We’ve reached that wonderful time of year when financial pundits pull out their forecaster hats and take a crack at the future. This time the exercise is particularly interesting because we’re at several turning points. Any one of them could remake the entire year overnight.
I should probably say up front that I am actually somewhat optimistic about 2017—optimistic, meaning I think we will Muddle Through—but that’s a lot better outcome than I was expecting five months ago. However, midcourse corrections may be warranted.
Instead of trying to answer questions about the future, I’ll try to list those we should be asking as 2017 opens.
We can’t afford for any of the major components of the global economy to break down; so, it’s smart to ask, “Where are the weak points?” That’s what we’ll do today. We’ll poke at the economic mechanism as it grinds along.
The biggest change will happen in Washington DC when Donald Trump takes office. Aside from the changes he can make on his own authority, he’ll be in position to approve the many Republican initiatives that President Obama blocked. Here are some items I’m watching.
Tax reform: Our monstrosity of a tax system needs major reconstruction: a reduction and simplification of corporate taxes, a significant reduction of the individual income tax, and replacement of the Social Security tax with a VAT-like consumption tax. What will come out of the House is still unknown.
My sources are telling me House members want to pass an initial tax cut quickly and defer the more complicated changes for later in the year. The easy initial tax cut is to remove the Obamacare tax when they repeal Obamacare (the Affordable Care Act), which it appears they will do early in the session.
Final thoughts on taxes: Some industries will suffer massive impacts if you slap tariffs on incoming goods. Further, putting a high tariff on products that are sold at Walmart and Costco and on Amazon is massively inflationary to those shoppers (and that’s most of us).
These policies can be tricky, and the consequences can have a big impact on consumer confidence.
Energy: The Obama administration’s heavy-handed environmental regulations are a major impediment to US energy independence. Trump can change many of them quickly because they came in the form of executive orders and rulemaking that doesn’t require congressional approval.
Trump can also approve some of the Arctic and offshore drilling projects that Obama would not consider. I am told that there are some $50 billion worth of oil-production projects that are ready to go, which would be a massive source of high-paying jobs.
If he wants to play hardball with OPEC, Trump could even impose a tariff on imported petroleum products that we can produce here (as opposed to the raw crude, especially heavy crudes, that we currently don’t produce). That would give domestic producers and refiners a further boost. It would also aggravate the rest of the world’s oil glut.
Economic stimulus: We have plenty of shovel-ready projects, or could create them in short order, that would create jobs and simplify trade and travel. Some will not be very profitable in the short run, so they may not happen under a tax-credit scheme.
Trade: Import-dependent businesses are on pins and needles right now, hoping the Trump administration doesn’t turn toward the kind of protectionism some of the new appointees have advocated in the past. We’ll see. The president has considerable latitude in this area, so almost anything is possible.
Banking: One reason the stock market has gone bananas since the election is the prospect of banking deregulation. Wall Street has been chafing under the Dodd-Frank Act’s requirements and restrictions. The Volcker Rule on proprietary trading has clearly worsened bond market liquidity and taken a major revenue center away from the banks.
The Dodd-Frank Act as presently constructed could actually aggravate matters if we find ourselves in another financial crisis. Dodd-Frank prevents the Federal Reserve from stepping in with liquidity and instead says that the FDIC should “resolve” any failing banks.
I see the point, but the main reason we have a central bank is to be a lender of last resort to the banking system. The FDIC simply can’t act fast enough, nor does it have the ability or the cash to act effectively in a crisis. Congress needs to fix this soon.
Finally, Dodd-Frank puts our regional and small community banks at a massive disadvantage. They get all of the costs and are restricted from their normal activities. Overhauling Dodd-Frank will be a big boon to entrepreneurs and small businesses and will create jobs.
Federal Reserve: We should also see at least two nominees to the Fed’s Board of Governors soon after Trump takes office. He may get a third one if Daniel Tarullo leaves, as some observers expect. He will get to nominate both the chair and vice chair next year, and it is likely that the remaining members will think about leaving as well when Yellen departs. But the early nominees will tell us a lot about Trump’s priorities and long-term plans—hopefully for the better.
Meanwhile, the Fed is in the middle of a long-overdue policy turn. There’s still a risk that they will find they started tightening just in time for a recession, which is also long overdue.
Economy – Surprises and Black Swans
Black swans aren’t a risk limited to the world of finance; they happen in politics too. Such an event could push aside all the best-laid plans and change everything.
Canadian bubble: Our neighbors to the north are at their own turning point. The Canadian economy was riding high in the commodity boom but has run into problems after two years of sharply lower oil prices. Since then Canada has avoided recession but has not enjoyed much growth.
Canada also has a housing bubble that looks increasingly ready to pop. House prices have little to do with oil and everything to do with Chinese buying property.
What happens in Canada will tell us something important about China and vice versa. Anything that keeps Chinese money from leaving China will raise the odds of Canada’s bubble popping.
US energy policy matters to Canada too. The country’s huge oil sands deposits would help its export balance, but in some cases the best access requires pipelines through the US, like the Keystone that Obama has held up. Trump can help Canada by letting that project go forward.
Crowded exits in Europe: I thought there was a good chance the Italian bank crisis would come to a head in 2016. The Italians seem to have yet again delayed the inevitable. Reality hasn’t fundamentally changed, though. Troubled institutions are not going to get better on their own, nor is the new government going to miraculously gain public confidence.
Saving Italian banks will take multiple hundreds of billions of euros, which Italy does not have, nor do they technically even have the legal right to unilaterally bail these banks out. They would have to utilize an ECB facility that does not now exist to get that much money, and such a measure would require German approval.
I keep telling you that Italy is the most dangerous economic issue on the world front. Attention must be paid.
That said, Europe is quite capable