More Krugman On Infrastructure And What To Worry About With Trump And The GOP

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Summary

Paul Krugman has reiterated his view that Trump will not be able to build much infrastructure due to the preferences of the House Republicans.

It seems to early to take this view.

The main source of conflict between Trump and his party is likely to be Trump's stance towards China and Russia. Investors should follow this closely.

After a healthy debate centered on the consistency or otherwise of Paul Krugman's recent statements concerning the desirability of deficit stimulus for the U.S. economy, Ian Bezek and I found some common ground on the idea that Krugman might at least be jumping the gun by, as I put it at the time:

"...writing off the chances of an infrastructure program too early. I think a lot of people entertain doubts about what Trump will be able to secure in terms of fiscal space from his own party, but it seems premature to say it won't happen".

I think most of us can see the interplay and natural opposition of deficit related factors at work: tax cuts, both corporate and personal, have been part of mainstream Republican Party thinking for a long time, while heavy infra spend has not. The party boasts a number of prominent fiscal hawks, and so on. With wage inflation and employment data suggesting strong (ish) labour markets, there is at least space to raise an eyebrow about Trump's job projections in the context of the deficit and U.S. inflation. After all, much energy is about to be bought to bear with the very soon to be President promising to be "....the biggest jobs creator God ever invented.....".

While all this poses questions (not least does Trump "get" the risks associated with forcing the Fed to 'break' a growth cycle) we are not there yet. Perhaps in the mix of it all, the GOP leadership and Trump will indeed manage to produce a combination of tax and infrastructure that lends some form to all the talk.

Nobel winner Paul Krugman though is having none of it:

"Trump has no policy shop, nor does he show any intention of creating one; he's too busy tweeting about perceived insults from celebrities, and he's creating a cabinet of people who know nothing about their responsibilities. Any substantive policy actions will be devised and turned into legislation by Congressional Republicans who, again, have zero interest in a public investment program."

This repeats and amplifies what Krugman has said on the subject previously. In apparent contrast to many in the Seeking Alpha community, I find Krugman a most useful resource in my investment thinking. For instance, I have him to thank for highlighting the risks of western government austerity programs post 2008 and I have never seen him come close to losing a debate on the subject.

But for now I think the right stance is that tax cuts are valuable, to one extent or another, and they are probably the easiest policy item to achieve while infrastructure investment is a further potential boost with attendant deficit/inflation risks depending on the moving parts. Likewise, from the perspective of policy direction in the industry group I focus on, any relaxation of things like Dodd-Frank provisions or DOL fiduciary changes will be good, even if they turnout to be less comprehensive than hoped.

Where I do see clearer risks of a breakdown between Trump and the Republican establishment is over policy towards China and Russia. It's not the 'kompromat', though anyone who isn't slightly concerned by this would be insane, it's the bellicosity of the stance on China and seeming determination to have a love-in with Russia come what may.

China

Start with Rex Tillerson, the nominee for Secretary of State. At his confirmation hearing Tillerson compared China's holding of seven artificially created Islands in the South China Sea to Russia's annexation of Crimea and suggested that China should be prevented from accessing them (presumably by the U.S. Navy). Trump followed this with a reiteration of his view that the U.S. One China policy is a "negotiating point" and accused China of 'artificially weakening' its currency and 'killing us' via the dollar channel, when of course China's currency interventions these days are aimed at supporting the value of the CNY.

Investors should worry about this because the Chinese economy appears ever more delicately positioned with regard to its debt financing problems and the attempt to shore up the currency's rate of descent. The last thing China needs is an attempt to pressurize it into a deep change in the terms of trade and the result would likely be similar to what has taken place with Russia's own diversion of domestic economic pressures into military assertiveness.

Given the impact that the ebbs and flows of Chinese economic data can have on global equity markets, this issue is of crucial importance for investors.

Russia

The Russian issue is less of a worry economically. Indeed, were Trump to end sanctions, which he clearly envisages at some point, it would arguably be an economic positive though not a huge one for the US economy. However, The matrix of Trump-Tillerson Russian connections is very complex and their overt positivity towards Putin threatens to clash seriously with members of the GOP establishment who have not notably softened their stance towards Russia following its annexation of Crimea and its activities in supporting the separatist side in the Ukrainian civil war.

And to my mind investors should reflect on Trump's restatement of his view that it makes sense to have a constructive relationship with Russia after he publicly accepted its role in hacking activities that attempted to influence the course of US democracy.

Russia appears to be the most ready source of a serious standoff between Trump and his party, and China a close second given that it involves the business interests that many House Republicans tend to align with, which in general are pro-status quo in terms of the trading relationship. This of course might translate into less willingness to embrace infrastructure building among other policy items as they unfold.

Conclusion

Paul Krugman is amping up his "no infrastructure" theme and it seems premature to forecast total failure on this front. However, there are deep differences in the Republicans over China and Russia policy and these might cause fissures sufficient to impact Trump's economic policies while his stance towards China at face value threatens disruption to global trade. The associated risks concentrate most heavily on EM equities and I would remain comfortable with along domestic US, short EM position.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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