Well, This Is What I Think

So, the much-discussed mid-terms are over and done with, and the US stock market is up about 2%, as it usually is when the uncertainty of elections is over.

As we predicted a year ago, the Democrats handily won the House, (probably by more than estimated in early reports), and there was an “as you were” result in the Senate, which is likely to leave the Republicans in control. (We say “likely”, because a number of races are still toss ups, but it’s by far the most likely result.)

But what happens next is vitally important to the health of the US economy, and more broadly the world.

Nancy Pelosi, who despite some rumblings is certain to hold onto her job as head of the Democrats in the house, (if for no other reason than she is both a wily negotiator and a fundraising ballistic missile), has spoken warily of the need to work with the White House across the “aisle”.

In return, President Trump has said he wants to work with Pelosi on boosting infrastructure spending and lowering prescription drug prices, two rare policy stances of agreement.

“I think she’s a very smart woman. She has done a very good job,” Trump said at a press conference Wednesday, adding that the two didn’t discuss the prospect of impeachment in a phone call. “A lot of people thought I was beings sarcastic or joking, I wasn’t,” Trump added, in reference to a tweet saying Pelosi deserved to be speaker. “There was nothing sarcastic about it, it was really meant with good intentions.”

But – and it’s a big but – two things are likely to impede both sides’ vaunted good intentions.

Firstly, the desire to impeach Trump for something – anything, frankly – may prove irresistible to many Democrats who are still smarting from two plus years of insults from the Cheeto-in-Chief, after what they consider to have been a stolen Presidential election, and would love to hurt him back.

And Trump does not take well to assaults on his person. If war is declared, it will be fought bitterly.

Secondly, despite some areas of agreement, the Democrats are distant by a country mile from the Republicans on healthcare and will also seek to spread the benefits of a moderately booming economy to their own middle class base and away from the 1% and rustbelt industries that they fell deserted them in 2016.

So whilst the two sides may co-operate – and let us all fervently hope so – the stage is just as likely set for a “do nothing” period of government akin to when Obama lost control of the House.

If the reality of so-called gridlock sets in, then it may limit the current “relief rally”, added Nigel Green, founder and chief executive of the financial consultancy deVere Group. Of such a gridlock, he said: “This will halt deregulation legislation, which in turn will hurt sectors such as banking, energy, industrials, and smaller companies that stood to gain most from looser controls.”

Green’s concerns would be just the beginning, though. The Democrats may choose to wade in on the nasty little trade war going on with China, introducing yet more uncertainty. (Whilst the world might welcome a move to free up trade again, uncertainty on policy settings is what drives stock markets down.)

And what is absolutely certain is there is no appetite in Washington to do anything serious to tackle the ever-ballooning American government debt, from either side, but most definitely not from “tax and spend” Democrats.

Failure to do anything serious about the debt is the ticking time bomb at the heart of the American economy, containing within it a potential fall in the value of the dollar through a general loss of confidence in the essential health of the economy and its currency, and a possible subsequent stoking of inflation. That inflation then causes more uncertainty, and so on we go …

In summary, a fall in the value of the dollar:

• Makes US exports cheaper to foreigners importing US Goods.
• It is cheaper for non-US citizens to go on holiday to the US.
• US consumers face higher price of imported goods.

However a devaluation is often just a temporary increase in competitiveness. Devaluation often causes inflationary pressures which reduce a temporary gain in competitiveness.

Also, as exports become more competitive (ie cheaper to foreign buyers) without firms having to make much effort to make that increase happen, then therefore there is less incentive for them to cut costs and boost productivity, and so in the long run costs will increase and therefore inflation will increase. If firms are well run and they cut costs when times are good then this may be avoided, but there appears to be little appetite for that in the USA at the moment.

If there is a devaluation in the value of the US dollar then there will be an increase in the price of goods being imported to the USA. After decades of manufacturing decline, imports are now quite a significant part of the country’s CPI, therefore increasing their prices will contribute towards cost-push inflation.

It is possible that retailers might not pass the price increases onto consumers but choose to live with lower profit margins, but if the devaluation is sustained, prices will inevitably go up.

The Financial Times have estimated that as a rough rule of thumb, a 10% devaluation may increase prices to consumers by 2-3%, affecting confidence. The components of the CPI most affected by a devaluation in the dollar are:

1. Air travel (-1.29)
2. Vegetables (-1.22)
3. Gas  (-0.71)
4. Fuel (-0.54)
5. Books (-0.35)

Numbers 2-5 hit ordinary consumers hardest, of course. That won’t help the party in power.

And after yesterday’s results, that means both of them.

The price of a war between the House and everyone else will be international market instability. That doesn’t help anyone, inn the USA, and beyond. Let’s hope Pelosi and Trump can work that out.