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2019: Actions From 1971 Relived

The economy can do without another Richard Nixon persuading it. Though his policies were a great tool for reelection, they presented further economic stresses. The same stresses found under Nixon’s presidency are becoming more visible under the Trump administration. Trump and Nixon may not be direct reflections of each other; however, they do lean the same direction on a few key economic issues: monetary policy and tariffs.

The most rudimentary effect that expansionary monetary policy has is that it leads to GDP growth, ignoring all other economic conditions. This view was a key point of focus under both Trump and Nixon. As fear of a slowing economy became present in both of their first terms, they leaned and pressed the FOMC to solve these issues by cutting interest rates. Although the FOMC should make decisions independently, after the July 2019 meeting, it appears that the attempts to puppeteer the Federal Reserve by president Trump may prove to be as successful as it was under Nixon. With both of these presidents adding to the pressure on the Federal Reserve the question to consider is, do lower rates always lead to higher GDP growth?

Lower interest rates are intended to spur greater borrowing from consumers and companies to add to the consumption and business investment within the GDP formula. Additionally, it is supposed to deter savings and promote other forms of spending and investing as money does not earn much sitting in a bank savings account. Under theoretical conditions, lower interest rates do increase GDP, however, the US economy is not theoretical. This economy is still producing jobs, keeping inflation low, has relatively low interest rates, and is on a ten-year bull run. However, it also has growing concern of a global slowdown, has the highest levels of corporate debt in its history, has an inverted yield curve, and is in the midst of a trade war. So maybe the question isn’t can lower interest rates increase GDP, but can lower interest rates increase this economy’s GDP? Maybe they can, or maybe the lower interest rates of 2019 will impact the US in a similar fashion as Richard Nixon’s lowered interest rates, which produced higher inflation.

Lower interest rates also have a direct effect on asset prices. As interest rates are lowered, the discount rate used to calculate net present value is also decreased leading to increased asset prices. This increase in prices can potentially help current investors, as their assets increase in value. If they choose to sell these investments, they can realize a gain and spend their money elsewhere, thus increasing GDP. The increase in asset prices do not directly lead to increased GDP as the unrealized gains will remain unrealized if they are not sold. If a strong economy does not react to the rise of asset prices correctly, due to fear or greed, it leads only to an increase in prices and subsequently a decline in demand. The lower interest rates are also supposed to encourage spending, however, with increased prices, the market may see the assets available as overpriced and save money to afford these assets.

If consumers don’t spend as intended, at least the lower rates may lead to increased business investment, right? The current low unemployment levels, growing demand for workers seen through increased job creation, increased “qualified” candidates due to higher numbers of college graduates, and subtle pressures from a rise in populism create an opportune scenario for wages to start increasing at a more rapid pace in the US. Though this can lead to an increase in disposable income for individuals, a real issue is the increasing student loan debt. These student loan payments prohibit the spending ability of a majority of the population, and if this is coupled by increased asset prices of living, such as rent, home prices, automobiles, etc, the income effect can become completely nullified. Though consumer spending has not yet begun to decline, we have seen signs of slowing business investment, and if inflation is caused by lower rates, we could begin to see consumer spending slowly decline. This is only one economic issue on which Trump is mimicking Nixon, the other is tariffs.

“Prosperity without war requires action on three fronts: We must create more and better jobs; we must stop the rise in the cost of living; we must protect the dollar from the attacks of international money speculators.” – Richard Nixon 08-15-1971

Both presidents also stood on the pillar of spending money within its country’s borders. Why? “To make America great again!” Both proclaim that the US needs more jobs created domestically, and instead of innovating to new jobs, they find the solution lies behind tariffs. The use of tariffs disrupts supply chains and can lead to increases in prices of foreign goods. If this increase in prices lasts for long periods of time, they can lead to higher inflation. The inflation from tariffs takes time to notice as it is not initially felt, but slowly seeps into the company’s financial statements and cuts down profitability. However, there may be some benefits to tariffs. Nixon and Trump both used tariffs as a negotiating tactic in international trade in attempts to skew net exports away from a deficit. The use of tariffs attempts to achieve longer term benefits while incurring short term costs.

For Nixon, he imposed 10% tariffs on all imports entering the US, but for only 4 months. His plan appeared to work, as he saw some GDP growth due to increased market sentiment with the economy feeling as if these policies helped boost American businesses. Trump’s tariffs have been ongoing for a year and is currently locked in an immovable trade war with China. As time passes, the negotiating benefits first thought to be achieved have become overshadowed with the potential long-term costs. The length of this trade war continues to be extended as China and other foreign countries alter their exchange rates and therefore mitigate the costs tariffs can cause to their economies. Where Nixon found short term success using tariffs for negotiation during his time, Trump has found trouble. Tariffs on top of a slowing global economy may have damaged Trump’s GDP growth plans as this trade war escalates into a currency war.

What would happen if the lower interest rates and tariffs have unintended consequences for GDP growth? What could Trump do to save his economy if all his attempts to boost it fail? For this we also turn to Nixon & the US dollar.

Trump has toyed with the idea of weakening the US dollar compared to our trade partners, the same as Nixon did. The strength of the US dollar is directly tied to and can theoretically help the country export more goods, import less, and raise GDP. Nixon, at a time when the US markets were on decline, initiated policies that increased market sentiment with quick tariffs, manipulated the FOMC to lower rates and changed the dollar forever. Nixon ended the Bretton Woods agreement by taking the US dollar’s exchange rate away from the price of gold. The dollar was overvalued as the US did not have enough gold to cover the volume of dollars circulating the world. This forced other developed nations into the Smithsonian Agreement, and allowed them to revalue their currencies to the new US dollar. The transition devalued the dollar further and led to a floating exchange rate for foreign currencies relative to the US dollar. Nixon’s stance on currency led to even higher levels of inflation as the US dollar lost value and imports became even more expensive. Eventually his economy ran into a recession in 1973 that was coupled by high levels of inflation, leading to a period of stagflation. But the recession was delayed and Nixon was reelected at the cost of a future economic downturn.

Though there are strong similarities between Nixon and Trump, the economic landscapes they operated through are vastly different. However, the mission to have increased economic growth is the same. Both presidents saw a strong economy as a sure sign of reelection, doing everything within their means to increase GDP. Does President Trump see the US currency as a tool to help trade negations? Can the bull market continue its long run? What costs come from attempting to raise GDP? As illustrated in history, policies do not always have the intended effects, and the effects of current policies can only be evaluated in hindsight.