Sorry Trump, protection and productivity can’t co-exist

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David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

I found it amusing that in the same week that there was such euphoria over the choice of Larry Kudlow for the top economics job at the White House, the guy who coined the phrase "free market capitalism is the best path to prosperity," Mr. Trump would in the name of "national security" decide to be anti-capitalist and prevent the possible Broadcom takeover of Qualcomm – even before the deal was formalized. It is yet another in the long string of events that makes it to Ripley's Believe it or Not. It seems as though whether it is trade or investment flows, the label "national security" is being deployed by the White House as a crowd-pleaser for the President's core base – a clear shot to China, the same country that holds US$1.2-trillion of U.S. Treasury securities. Broadcom was the same company that Mr. Trump lauded just last November and whose chief executive he invited to the White House to boot! Very aggressive moves by the White House, unprecedented in fact, and another reminder of the regime change we are in.

Yet, this is still not recognized by the plethora of investors who, in classic fashion at turning points, continue to play by the old rules.

Let's face it – when CNBC labelled a brief interim rally the other day (didn't last, mind you) the "Kudlow Bounce," you know there is something very seriously wrong out there … as in the revival of the Flat Earth Society. In major cheer-leading fashion (quickest way to get a job these days in the West Wing), Mr. Kudlow, the newly appointed chief economic adviser to the President, penned this at the end of last year:

"Trump and the GOP are on the side of the growth angels with the passage of powerful tax-cut legislation to boost business investment, wages and take-home family pay."

No talk of productivity here, by the way – the surest way of creating long-term prosperity. It remains to be seen whether tax cuts will go into capital spending at a time when corporate liquidity and cash flows were already at record highs, but maybe it goes into bonuses, dividend payouts or stock buybacks. None of these boost productivity. Business spending despite the surveys has been anemic of late with core capex orders retreating each of the past two months, to little fanfare.

Productivity was stagnant in the fourth quarter and there was little growth on this score for all of 2017.

I find it very interesting (actually quite disturbing) that the word "productivity" did not show up once in either Donald Trump's inauguration speech in January, 2017, or in the recent State of the Union address two months ago, though the President used the term "protection" no fewer than seven times in both sermons. Here's the reality: you cannot have both "P's" co-existing since protectionism by its nature is anti-competition, and it is competition that drives innovation, and innovation that ultimately drives productivity. Sorry, Larry, but this is not the case where you can have your cake and eat it too. As Mark Twain sort of taught us, east is east and west is west, and never the P's shall meet.

And one would expect "take-home family pay" to improve in any event, given the tightening in the labour market, which says much more about the nature of the economic cycle than it does about any particular policy. I come back to the fact that the government is borrowing on everyone's behalf – our future liability – to pay for a tax cut. Again, that is simply running up the credit card and treating the loan as "income" to spend. The difference between borrowing for a tax cut and actually generating improved productivity growth – meaning a greater focus on education, skills and human capital which would bring greater and more durable income growth – is rather considerable.

If you recall, the supply-side economics, which people like Mr. Kudlow support, never did work in the 1980s, because if it did, the public debt ratio would not have doubled from 30 per cent to 60 per cent.

And George H.W. Bush would not have been compelled to boost taxes in the early 1990s, allowing independent presidential candidate Ross Perot to garner 20 per cent of the vote in the 1992 election and hand the reins to Bill Clinton (who only ended up raising taxes even further).

To make the case here – the gap in the USA between spending and revenues is simply not sustainable, and was the case three decades ago.

Today's tax cut will inevitably morph into a future tax hike by some future government. Without some fundamental reforms to "entitlement spending", which the President has already said is off the table, the current fiscal stance is simply on an unsustainable path – and one that does pose risks to the interest-rate landscape.

We have a regime change in trade, global capital flows, inflation, monetary policy and U.S. fiscal policy, and heightened uncertainty that are not at all consistent with term premiums in bond markets, spreads in the investment-grade and high-yield corporate credit markets, cap rates in real estate and P/E multiples in the equity markets. Not to mention that the rising tide of populism has not gone away. The recent anti-EU election in Italy is a very big event, and likely to be making a more intense wave when the budget wrangling soon begins with Brussels.

Let's just call it a return to Greece seven years ago, except that Italy is the third-largest economy in the euro area and the ninth largest in the world: ten times bigger than Greece, and with a debt rollover calendar of US$350-billion annually for the next two years. This is a time to put your historian hat on, and recognize the similarities to the pre-Second World War global backdrop.

Let's do the prudent thing here and reassess the sage advice from Bob Farrell, 17 years ago, in his legendary piece, A Secular Inflection Point:

"Change of a long-term or secular nature is usually gradual enough that it is obscured by the noise caused by short-term volatility. By the time secular trends are even acknowledged by the majority they are generally obvious and mature. In the early stages of a new secular paradigm, therefore, most are conditioned to hear only the short-term noise they have been conditioned to respond to by the prior existing secular condition. Moreover, in a shift of secular or long-term significance, the markets will be adapting to a new set of rules while most market participants will be still playing by the old rules."