Finance Finance News Trump’s tax cuts stick a pin in the ‘everything bubble’

Trump’s tax cuts stick a pin in the ‘everything bubble’

trump inflation tax plan
President Trump is proceeding with an economically flawed tax plan at the worst possible time. Photo: Getty
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The Trump administration’s tax plan, which passed Congress this week, brings with it a huge risk for the global economy.

The package involves slashing the corporate tax rate from 35 to 21 per cent, giving personal tax cuts to millions of upper- and middle-income Americans, and giving instant tax breaks to companies that bring capital home from abroad to invest in the US.

Together, those measures are supposed to stimulate the economy, mostly by boosting the ‘supply side’ through new investment, but supposedly also via wage rises and higher consumption spending.

To a large extent, the Trump plan is a re-run of the discredited ‘trickle down’ economics used by the Reagan administration in the early 1980s – an approach that can boost growth, but which also increases inequality.

That’s bad enough, but it gets worse.

At home, the President will be aware that the US Federal Reserve expects to increase interest rates three times next year to prevent uncontrollable wage- and price-inflation breaking out – because, as the old saying goes, that’s a lot easier than getting the ‘genie’ back into the bottle.

US unemployment is an astonishingly low 4.1 per cent, and headline inflation has risen to 2.2 per cent, so the Fed is looking ahead to the time when there will be way too many dollars chasing too few goods and services.

Economist Saul Eslake points out that the Reagan tax-cutting experiment was conducted when unemployment was 10 per cent, there was plenty of spare productive capacity in the economy, the US national debt was less than half its current level, and the Fed was busy cutting rates – a completely different scenario.

Global waves

The fallout of the Trump tax plan won’t only be felt at home. If it forces the Fed to make even more interest rate increases next year, it will push borrowing costs around the world higher still.

For a country like Australia, that’s bad news – not only because of our huge housing credit bubble, but because of the effect higher rates will have on our trading partners.

At present, the global economy is finely balanced, but is nonetheless gaining strength by the day.

The eurozone economies are growing strongly enough for the European Central Bank to stop stimulating the region via its ‘quantitative easing’ bond-buying program.

China, too, is cutting back on stimulus spending. It knows that all things being equal, its largest export market – the EU – will help support market-based growth rather than government-funded growth.

That, in turn, would be good for Australia and other Asian economies that form such a large part of China’s supply chains.

A double whammy

The Trump plan is putting these finely balanced developments at great risk.

Donald Trump doesn’t seem to care much about historical context. But if he did, he’d realise that the world’s central banks are doing their best to unwind a decade-long period of monetary intervention in world markets.

Cheap money flowing from those banks has pumped up asset markets – bonds, shares, property, you name it – and created what some are now calling an ‘everything bubble’.

The global recovery should be able to handle a gradual deflation of those bubbles, but not a sudden shock.

By stoking inflation in the US, pushing up global borrowing rates, dragging American capital home from abroad, and sending shockwaves through currency markets, Mr Trump is raising two fingers to the global recovery.

As a political gamble it may work. The depressed and struggling Americans who voted for him may not realise before the next election how reckless his ideologically driven tax-cut plan is.

But as the centrepiece of his economic strategy, the plan looks certain to leave him utterly discredited – even more than poor old Ronnie Reagan, who ended up having to borrow and spend his way out of trouble and raised taxes numerous times later in the 1980s to undo some of the damage.

When the ‘everything bubble’ bursts, Mr Trump will be left like a naughty schoolboy protesting that “it wasn’t me” but holding a giant pin in one hand.

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