Following Donald Trump’s Victory: Economic Goals and Policies for the U.S.
26 DEC, 2024
By Tiffany Wilding from PIMCO
By Tiffany Wilding, Economist at PIMCO
What will the president-elect and his administration aim to achieve for the U.S. economy, and how? The improvement in living standards following the pandemic has not benefited everyone equally. Signals from the incoming administration suggest a potential focus on policy pivots aimed at achieving a more equitable distribution of the United States' economic gains. Based on public statements from Trump and key economic policy officials, we believe these policy shifts may attempt to address three long-term imbalances:
- The U.S. Trade Imbalance
- The U.S. Fiscal Imbalance
- The Imbalance Between Labor and Capital's Share of National Income (with capital represented by shareholders): Labor's share has declined drastically in recent decades.
Correcting imbalances that have built up over decades could lead to economically painful transitions, both within and outside the U.S. This raises a key question for Trump’s second term: How much underperformance in the U.S. equity market is he willing to tolerate? Many investors believe the answer is “not much,” as U.S. stock markets are seen as a key metric of success for his policies. Current market prices suggest a widespread belief that equity performance will limit any significant ambitions to modify trade and fiscal deficits. Therefore, a critical question for 2025 is whether Trump will surprise with more aggressive policy measures.
Global Trade Imbalances: Why They Exist and How to Address Them
The U.S. trade deficit results from the industrial policies of other countries. China in particular, but also Germany, Japan, and others, have been able to maintain serial trade surpluses through government policies that effectively subsidize their manufacturing sectors while boosting household savings. This process, which became central to China's export-driven growth strategy, also created a significant savings surplus that needed reinvestment. Relatively open and stable U.S. capital markets provided a venue for these savings, contributing to asset bubbles over the years and a stronger U.S. dollar.
Foreign savings surpluses also coincided with U.S. dissaving. The contraction of the manufacturing sector and the reduction in labor's bargaining power, termed the “China shock,” led to stagnating real wages, increased political polarization, and rising fiscal deficits. Over time, these trends increased consumption’s share of GDP while reducing domestic savings, whereas China's manufacturing share of GDP and savings rate both rose.
The winners of this system have been foreign industries (primarily Chinese), capital owners, and U.S. consumers (via lower goods prices). The losers have been non-U.S. households that subsidized their respective national manufacturing sectors, the U.S. manufacturing industry, and middle-class U.S. workers.
To address these imbalances, surplus countries would need to rebalance their economies away from manufacturing, likely through economic reforms that reduce implicit subsidies to manufacturing and fiscal policies aimed at stimulating household consumption. It is unclear whether they will do so.
If surplus countries are unwilling or unable to make these adjustments, the U.S. has little choice but to implement policies that effectively force such adjustments. These policies could include imposing higher universal tariffs (not just tariffs on China or specific regions) or a tax on foreign investment while maintaining the ability to limit compensatory dollar appreciation. In other words, the U.S. would need to orchestrate an effective dollar devaluation to force these adjustments. Simultaneously, the U.S. would need to promote domestic savings, most likely through a substantial reduction in the U.S. fiscal deficit.
Market Implications of These Hypothetical Adjustments
If these significant policy and market pivots were to occur, we would likely see steeper interest rate curves in regions with serial trade surpluses relative to the U.S. Higher prices in the U.S.—whether driven by tariffs or a weaker dollar—could slow the pace of Federal Reserve rate cuts (although we believe rate hikes remain unlikely), while negative relative price adjustments in other regions might accelerate central bank rate cuts elsewhere.
Improvement in the U.S. fiscal deficit relative to some expansion in surplus countries could lead to U.S. long-term rates exceeding those of surplus countries.
For equity markets, the implications of these potential policy changes are likely negative. In fact, the outperformance of long-term bonds would probably be offset by increased equity risk premiums (i.e., the return above the “risk-free” rate that equity investors demand for taking on risk). A greater share of U.S. national income going to labor would erode margins and profits, while a sharp reduction or elimination of excess foreign savings flows into U.S. capital markets could increase the cost of capital.
The Challenge of Predicting Trump Administration Policies
Here lies the complication in predicting Trump’s policies. Undertaking difficult adjustments is likely to result in equity underperformance, at least during the transition phase. If Trump’s tolerance for any equity downturn is low, then his tariff, trade, and deficit policies are likely to be more limited, symbolic, and economically manageable.
