The Bear’s Lair: Peering ahead in Trump’s America

Four weeks ago, I wrote of the likely future in Hillary Clinton’s America; it was not a pretty sight. Since we have now been spared that future, it’s now worth looking forward to what Donald Trump’s America may look like in eight years. Unfortunately, there are still a few hiccups.

I have seen Trump’s “Make America Great Again” economic philosophy before – in a 2007 Japanese sci-fi movie “Bubble Fiction: Boom or Bust.” Like Trump, the movie’s protagonists are concerned about a lengthy period of economic malaise, in this case since the Japanese bubble burst in 1990. They believe the downturn has been caused by a lack of infrastructure investment, just as Trump does (the fact that in the 1990-2007 period Japan spent twice as much on state infrastructure as any other country doesn’t register here.) Fortunately, they have a solution – a time machine built into a washer/dryer. So they go back to 1990, meet the earlier versions of various contacts there, change the world and return to a magnificent 3-tiered bridge across Tokyo bay and universal prosperity.

If this isn’t Trump’s vision of the solution to America, I don’t know what is.

The movie has numerous poignant parallels between 1990 and 2007. Back in 1990, one of the characters, about to graduate from college, is ordering bottles of vintage champagne because he has just secured a job with Long-Term Credit Bank (LTCB), one of Japan’s most prestigious financial institutions. In 2007, LTCB has gone bust and he is working as a loan shark for the criminal yakuza, minus the end of his finger and plus a few tattoos.

Of course, in the U.S. financial system in 1990-2007 he could have achieved the same ethical transition, while retaining his finger-end, just by keeping his job at Goldman Sachs.

Trump’s central sales pitch “Make America Great Again” agrees with that of the movie, that if we could only go back to a period before all the troubles began and change some policies, all would be well. In the movie’s case, that period was the pre-1990 Japanese bubble, when the stock market sold at levels more than double those of recent years, while the Imperial Palace gardens were nominally worth more than the state of California. We are shown a world of 1990 in which Japanese are all not merely comfortable but ostentatiously wealthy, and asked to contrast it with an impoverished, downbeat present.

Trump’s appeal is similar, except that he has had to fuzzify what period he is referring to in which America was “great.” For Republican stalwarts, he appears to be talking about the 1980s, in which the U.S. defeated Soviet Communism and brought down the Berlin Wall. Yet to the blue-collar Democrats who formed the base of his incremental appeal, the 1980s won’t do; the big industrial collapses that took away blue-collar jobs had already happened by then and the era was one of free trade and globalization. For them, the “great” period must be the late 1960s, when American factories hummed, free from foreign competition and environmental regulations – but of course, in that period, the politics were all wrong for Republican stalwarts, as the Democrats were mostly in power.

“Bubble Fiction” was able to get back to 1990 with its washer-dryer time machine; indeed one presumes that the only reason the heroine, having reached 1990, didn’t stay there is that by the inexorable process of aging she would eventually have arrived back in 2007 again with LTCB still bankrupt and the economy still in malaise. However, absent the time machine, the reality is that the economic nostrums she attempted to apply to 1990 Japan were actually applied in reality; the country did go on a massive infrastructure binge and it didn’t work.

In the 1990-2007 period, Japanese productivity increased more rapidly than U.S. productivity, allowing the society to continue getting richer. That is no longer the case; Japanese productivity has declined in absolute terms since 2007. Furthermore, Japanese public debt, already too high in 2007, has now reached crisis levels while the Bank of Japan is pursuing policies that within a couple of years will result in effective government control of most Japanese companies.

In reality, the Japanese economy of 1990 was at the very top of an unsustainable bubble, and all that champagne and high living was merely the froth of an extreme bull market. Japanese companies had stopped concentrating on their core businesses, and instead were focusing on “zaitech” financial engineering to produce frothy additional profits. The correct solution to 2007’s problems was to raise interest rates to their historic 2-3% norms, balance the budget and open up the Japanese economy, especially its overprotected labor market, allowing productivity to continue improving while debt levels gradually declined. That would gradually have transferred Japanese investment away from the monstrous 10-year Japan Government Bonds and towards the economy’s productive sectors, while the exchange rate declined and savings, job opportunities and wages rose. This set of policies should still be adopted today, but a JGB bankruptcy is probably in any case inevitable, and much pain and value destruction will have to be endured.

Massive infrastructure spending is as delusional a policy for Trump as it was for “Bubble Fiction,” indeed more so. As in 1990 Japan, asset markets are hugely overheated, with real estate and share prices, especially in sectors like tech, far exceeding what can be economically justified. More ominously, the cost of infrastructure in the United States, because of legal and environmental obstacles, is about ten times what it was 50 years ago, in real terms.

Unless Trump can eliminate the additional barnacles that have accrued over the infrastructure process, for every $1 billion he spends on infrastructure, he will get in real terms only $100 million of infrastructure. In essence, for each $1 billion he spends on infrastructure he will waste $900 million, compared with a market-driven allocation of capital. That’s no way to stimulate the economy, and as in Japan it will greatly worsen the U.S. budget deficit, a major long-term problem.

Overall, the United States’ current problems are a mix of Japan 1990, Japan 2007 and Japan now. Asset prices are grossly overvalued, as they were in Japan in 1990. The budget is perpetually in deficit, but the debt is currently only as big a problem as Japan’s in 2007, and the demographic challenge is similar to Japan’s in 2007 rather than Japan’s now – many of the baby boomers are still in the workforce. On the other hand, monetary policy has been skewed for eight years already and productivity has stopped increasing, as in Japan currently.

In this context, Trump’s expressed policies are somewhat misdirected, and are likely to push the U.S. down Japan’s current road of spiraling debt and no growth. His massive tax cuts are mostly designed in a way that will do little for growth, and will widen the budget deficit. His plans for deregulation certainly should help productivity and growth in the medium term, although experience in Britain, the EU and Japan suggest that regulation is not the major current problem with productivity. His infrastructure spending will make matters worse. His moves towards protectionism will be growth-negative, although they may have some positive distributional effect within the U.S., as they reduce manufacturing outsourcing. Thus, even though Trump’s overall package has some positive elements, there is an unpleasant chance that he will end after eight years in the same indebted, unproductive mess as Hillary Clinton would have done.

One exception to this generally negative view is Trump’s plan to cap tax deductions at $100,000 for a single person and $200,000 for a married couple. This will close the major loophole of the very rich, the charitable tax deduction. It will also put out of business innumerable scams that have infected the U.S. economy in recent decades, sucking the lifeblood out of it to the extent of 6-7% of GDP.

Unemployment is currently low (at least nominally) and we are clearly close to the top of this lackluster business cycle. It is therefore a good time, four years before Trump has to face the voters again, to bite the bullet on some unpleasant realities. Beat up the Fed and change its personnel until it raises interest rates, thus getting us out of the current low-productivity trap. Cut public spending savagely, eliminating corporate welfare and agricultural subsidies and limit total tax deductions, but without significant other personal tax cuts. Cut corporate tax rates, but make the most gigantic possible bonfire of tax loopholes (and don’t listen to the siren songs suggesting the U.S. move to a “territorial” tax system – that will just drive even more business offshore.) Make another bonfire of regulations that have stifled the U.S. economy – preferably abolish the EPA altogether and let the environment take care of itself.

That should push the U.S. economy back on the path of healthy growth, although there may be an unpleasant recession on the way. Still, face the reality, those Republican Senate seat gains in 2018 were probably unattainable anyway, and by 2020 we should be into a decent, more robust recovery with genuine productivity growth.

Unlike with Hillary Clinton, there is at least some chance that Trump will move closer to the above agenda. We must hope so, and in any case wish him well for a productive and successful term in office. After 28 years of failure, the country needs it.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)