More Thoughts on Trump’s Economic Plan
Exploring President Trump’s strategy for a seismic economic shift.
Summary:
The US economy requires a "seismic shift" to correct significant fiscal and trade imbalances, as the current standard of living and costs are too high compared to China and require controlled deflation.
A rapid currency devaluation similar to the 1985 Plaza Accord is viewed as impossible today because it would disrupt the $729.8 trillion derivatives market that relies on US Treasuries for collateral.
The necessary economic transformation involves achieving a zero or low budget deficit, reducing the Balance of Payments deficit, and building national reserves in assets like gold and cryptocurrency.
To restore self-sufficiency, the US must restructure its industrial base using tariffs and extensive automation to replace labor cost arbitrage.
This transition is expected to create short-term shocks that negatively impact companies relying on global pricing arbitrage, such as Apple and Nike, making individual stock selection critical.
A seismic shift is needed
Reversing the current economic predicament of the US and the West from trade and fiscal deficit is an extremely difficult task, and no politician will be willing to take that risk. In Asia in 1997, the politicians did nothing, hoping nobody would notice, and it went away.
Trump is different. He has a plan.
To understand this, one must look at it from China’s lens.
If it is possible to live in China at 1/5 the cost at a standard of living no worse than the US and many developed countries, there is a significant imbalance that needs to be corrected. Not because there is a trade deficit, but the US and the West, which have lived on accelerated wage rises and wealth creation over the last 30-40 years, have become too expensive and must deflate economically. This was largely the result of the financialisation of the economy and the significant fall of interest rates over that period that boosted asset prices.
A seismic shift is needed to correct it.
Can we entertain the idea of another Plaza Accord?
A quick way is currency depreciation, ala Plaza Accord. While it seemed to remove the US trade deficit problem but didn’t, it left a significant impact on some countries and many companies. Disorderly FX and bond trading activities would lead to a currency crisis and a US government bond crisis as foreign creditors would attempt to sell this asset to avoid devaluation. It would affect other USD bonds, too. The implications are too great, and it is no longer possible, unlike in 1985.
Two other key reasons are that the current market structure is highly digitised, unlike in 1985, and will create days and months of mayhem. In addition, UST and USD are used to collateralise the $729.8 trillion dollar derivatives market (as initial margin [IM] and variable margin [VM] to derivative specialists). While other G7 currencies and bonds are eligible, none are as liquid and widely held as UST and USD. Any change in the valuation of USD would send the value of USD and UST down substantially. Hence, such chaos is unimaginable and should not happen.
As of June 2024, the total notional outstanding for over-the-counter (OTC) derivatives was $729.8 trillion*, according to the International Swaps and Derivatives Association (ISDA). This notional is back to the pre-GFC peak level** after several years of cleaning up with new Basel rules that made derivatives cost expensive, where the amount had once declined to low $400 trillion in 2015-2018.
**https://www.bis.org/publ/otc_hy0811.pdf
An alternate scenario is a wage and price deflation, which the West dislikes. Something like what the Japanese have gone through, but worse.
Therefore, a combination of currency depreciation, price deflation, and adjustment must start to take place. Hence, control depreciation of USD and controlled deflation should be expected.
For this to happen, the US needs a serious multi-year transformation ranging from fiscal, economic and industrial perspectives:
A strong fiscal position, ie, zero budget gap or low deficit. A benign 3% budget gap and 3% GDP growth would support healthy tax collection even if its is at a lower tax rate. The 3% target could be a stage 1 target.
Reduce BoP deficit through increasing FDI and reducing trade deficit. This is now being executed. All this while maintaining US leadership in software and services export surplus.
A strong national reserve that is not USD. This alternate source of collateral to support the strength of the USD can maintain its ability to soften any import inflation. It should not be correlated to the USD or any other currency that might. Hence, cryptocurrency reserves, besides gold, are becoming a good alternative plan.
Industrial, manufacturing, energy, and agricultural restructuring must happen, too.
The US must restore its ability to be self-sufficient in every aspect, or to a great extent, back to the 1970s, when “made in USA” was found on most products sold domestically. This would remove the risk of sustained hyperinflation from a weak currency, as Japan experiences today.
While China controls the supply chain for raw and processed materials, it is an industry that is not difficult to replicate with a significant amount of automation. The key is obtaining the source, such as in Greenland and Canada.
This makes a slow, sustained depreciation of the USD possible; otherwise, inflation would send her back to the third world.
Who will be impacted?
In the first stage, companies that historically have lived off pricing arbitrage would suffer first. Apple and Nike are obvious examples, but there are many more. While Trump would want Apple to make in the USA, he might be less interested in Nike’s textile manufacturing facility.
Who will build these factories, and where is the supply coming from?
US workers and construction migrants on special visas. When the time comes, an EO would solve the labour issue. However, the US labour force would first be exhausted.
Who will provide the supply?
Domestic suppliers will be prioritised initially, and once their supply is depleted, foreign imports will be considered. This approach is likely to attract numerous foreign suppliers to the US, resulting in a sustainable supply chain. For example, while US Steel may be more expensive than steel shipped from China or Japan, if the tariffs are sufficiently high, US Steel’s supply would benefit. Increased business would allow it to consider expansion. Similarly, Nippon Steel might build a new factory in the US.
Who will work in the future factories?
To arbitrage labour costs and generate greater cost savings, robots and extensive automation are a must. This would be the future of US factories. The robotic revolution would reduce wages as unemployment will increase in a few years when the building slows. However, a strong fiscal position would enable the country to provide a Universal Social Benefit system that would meet minimum needs.
It often puzzles me why Tesla workers are willing to be non-unionized. Could it be that they are mostly unskilled labour that can be easily replaced, that they are given Tesla shares, and that most skilled jobs are automated?
Who is already committed or thinking about it?
Honda and TSMC have. The incremental is substantial.
BYD is reconsidering its Mexico factory, and other US automakers must reconsider their Mexico operations and Mexican suppliers, too.
Change should accelerate.
Mr Market does not like it. They are looking for a Trump Put.
Not changing is more detrimental. The current situation will harm the US long-term, make its companies irrelevant, and diminish wealth.
These changes will have short-term shock but long-term benefits. Lower individual and corporate tax rates could soothe the shock that is yet to be announced. It’s just 45 days since Trump took over, but it feels like a long time as the number of changes has been immense. So far, it seems he has a well-planned and organised work schedule. We need to be patient.
It is a difficult balancing act for consumers on their balance sheets, and even more so for Mr Bessent on the USA balance sheet.
China has already experienced the robotic and automation revolution in its ascension to a world- leading manufacturing hub. China’s production technology and industrial equipment are world-leading. Tim Cook famously said that companies come to China not for cheap labour but for the skilled labour, advanced tooling, and manufacturing technology available in the country. The automation revolution has led to lower job creation versus the pace of economic growth in China.
As a result, it has led to a higher degree of unemployment among younger adults and fresh graduates.
How to invest?
That does not mean the stock price will be in free fall, but that some companies will become less relevant and disappear, and some will flourish. Research and judgment are needed.
Related Insights
