The immediate reaction from investors to the news of Donald Trump’s election was to freak out, evidenced by the volatility in financial markets. Even in Australia, both the share market and the Aussie dollar took a beating. Market commentators blamed uncertainty, as Donald Trump’s ascension was unprecedented.
But was it really?
Way back in 1980 an actor called Ronald Reagan capitalised on a weak economy to engineer a hostile takeover of the Republican Party. Like Trump, he was a pop culture personality from outside the establishment who convinced many voters to cross traditional party lines.
The similarities don’t end there.
What We Know About Trump-Economics
Both Reagan and Trump found a following amidst need for budgetary repair and both ran on platforms of reducing taxes and regulation. Trump differs in that he campaigned on increased spending, via infrastructure investment, while Reagan declared an intent to decrease spending. In the end though, Reagan still managed to greatly increase the amount of government spending during his tenure.
Like a true business man, Donald Trump has remained insistent that it the economically sensible thing to do is borrow big to finance much needed infrastructure improvements while interest rates are historically low. After all, inflation virtually wipes out the borrowing costs.
“I’m the king of debt. I love debt.”
– Donald Trump
Donald trump is also an unapologetic protectionist. He has promised to prohibit American companies like Ford from building plants in Mexico, to tighten up on immigration, and he plans to renegotiate virtually every international trade deal the U.S. has made.
“Decades of disastrous trade deals and immigration policies have destroyed our middle class.”
– Donald Trump
As a nation that relies heavily on international trade, any closing of the US economy would be bad for Australia, although we would be somewhat insulated by our close trading ties with Asia. The greater worry is that a move towards protectionism in America would give other nations an easy excuse to erect higher trade barriers and the domino effect could slow down the global trading system.
The Future of Interest Rates Under President Trump
A low interest rate environment in the U.S. generally requires our own central bank to suppress rates here, as higher rates make a currency more attractive and drive up its value. The RBA has been clear on its preference for a lower Aussie dollar to help make Australian businesses more internationally competitive and to drive economic growth.
“If interest rates go up one percent, that’s devastating. “What happens if that interest rate goes up 2, 3, 4 points? We don’t have a country.”
– Donald Trump
It seems a safe assumption that Mr. Trump wants interest rates to stay low.
As I mentioned in my last post, low interest rates have been a constant in the developed world for quite some time. In Japan it is now closing in on 30 years. But Trump raised eyebrows by suggesting an unorthodox approach to cutting the national debt. Asked if the U.S. needs to pay its debt in full or if it could negotiate a partial repayment, Trump said: “I would borrow, knowing that if the economy crashed, you could make a deal.”
That sounds a little ominous. What are the implications if Donald Trump really was to “make a deal” with U.S. creditors?
Trumps suggestion is that he could buy back U.S. Government debt for less than its face value. It is not uncommon for businesses to buy back debt when they are in trouble or are perceived to be. Australian banks made large profits during the Global Financial Crisis, borrowing money at low rates using the Federal Governments guarantee and buying back existing debt that had been priced down because it was not guaranteed.
The problem with the U.S. Government buying back its own debt at a discount is that the world financial system is built on the premise that U.S. Government debt is “risk free.” Banks worldwide, including central banks, hold large amounts of sovereign debt, especially U.S. dollars, as capital to buffer their balance sheets against defaults on their “riskier” holdings.
Any erosion in the perceived value of U.S. debt would have a flow on effect on the price of all other debt, which would almost definitely lead to a wave of bank insolvencies. The Chinese and Japanese Governments, being the largest holders of U.S. debt in the world would also likely not be thrilled.
In the business world it is clearly a smart business strategy to borrow money at a low rate and use it to build wealth by returning a profit greater than the interest cost. This is what we all try to do as property investors. If Trump can someone direct borrowed capital toward productive investments and stimulate economic growth, the U.S. just might be able to trade its way out of its debt.
The worst thing that can happen to a failed private investor is to declare bankruptcy and start again in a few years’ time. This option isn’t available to sovereign Governments. A default that reflects what Trump may have done as a business man would be devastating to the U.S. economy and the world.
They also have the option of issuing themselves money to invest and pay their debts, but if this continues with no “real” economic growth that exceeds inflation, the result is a worthless currency.
How Trump’s Presidency Could Impact Australian Property Investors
Trump’s economic reforms, depending on whether they succeed or fail, will have an impact on Australian property investors. A successful U.S. recovery would be a fillip for economic growth and provide a driver for wealth creation in the wider Australian economy. Stagnation, or a slow deterioration in the economy like we’ve seen in Japan, would also likely be good for owners of property, as this would likely mean prolonged low interest rates. If the result were to be a repeat of or something similar to the GFC, this would of course be very bad, not only for us, but for the entire world.
Trump comes to office with expectations for significant changes and, with both houses of Congress now Republican, there seems little in his way. It remains unclear how protectionist U.S. foreign policy will effect Australia, and property investors in particular. There would certainly be some sectors hit hard, such as agriculture, but at the same time it could cause a spike in commodity prices as Asian countries look to increase internal infrastructure expenditure to make up for loss of export business. That would be a win for Western Australia, Northern Territory and Queensland economies, and would boost property prices in those areas.
Higher inflation in the United States is definitely a possibility, but hyperinflation and the destruction of the U.S. economy does not seem likely in the foreseeable future. The political and social fallout would be too great for any government to allow that to happen.
Borrowing to build a wall on the Mexican border will do nothing to drive long-term economic growth, but perhaps some other infrastructure spending will. Regardless, it is doubtful that the U.S. would trigger the demise of its own economy and standing as the world’s superpower. More likely. it will continue to borrow to meet its infrastructure requirements and interest obligations (i.e., keep kicking the can down the road) and hope for higher inflation to make its debts cheaper to pay, ideally without much loss in standard of living.
For now, the U.S. can export much of its inflation, owing to the Greenback being the world’s reserve currency. How this occurs is perhaps a topic that can be covered later, but what it means is that inflation in the U.S. will inevitably drive inflation here, which should be good for property investors as it means the RBA should keep interest rates low here.
How Much Are You Paying To Borrow?
While nothing in the macroeconomic environment is certain, you can control the interest rates that you pay, at least to some extent. Get in touch with PropertyInvestingFinance.com to find how you can access rates from as low as 3.59%.