Investing Insights

TRUMP POLICIES  •  November 11, 2024  •  Jon Wolfenbarger

Trump’s Economic Playbook: What Investors Need to Know for 2025 and Beyond

GOLEGA, PORTUGAL — The wisest saying about US Presidential elections is: “It’s the economy, stupid.”

While there are many reasons for Trump’s victory in this election, we believe the primary reason he was elected again is the fact that the American people have suffered under the highest inflation rates in over four decades due to the Fed creating 40% more dollars in 2020 in response to covid.

Regardless of the reasons for Trump’s victory, the key question now is:

What can we expect for the economy and investments during Trump’s second Presidency?

How The US Federal Government Impacts The Economy

The US economy is ultimately driven by millions of people working hard to create and trade goods and services. But government policies can have an enormous impact on the health of the economy.

The US Federal government can impact the economy and living standards of Americans in three main ways:

1. fiscal and regulatory policy: impacts production and who benefits and loses
2. foreign policy and war: impacts production, life and quality of life
3. monetary policy: impacts inflation/deflation and boom-bust business cycle

The key lesson of non-partisan rational economic science was articulated well by Adam Smith in 1776 and has been repeated by all knowledgeable economists since then, including David Ricardo, Ludwig von Mises, F.A. Hayek, Milton Friedman and Murray N. Rothbard: free the economy!

That means to avoid any counterproductive government interventions in voluntary trade and private property rights.

Economic science teaches us that good fiscal and regulatory policy is to minimize government taxes, spending, regulations and bureaucratic red tape. Good foreign policy is to pursue diplomacy, peace and free trade with all countries whenever possible. Good monetary policy is to prevent expansion of the money supply, which causes inflation and the boom-bust business cycle.

Current US Fiscal Situation Is A Disaster Waiting To Happen

The US Federal debt to GDP ratio is 120%, which is one of the highest levels in the world. The Federal deficit to GDP ratio is 6%. Since 2000, the Federal government has persistently run the highest deficit to GDP ratios in history, outside of World War II. Interest expense has more than doubled in the past five years to $1.2 trillion. It is now one of largest line items in the Federal budget. It is much bigger than national defense and Medicare and almost as big as Social Security.

Federal spending doubled during Trump’s administration and has stayed at high levels since. Federal tax receipts have risen 50% over the past four years.

There is over $200 trillion of Federal government unfunded liabilities, primarily for Social Security, Medicare and Medicaid. That is more than six times larger than US GDP. That means these commitments to the American people cannot be met and there will be a government financial crisis in the future, likely resulting in some combination of much higher taxes, much lower benefits, much higher interest rates and much higher inflation. 

Trump’s First Term Was Not An Economic Boom

During his first term as President, Trump cut taxes, pursued deregulation, encouraged domestic energy production, limited immigration, initiated a trade war with China, raised tariffs and pressured the Fed to keep interest rates low.

How did that turn out? 

During Trump’s 3.25 years in office before the covid lockdowns hit in Spring 2020, real annual GDP growth was 2.3%. That is lower than the 2.4% growth seen during Obama’s second term and the 3% growth seen from 1954 to 2016.

In other words, there was no economic boom during Trump’s first term in office.

How about the stock market?

As shown in the chart below, the stock market rallied in Trump’s first year but then gave most of it back in his second year, when the S&P 500 fell 18% during most of 2018. Then it rallied through early 2020 before crashing 35% during the covid panic, which erased all the gains of his term up to that time. The Fed raised rates through the first 2.5 years of Trump’s term. Then the Fed created 40% more dollars in response to covid and the market rallied to new all-time high valuation levels. In other words, the stock market was very volatile during Trump’s first term and the Fed likely had a much bigger impact than anything Trump did.

Trump’s Proposed Economic Policies — The Good…

Trump has proposed a wide variety of economic policies for his second term, most of which are similar to his first term.

Here are the positive ones based on economic science. 

Tax Cuts

Tax cuts are always good from a free market perspective. Tax cuts allow hard-working Americans to keep more of their money for spending, saving and investing. Investing in new equipment and technology raises labor productivity, wages and living standards. 

Trump is proposing to extend the 2017 Tax Cuts and Jobs Act provisions, which are set to expire after 2025. This includes maintaining lower individual tax rates and a higher standard deduction. He favors reducing the corporate tax rate to 15%. He is also talking about eliminating income taxes on Social Security benefits and exempting tipped income and overtime pay from taxation. Eliminating taxes on Social Security would be a huge benefit to seniors and is only fair, since they paid taxes their whole lives to get those benefits.

However, the House of Representatives controls the legislative agenda and Republicans will have a tiny majority in the House, at best. Thus, it will be very hard for Trump to get big tax cuts passed.

Spending Cuts

Spending cuts are also generally always good from a free market perspective, since they leave more resources in the private economy for consumer spending, saving and investing. A good example of how beneficial cutting spending can be is after World War II, when Federal spending was slashed by 45% and there was a postwar boom. This is proof that Keynesian economics has everything backward.

Trump has suggested his vocal supporter Elon Musk could be “Secretary of Cost-Cutting”, with a goal of cutting $2 trillion or more from the Federal government’s $6.7 trillion budget. Musk says he does not want to be in the Cabinet and “no pay, no title, no recognition is needed” for his services. He hopes to “curtail [federal] agencies to be much smaller,” make sure they “stick to what Congress authorized instead of all this other stuff” and “clear the decks” of unproductive regulations, noting that if his task force removes “some regulation or agency that was doing something useful, we can put it right back.”

Deregulation

Deregulation is also generally always good free market policy, since it eliminates bureaucratic red tape and frees entrepreneurs to create new businesses and jobs.

Trump wants to reduce regulations in the energy sector, in particular, to promote domestic production, which would help lower energy prices and reduce US reliance on Middle Eastern theocracies for energy.

Trump’s Proposed Economic Policies — The Bad…

Higher Spending

On the other hand, Trump has proposed spending more on infrastructure. This usually leads to wasteful spending and corruption with lots of money going to favored government contractors. It would better to privatize as much infrastructure as possible. Since the Federal government is broke, the last thing they need to be doing is spending more money. Instead, they should be slashing spending to free up more resources for the private economy.

Tariffs And Protectionism

Tariffs and protectionism are always bad for living standards, as proven by economists like David Ricardo in the 1800s. Tariffs are a tax on US consumers for buying foreign goods. If Trump is able to use them solely as a negotiating tool to free up foreign markets for American goods, that would be good. But it would not good for Americans if he actually implements them.

Trump is proposing a 10% tariff on all imported goods and a 60% tariff on Chinese imports. He has also proposed a 25% tariff on Mexican imports if Mexico fails to prevent illegal migrants from crossing into the US.

Trump’s Proposed Economic Policies — And The Uncertain…

Reduce Fed Independence 

Trump and Vice President Vance have talked about how they would like to limit the Federal Reserve's independence by allowing Presidential influence over interest rates and potentially removing Jay “Transitory Inflation” Powell from office.

If this means that Trump wants to artificially and temporarily goose the economy with lower interest rates and money creation, that would be bad, as it would lead to higher inflation and a more intense boom-bust cycle.

But if they could really limit or eliminate Fed “independence” and put monetary policy in the hands of elected officials rather than unelected bureaucrats like Powell, that could be very positive. 

Economists like Milton Friedman have proposed a better system than what we have now, which would include requiring banks to hold 100% reserves (which would eliminate risks of bank runs and the business cycle) and putting elected officials in Congress in charge of the Fed. Then, instead of the US government borrowing money, the Treasury could just tell the Fed to give them whatever money they wanted to spend. This would cause inflation, but at least it would be in the open and elected officials would be responsible to voters so they can be voted out if inflation is too high, which cannot be done with Fed bureaucrats.

It’s hard to imagine Trump can get anything changed concerning the Fed, but it would be interesting to see him try.

Foreign Policy and War

Trump was the only US President in recent memory who didn’t start any major new wars. He says he wants the end the war with Russia, which has cost over one million lives and $175 billion in US taxpayer money and could lead to WWIII. However, it is less clear what he wants to do with the conflicts in the Middle East and he is generally antagonistic towards China.

Immigration 

The US economy needs peaceful hard-working people to grow the economy. But it does not need people who commit crimes and go on welfare paid for by hard-working taxpaying Americans. It remains to be seen what, if anything, Trump can do to improve the immigration system in the US.

What’s The Net-Net?

David Stockman was Director of the Office of Management and Budget (OMB) under President Ronald Reagan from 1981 to 1985, so he knows a thing or two about fiscal policy. In this recent article, Stockman estimates Trump’s proposed tax cuts will total $11.5 trillion over the next 10 years. That is a whopping 34% of the Congressional Budget Office’s (CBO) estimated income tax revenue over the next 10 years.

Trump’s proposed tariffs could generate an estimated $9 in revenue, offsetting 80% of the tax cuts.  Those tariffs would amount to 10% of annual US consumption of consumer goods and fixed investment goods.

Assuming Trump’s tax cuts and tariffs and the CBO's estimate of $85 trillion in spending over the next decade, there would be about $25 trillion of Federal budget deficits over the next 10 years. Note that Trump has promised to not cut Social Security, Medicare, national defense, veterans programs and Federal pensions, which comprise over 80% of the CBO’s spending estimate.

How would these enormous deficits be paid for?

Deficits can only be paid for by:

1. borrowing even more money, which would take scarce capital away from productivity-boosting private investments and put upward pressure on interest rates and/or 
2. creating even more money out of thin air, leading to higher inflation and more boom-bust cycles

How Would Investments Fare Under Trump?

Economics is important, but Investor psychology ultimately drives financial markets. 

Investors are incredibly bullish right now, which has driven stock market valuations to all-time high levels, even higher than the peaks in 1929 and 2000. As a result, the stock market is likely to be much lower in a decade than it is now, regardless of government economic policies.

As economist David Rosenberg recently noted, “Trump is walking into one of the most acute equity market bubbles of all time and he too will at some point be dealing with the fallout from the pricking of said bubble.”

Investors hoping for Fed rate cuts to fuel even more “bubbleliscious” valuations may be disappointed due to rising growth and inflation expectations in the wake of Trump’s victory. 

Again, the Fed created 40% more US dollars in 2020 in response to covid. This caused the highest inflation rates in over 40 years. That forced the Fed to hike interest rates at the most aggressive pace since the early 1980s. That caused the biggest decline in the money supply and the longest yield curve inversion since the Great Depression of the 1930s.

If this does not lead to a recession, it will be the first time in history.

Note that employment is already falling. The unemployment rate has risen 0.7% and every time it has risen at least 0.5%, there has been a recession. Housing starts have fallen significantly and leading economic indexes are pointing to recession.

Thus, we believe a recession is highly likely over the coming year or two regardless of what Trump does.

This could lead to at least a 50% decline in stocks and other risk assets, including Bitcoin, since Bitcoin has been highly correlated with stocks so far during its relatively brief history.

As this chart shows, if there are major trade war and tariff concerns, more cyclical stocks will likely underperform defensive stocks.

The big question is inflation and interest rates. If a recession becomes obvious, that would usually be bullish for bonds. But if the Fed cuts rates aggressively, that could lead to a resurgence of inflation during a recession. That would be “stagflation”, which is the worst situation for American living standards, as well as stocks and bonds.

Gold and silver would likely the best investments under that scenario, in addition to inverse ETFs on risk assets.

Conclusion

Hopefully, Trump will implement free market-oriented policies, rather than interventions that harm the free market. The problem for the economy and financial markets is that valuations and sentiment are already extremely high and the Fed has already hiked rates at a pace that will almost certainly lead to a recession. Thus, we should hope for the best, but prepare for the worst.