How Trump's Economy Can Go Right (or Wrong)

How Trump's Economy Can Go Right (or Wrong)

REUTERS/Carlo Allegri

Wall Street remains ebullient a week after Donald Trump’s shocking election victory, hopeful that his aggressive plan to cut taxes and pump up spending on infrastructure and the military will provide a massive boost to the economy at a time when monetary stimulus from the Federal Reserve is winding down.

His skeptics point to the possible downside effects of his calls for an "America first" trade policy and tightened immigration, and to the rising interest rates that would be associated with expectations for higher inflation and a ballooning national debt under his plans.

What should investors expect?

To start, much depends on how pliable the fiscal hawks in Congress are. We'll know soon as the statutory debt limit will need to be raised by March.

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As a reminder, the Committee for a Responsible Federal Budget estimates that Trump's plans would add $5.3 trillion to the national debt over a decade and that merely a stabilization of the debt as a percentage of GDP would require a combination of severe non-entitlement spending cuts and a doubling or tripling of the current economic growth rate. Possible, yes. But highly improbable.

Given Trump's unorthodox approach, and his self-proclaimed status as the "King of Debt" as well as his brief campaign calls for a possible restructuring of the national debt, I believe some type of debt write-down is coming. Which, honestly, is probably the most politically viable means of "resetting" America's credit situation. Should we tell China they get 80 cents on the dollar? Or should we tell seniors that we're cutting back on end-of-life care?

Related: 4 Reasons Trump’s Economic Policies Would Be a Disaster

Given this outlook, researchers at Goldman Sachs peered into their crystal ball (and by that, I mean their economic models) and came up with three potential scenarios for the Trump economy, ranging from GDP growth accelerating to a 2.6 percent rate by 2018 to a downside forecast of growth stalling out under 1 percent in 2019.

Goldman’s "full" implementation case includes Trump's fiscal, trade, immigration and hawkish Fed policies (he has railed against the cheap money policies of Fed Chair Janet Yellen). The "benign" scenario factors in only his fiscal proposals for tax cuts and increased spending. And the "adverse" scenario includes import tariffs, immigration restrictions and higher interest rates without the benefit of fiscal stimulus.

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Under the full scenario, Goldman’s economists believe growth will get a temporary boost of 0.2 percent via tax cuts late next year before the effect fades and becomes a drag by 2018 and 2019. Inflation would rise to a 2.3 percent annual rate in late 2019, accelerating the pace of the Fed rate hikes.

The benign package provides a similar, but smaller, temporary boost.

The adverse scenario leads to a nightmare "stagflation" situation in which the economy slows and inflation surges (on higher import and labor costs), risking a new recession.

Overall, Goldman expects Trump to deliver a boost to growth, inflation and jobs over the next two years before the drag from higher inflation and higher interest rates starts to weigh.

Globally, the outlook is more difficult. The economies of our trading partners would be negatively impacted in all but the benign scenario, with China getting hit particularly hard.

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A similar analysis by the folks at Oxford Economics also looked at three potential scenarios for the Trump economy. In the most positive of those scenarios, larger tax cuts focused on working families and less aggressive trade terms would see GDP growth doubling from its current pace, resulting in an economy 2 percent larger by 2020 and the creation of 2 million additional jobs. In the downside scenario, acrimony between Trump's White House and Congress would result in a new recession within the next two years and the loss of 4 million jobs by 2020.

That at least gives us a sense of just how much is at stake as Trump takes office.