recourse for situations in which others cross lines at will.

The much-touted turn towards Asia, which the US completed under Obama's leadership, may have taken place in the economic and, to a certain extent, in the military realms -- but not emotionally. For Merkel, Obama was a true partner. Her relationship to him was different from her oddly shallow bonds with European leaders such as François Hollande, Matteo Renzi or, in the past, Silvio Berlusconi. And with, as seems likely, Donald Trump.

Perhaps Merkel hasn't even realized it yet -- after all, Obama still has two months to go -- but with the end of the Obama years, she will be largely alone.

 Another Election Year, Another Bunch Of Fake Growth Numbers

Some pretty good economic reports have energized various parts of the financial markets lately. Consumer spending is up, GDP is exceeding expectations and even factory orders, that perennial downer, popped this morning.

In response the dollar is soaring and interest rates are at breaking out of their multi-decade down-channel. The economy is clearly recovering, implying a return to normality. Right?

Nah, it’s just the usual election year illusion. When the presidency is at stake the party in power always pumps up spending in an attempt to put people back to work and create the impression of a well-run country whose leaders deserve more time in the spotlight. After the election, spending returns to trend and the resulting bad news gets buried in “political honeymoon” media coverage.
 
How do we know this year is following the script? By looking at the federal debt. If the government is borrowing more than usual and (presumably) spending the proceeds, then it’s likely that the economy is getting a bit more than its typical diet of stimulus. So here you go:

us-federal-debt-nov-16


Note that after seven years of massive increases, the federal debt plateaued in 2015, which is what you’d expect in the late stages of a recovery. With full employment approaching and asset prices high, there should be plenty of tax revenues flowing in and relatively few people on public assistance, so the budget should be trending towards balance.

Well, more people are working this year than last, and stock, bond and home prices all rose in the first half of the year. So why the approximately $1.8 trillion surge in government borrowing?

Because a robustly-healthy economy was necessary to help the party in power stay in power.
 
This is a huge jump in government debt, even by recent standards. And its impact is commensurately large, accounting for a big part of the “growth” seen in recent months. But it’s also unsustainable.

You don’t double a government’s debt in a single decade (from an already historically high level) and then keep on borrowing. At some point an extreme event or policy choice will put an end to the orgy.
 
Either the markets impose discipline through a crisis of some sort, or the government adopts a policy of currency devaluation or debt forgiveness. And – in a nice ironic twist – the people who did the insanely-excessive borrowing are leaving town, to be replaced by folks who will inherit something unprecedented, with (apparently) no clear idea of what’s coming or what will be necessary in response.


Wall Street's Best Minds

The Trump Era’s Impact On Real-Estate Values

If the U.S. is heading into an inflationary period, hotels and other properties can provide a good hedge.

The bond markets are panicking about President-elect Trump’s proposed inflationary policies. Bonds have lost over $1 trillion in value, globally, since the election. Ten-year Treasury rates rose by 27 basis points over the two days after the election, their biggest jump since October of 2011. Popular thinking is that higher rates are bad for real estate, as evidenced by the 4.2% drop in REIT stocks in the two days following the election.
 
Pixabay
 

If Trump has his way with tax cuts, infrastructure spending, the border-wall policies, and immigration policies that would reduce the supply of low cost labor, there is no doubt that inflation and higher interest rates would follow (see our previous story on barrons.com about how Trump’s proposed wall on the Mexican border would affect real estate.)
 
Some of these policies could hurt real estate in ways unrelated to inflation, by restricting capital flows to the US and dampening population growth. The immediate impact of higher interest rates would likely be negative for REITs and for real estate values, because higher cost debt reduces equity returns. Over the longer term, however, large deficits stimulate the economy, and inflation increases the value of hard assets.
 
The conventional thinking goes like this: real estate values are based on cap rates (property net income/ property value). When interest rates go up, cap rates have to increase to keep real estate competitive with fixed income products, and this drives values down. This analysis misses real estate’s essential role as an inflation hedge. Inflation drives up rents, which increases property values. In an inflationary environment, investors derive most of their return on real estate from appreciation, not from cash flow. As a result, cap rates go up far less than interest rates do. Real estate investors do demand higher returns, but they expect to get much more appreciation in value.
 
Back in the late 1970’s and early 80’s, cap rates were up to 600 basis points lower than 10 year Treasury rates. During the real estate recession of the early 1990’s the trend reversed itself.

Interest rates fell due to the weak economy, and cap rates rose, due to the low expectations for growth in real estate values. This happened again in 2008, when cap rates increased while interest rates fell.
 
Historically, real estate values have increased when interest rates are rising. Another way to put this is that real estate is negatively correlated to bond values. Between 1978 and 2014, real estate had a -0.27 correlation with investment grade bonds, according to a Pension Real Estate Association (PREA) study. In other words real estate values tend to increase when bond prices decrease (bond prices go down when interest rates go up).
 
So what does all of this mean for real estate values in the Trump era? If we are truly heading for a period of inflationary deficit spending, direct property investments should provide a good inflation hedge over the term of Trump’s presidency. This is particularly true for hotels and apartments, which have short leases. On the other hand, office buildings and industrial properties that are locked in to long term leases will take longer to adjust.
 
We may also see a divergence between REIT stocks and direct real estate values. This has certainly been true of REIT prices since the election. Unlike real estate funds and direct real estate, REITs are subject to stock market volatility and the whims of short term capital flows.
 
They could continue to take a beating due to the popular perception that they behave like bonds.
 
Of course, inflationary expectations are only one factor. Trade policy and immigration policy will also have a major impact on capital flows and the overall demand for space. The jury is still out on the combined effect of these factors. Just don’t blame whatever happens on inflation. 

Wasterlain is founder and co-CEO of CAPFUNDR, a curated marketplace for real estate



About that Economic Inequality

By: Keith Weiner


I address this essay to two groups. One group is those among the liberty movement, who believe that there's nothing wrong with inequality. These are often Objectivists, who unknowingly defend a regime that artificially suppresses working people. The other group is those among the Left who still call themselves liberals. They say they don't like inequality, but nevertheless continue to support this regime, and they often demand more of its interventions.

I am talking, of course, about our regime of the Federal Reserve and its zero-interest policy.

I have written before about how falling interest rates have pushed up the prices of stocks, bonds, and real estate (also artwork, antique cars, etc.) This is seemingly good for those who own capital assets (it's not, but go try to tell someone it's not good that his house doubled). At the same time, falling interest causes falling wages if not mass layoffs.

In other words, the Fed drives down interest. This drives up asset prices and drives down wages. The minority who own assets seemingly get richer (an illusion) and everyone else suffers.

That is not the only way that falling interest rates cause inequality. Nor is it the only way that it targets certain groups for greater harm than it brings to others. Consider that zero interest makes it impossible to save. I don't mean hard to save. I don't mean excuse-making for lazy people who don't plan for their futures. I mean impossible in the full context. Let me explain.

When I started my career in 1990, the standard advice was to set aside 10% of your salary and put it in the bank. By the time you reached 65, you would have a big nest egg. The key to this strategy was earning interest. Every bank had brochures showing that by age 65 most of your nest egg would be the accumulation of compounded interest.

Let's put it in human terms. Suppose you're a young worker, just starting out. You make the median income of $52,000 a year. You set aside 10% of your gross paycheck before tax. Over 45 years, your salary set-aside adds up to $234K.

Back in 1990, a 1-year Certificate of Deposit paid 8.1 percent. At this rate, you would have about $2.4M by the time you retired at age 65. Over 90% of that total is the compounded interest.

However, today, the same 1-year CD yields less than ¼ percent. At this scant rate, you can expect to have only $246K. Over your entire career. Of that sum, just $12,000 is interest. Let that sink in.

Needless to say, $246K is not enough to live in retirement. If you can't keep working, you're going to have to go on the dole. And this leads us to an underappreciated point.

Business consultants, writers, deal makers, and many other white-collar professionals can easily continue to work for 10 or 20 years past the conventional retirement age. So long as you're healthy, why not keep working? Aside from the money, it gives you something to do, keeps your mind engaged, and you're contributing to society.

However, there are many jobs where you cannot keep working. Think about brick layers, plumbers, and roofers. These jobs both take a toll on the body and demand more than most 75-year olds can give. Whereas a business consultant may continue to grow his network and expertise even as he gets older, a worker in a physical job is slowing down as well as wearing out.

There is never a good reason for government to intervene and attempt to prevent people from experiencing the consequences of their actions (whether good or bad). Many of those crying about income inequality, just use it as a rationalization to move America down the socialist road.

That said, there is an inequality problem. It is not due to lack of government intervention, as the socialists would have you believe. It cannot be cured by yet more taxes and interventions.

Its cause is intervention. I refer to the most pernicious and least-appreciated kind of intervention.

Monetary policy.