Traders work on the trading floor at The New York Stock Exchange in New York, on Sept. 18.Andrew Kelly/Reuters
The most consequential U.S. election in decades is headed into its final few days. What is remarkable is not the anxiety on display, but the complacency.
Stock and bond prices in the United States have sputtered in recent days, but they remain mostly cheerful. Share prices are still hovering near record highs. Credit indicators are displaying no signs of worry. Analysts continue to predict solid growth as far as the eye can see.
So what’s not for investors to like? A few things, actually.
The most obvious one is Donald Trump. When a convicted felon described as a “fascist” by his former chief of staff is this close to regaining the presidency, even calloused market veterans should worry, at least a little. If the Great Bloviator’s failed coup d’état after the 2020 election is any guide, U.S. democracy is at risk. He is increasingly out of control – as demonstrated by his declaration on Thursday that Liz Cheney, a prominent critic of his, should face “nine barrels shooting at her.”
Shrug off such threats if you will, but his crackpot economic policies pose their own dangers. He is proposing tariffs of 60 per cent on imports from China and up to 20 per cent on imports from the rest of the world.
His sweeping proposals would apply to more than 10 times as many imports as the relatively modest tariffs of his first term, the Peterson Institute for International Economics estimates. They could set off a trade war that would slice global output by 7 per cent – roughly the combined size of the French and German economies – according to the International Monetary Fund.
Granted, he might pull back on his tariff proposals if elected. His other policies don’t seem much better, though.
Notably, he has promised to abolish federal income taxes on tips, social-security payments and overtime wages, while creating a tax deduction for car payments. He has also vowed to slash corporation tax to 15 per cent from 21 per cent. And, oh, yes, he has also declared he is thinking about exempting police, firefighters, members of the armed forces and veterans from paying income tax.
Mr. Trump’s something-for-everyone barrel of tax-cut promises seems entirely unconnected with fiscal reality – especially at a time when the U.S. is already running massive deficits equal to more than 6 per cent of U.S. economic output.
To be sure, those deficits are a bipartisan achievement. Mr. Trump boosted the budget shortfall during his term in office, then Joe Biden took it to new levels as he fought the economic impact of the pandemic. Astonishingly, neither Democrats nor Republicans are now offering any plan to significantly rein in the spending.
According to the non-partisan Committee for a Responsible Federal Budget, Kamala Harris’s campaign proposals would swell the U.S. national debt by US$3.95-trillion though 2035. However, Mr. Trump’s proposals would nearly double the size of that additional shortfall, taking it to US$7.75-trillion.
One big question is how long the bond market will support the levels of borrowing required to fill Washington’s gaping budget hole. Yields on 10-year U.S. Treasury bonds have climbed in recent weeks, surging from about 3.65 per cent to around 4.32 per cent, as Mr. Trump’s standing in the polls has improved. Bond buyers appear to be pondering the potential impact of his proposals and looking for extra payoffs to protect themselves against the risk that a new Trump presidency would propel already huge deficits into even more outrageous territory and perhaps fuel a renewed outburst of inflation.
Why isn’t the stock market quivering? It may reflect the market’s short-term orientation.
No matter who gets elected president, U.S. stocks are likely to do okay over the next few months for the simple reason that government deficits tend to reappear as corporate profits (something economist Michal Kalecki taught us in the 1950s). Big deficits therefore go hand in hand with big corporate earnings. Couple that with the strong probability of more interest-rate cuts by the Federal Reserve and investors have some decent reasons to be upbeat about the immediate future.
Look further ahead, though, and the picture looks less appealing. The next president is going to have to grapple with the problem of how to shrink the enormous U.S. budget gap. There is no easy solution.
If the deficit continues at its current size, the most likely outcome is significantly higher bond yields and increased borrowing costs – something that would not be good for stocks or the federal budget. Alternatively, the successful candidate could surprise everyone and make a determined effort to reduce the deficit. However, that might not be great for shareholders either given the relationship between government deficits and corporate profits.
Investors may want to ponder these risks as they contemplate how to deploy their investments. U.S. stocks have had an amazing run over the past 15 years, far outpacing the rest of the world. It is easy for investors to be complacent. But it may be wiser to start thinking about gradually reducing your U.S. exposure as the country enters an increasingly uncertain future.