President-elect Donald Trump promises to return the American economy to its historic long-term growth rate of between 3 and 4 percent. But there are a number of ways he could fail to meet his objective. Here are two.
First, a soaring U.S. dollar could prove highly problematic. The Trump stimulus plan is largely the Reagan domestic agenda (big tax stimulus, higher spending and deregulation). In the 1980s, those policies produced a strong dollar. By the mid-1980s, industrialized world policy makers under the leadership of the U.S. Treasury were forced to organize the Plaza and Louvre Accords to stabilize and bring down the dollar's value to avoid a trade war.
Since the November election, the dollar has strengthened significantly. But today's conditions are different from those in the 1980s. International currency coordination would be a lot more difficult. Back then, emerging markets including China and India were only 20 percent of the world's GDP; now they represent nearly 50 percent of the world's output. Back then, the world wasn't sitting on $18 trillion in dollar-denominated debt, half held by emerging markets. European and Japanese banks weren't as massively exposed to these markets as they are today. Italy's banks weren't hanging by a thread.
If, as expected, the Trump dollar continues to appreciate, the problem is not just that America's trade position could be negatively affected. The value of the world's dollar-denominated debt will rise. So will the cost to emerging-markets of commodities, including energy, which are denominated in dollars. The risk is a series of emerging-market defaults that could wreak havoc on the world's banking system. In the 1980s and 1990s, each time the dollar soared, the result was serious financial problems abroad. But be assured, American multinationals and the U.S. stock market would also take a hit.
The conditions for a stronger dollar have been building for some time. After the 2008 financial crisis, for example, one thing seemed certain. With Wall Street at the center of the crisis, the United States was the international goat. Yet, incredibly, dollar-strengthening U.S. asset purchases by foreigners since the crisis have been double the rate before the crisis. This phenomenon is likely to continue as over the next year as U.S. interest rates rise while the rest of the world's rates stay the same.
If the United States moves to the border-adjusted tax system being discussed in Congress in which a new lower corporate tax rate is levied on where goods end up rather than where they were produced the end result will likely be more dollar appreciation.
Trump could mitigate some, if not a lot, of this risk with a shift in emphasis.
That's the second way Trump could fail to reach his objective. By habit, Trump will likely side with a kind of top-down corporatist thinking in trying to manage his way to higher growth. After all, Manhattan skyscrapers originate from a centralized design, not from an evolving, bottom-up, spontaneous, chaotic process of creative destruction. If he goes the corporate route he knows well, Trump would ironically be engaged in a centralized, top-down approach to economic growth at the precise moment the rest of the economy is experiencing a bottom-up revolution. Evolving technologies seem to be springing up everywhere.
Trump is proud of the stock market's performance since the election. But if the stock market measured the success of the economy for average working families, Hillary Clinton would have won a 50-state landslide. The more important target Trump seems to be ignoring is a rise in social mobility. Thirty years ago, a person born into the bottom 25 percent of income earning families had a 25 percent chance of rising to the top 25 percent. Now only 5 percent make it to the top. That's in large part because there are not enough businesses starting up. And, when they do, they find going public extraordinarily difficult (more than 80 percent of new jobs produced happen after a firm goes public).
That's why start-ups are so important. They take place and produce jobs in America. And they are happening at half the rate of 15 years ago.
Trump loves to encourage large corporations to fall in line. Nothing wrong with that. But he also needs to fixate on encouraging start-ups, or helping young firms survive, and on ending the regulatory and patent arbitrage game that large corporations use to gain competitive advantage over the small. He should make the process of going public easier and less expensive. In any reform of Dodd-Frank, he should concentrate on helping the workhorses of the grassroots economy, regional and community banks. America's innovators need to start to dream big and to dare big again.
And Trump needs a strategy to deal with the effects of a strong dollar. The global financial system has become a dangerous paradox wrapped in a riddle. A lot can go wrong.