The year 2017 is viewed with some fear by people because they think the long period of peace the world has enjoyed is too good to last much longer with new players on the world scene. The USA has elected a new President who has promised major changes in US foreign policy and has already made some dangerous statements. Three hundred and seventy prominent economists are warning that a Trump presidency would be "dangerous, destructive" for the national and the world economy.Sri Lanka of course is dependent on the world economy and world free trade. We are an export-import economy and our welfare depends on the prospects for the world economy. We prosper if the world economy grows at the same rate or better.
The new US President Donald Trump who will assume office in January has promised to shift the US economy from its post-financial crisis stagnation by cutting taxes and increasing spending, running a larger budget deficit and reducing interest rates. But there is the risk of higher inflation by his doing so. Such policies have been tried before but without success to promote higher growth without inflation. Ronald Reagan said his tax cuts and extra spending for the Pentagon –the US Defence Establishment, would generate higher revenues and also balance the budget despite such higher spending. It didn't happen.
Instead the Tax breaks went for the rich and military Keynesianism (spending money on Defence to boost effective demand in the economy) sent the fiscal deficit rocketing. So the risk of higher inflation through larger budget deficits cannot be ruled out. World inflation is now under control and has been so for some years without the usual boom and bust cycle. But undue deliberate expansionary policies in USA could rekindle inflation and cause larger deficits in the balance of payments with other countries and also cause imbalances in other countries since the US economy plays a key role in the world economy.
The Guardian's economics editor Larry Elliott says Americans have gambled on Trump's promise that he can shift the US out of its present low growth even though they run the risk of higher inflation and a bigger budget deficit. Businessmen in Wall Street of course see bigger profits through higher economic growth . Higher growth will mean bigger corporate profits and higher share prices. But the issue is whether such higher corporate profits are sustainable or merely lead to intractable imbalances in the economy. It is no easy task to maintain the delicate balance between growth and inflation. Unbalanced growth creates unsustainable imbalances which then mean a return to the previous boom and bust phenomenon.
Some think President-elect Donald Trump lacks experience in macro-economic management, a task that is delicate and can be acquired only on the job. But don't panic, too much says Berenberg, the Bank of America's chief. America's economist Mickey Levy in a note to clients says :
Trump will learn quickly that international affairs are very complex and he will quickly come to rely on the various government agencies and experts that understand and influence the US' approaches on international affairs. This will serve to soften some of his brash statements during the campaign. Trump made some outrageous statements during the campaign. For example he promised to build a wall with Mexico to restore better balance with her payments. He also promised to tear up global trade agreements. He expressed similar sentiments with respect to China, one of USA's important trading partners with whom the US runs a large deficit in its balance of payments.
Trump's economic advisers accused Janet Yellen, the chairperson of the Federal Reserve (the Central Bank of USA) of creating a "false economy" by keeping interest rates artificially low to help President Obama and his Democratic opponent Hillary Clinton.
Trump has attacked Yellen throughout his campaign. In September he said Yellen "should be ashamed of herself. I used to hope that the Fed was independent," he said in an interview with CNBC. "And the Fed is obviously not independent. It's obviously not even close to being independent. It is important that the Fed - the Central Bank in USA - is independent and unconstrained by fiscal considerations.
His proposals to raise trade tariffs – pledging, among other things, a 45 per cent tax on Chinese imports – are a big worry to those who believe in Free Trade. The world has seen a period of free trade which has contributed to the growth of the world economy.
"His denouncing of China as a currency manipulator could also invite retaliation from the world's second biggest economy. At a time when global trade appears to be experiencing a structural decline, Trump's stance casts a shadow over the world's economic prospects," say some economists. Others say Trump constitutes perhaps the biggest threat to both world growth and financial markets.
We as a small country depend on the world economy for our growth and development. So in case the world turns protectionist we may have to look out and strengthen our bilateral economic relations with countries like China and India.
As for the USA, China and Mexico are two of its largest trading partners. Neither wants to enter into a trade war with the US, and neither can afford to do so. The US relies heavily on imports from those partners since they offer lower priced imports which contribute to the present level of price stability. So it is unlikely that Trump could erect any major trade barriers against China or Mexico who are important trading partners of the USA. Just hours after Trump's election, Judy Shelton, his only female economist adviser, told the FT that Trump wanted to have a new chair of the Fed. She said:
"He has made it a very strong point of his campaign that he thinks that the Federal Reserve's intervention and elongated accommodative monetary policy has created a false economy. People who have worked all their lives have been penalized by these low rates". The Fed last increased the benchmark federal funds rate to between 0.25-0.5% in December 2015, and has held it there since, due to various national and global uncertainties. Trump has however repeatedly criticized Yellen for not raising interest rates fast enough.
Trump "no friend of trade" warned that he wants to introduce protectionism to correct the US trade imbalances . Trump has suggested building a wall around the US borders. But this attitude of his will have an adverse effect on the US economy and thereby the world economy which is driven by the US. He may want to help US businesses but the repercussions may not be what he hopes for.
But economists ascribe Trump's comments to a lack of experience and do not expect him to follow through on his comments. Of course they are likely to cause short term volatility in the weeks ahead. But many Economists think the current concerns about major trade barriers being erected are perhaps over stated and not realistic . One writer, Levy, said Trump's often outrageous campaign pledges "will fade, with no material follow through or implementation" and "no wall will be built between Mexico and the US. Despite such talk by Trump. Trump will have to temper his global antagonism, economists say.
What about Trumps interest rate policy?
The market expected the Fed to raise rates in December but it failed to materialize. Trump has repeatedly said he is unlikely to nominate Yellen to continue as Fed chief when her term expires in early 2018. He wants to replace her with a Republican who follows his economic thinking.
Don't panic, too much says Berenberg bank's chief America's economist Mickey Levy in a note to clients:
'Trump will learn quickly that international affairs are very complex and he will quickly come to rely on the various government agencies and experts that understand and influence the US' approaches on international affairs. This will serve to soften some of his brash statements during the campaign.
Levy said Trump's often outrageous campaign pledges to build a wall with Mexico and tear up global trade agreements "will fade, with no material follow through or implementation" and "no wall will be built between Mexico and the US".
China and Mexico are two of the US' largest trading partners. Neither wants to enter a trade war with the US, and neither can afford to do so. The US relies heavily on imports from those partners because they are comparatively cheaper and hence the US cannot afford to block them without raising the US cost structures and the cost of living. His proposals to raise trade tariffs – pledging, among other things, to levy a 45 per cent tax on Chinese imports – are a worry. His denouncement of China as a currency manipulator could also invite retaliation from the world's second biggest economy.
At a time when global trade appears to be experiencing a structural decline, Trump's stance casts a shadow over the world's economic prospects. But several economists say that current concerns about major trade barriers being erected are overstated and not realistic. Will he do so? Not likely according to several economists. So we could be happy that there will be no dramatic changes in the world economy.