By Ricardo Ulivi, Ph.D.
February 2017

President Trump has indicated that he will reduce income taxes, impose tariffs on imported goods from certain countries, and embark on a major infrastructure rebuilding program. The stock market has loved these suggestions, and so it has risen by 8% since his election. However, this love affair is based on expectations, and reality may be very different.

What might be the consequences of these measures on the economy in general, and more specifically, on the investment world? Let’s review these.

Likely effect of reducing income taxes:

A reduction in income tax rates will benefit the high earners and the rich, but it won’t do much for the 40% or more of the population who either pay no income taxes or pay very little. However, reducing taxes will make the chronic federal government deficit even worse. And this is likely to cause interest rates to go higher, and that’s no good for the bond and real estate markets.

Traditional economic policy suggests that tax cuts are effective in fostering economic growth when you have a country suffering from a recession. The side effect, in these cases, is a greater deficit but that is justified on the assumption that putting more money in consumer’s pockets will make them spend it, and this will make the economy grow and leave the recession. But the US is NOT in a recession–rather, we are at near full employment, so cutting taxes will increase the federal deficits.

Let’s assume for a moment that the real beneficiaries of the suggested tax cut, the high income earners and the rich, spend the money (rather than saving it). Will this make our economy grow more? This group of people will most likely buy imported goods, not made-in-America goods. So, the tax cut, rather than benefit the US economy, will benefit the Chinese and the Mexican economies.

The tax cuts will make the federal deficit worse, and will benefit foreign producers. Most of us will lose.

Likely effect of tariffs:

Undeniably, the US has a horrendous trade deficit, and something has to be done to improve it so that the economy, and wages, can grow on a sustainable basis. But raising tariffs will make things more expensive, and will not increase employment in the US.

I grew up in Argentina, and I travel there annually. They love tariffs in Argentina. As a result, imports are few, and locally produced goods are shoddy and high priced. For example, you buy an Argentine made shirt, pay a fortune for it, put it on and the buttons will fall off. Wash it once, and the colors will fade! What about employment? One third of the Argentine population is officially considered poor. That’s the consequence of tariffs. Is that what we want for the US?

Tariffs are not the answer to creating good jobs. While we cannot compete with the Chinese, because they have a communist system with a sprinkle of capitalism, we can compare ourselves to the Germans. While the US runs a trade deficit of about $500 billion a year, Germany runs a trade surplus of over $300 billion a year! They have high salaries, low unemployment, very strong unions, and yet they export like crazy. Rather than put tariffs in the US, we should be spying on the Germans and figure out what they are doing right.

Tariffs will only increase inflation in the US.

Likely effect of infrastructure spending:

The perception is that Trump’s administration will want to spend a trillion dollars over the next few years in improving airports, roads, ports, etc. But where’s the money going to come from? The president has indicated that he will cut income taxes, which reduces federal receipts, so he will need to borrow money like crazy to pay for his spending. What will this do to interest rates? It will most likely increase them, and this is never good, unless you are battling inflation.

Increased interest rates, and higher spending will make the federal deficit skyrocket, and that will likely slow down the economy, if not produce a hard landing.

A presidency led by a billionaire, and supported by a cadre of officials who are multimillionaires, does not bode well for us regular people, at least not in my opinion. They will take care of themselves, and make us pay for their party.