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The new U.S. administration’s proposals place America in a race between growth and debt, say Allianz economists Mohamed A. El-Erian and Michael Heise.
What does that mean for the under-40 generation?Allianz SE
Millennials have rarely had it harder to anticipate how proposals by an incoming presidential administration will affect them in terms of jobs, inflation and growth. But one thing is clear: The Trump administration’s proposals place America in a race between growth and debt, say Allianz economists Mohamed A. El-Erian and Michael Heise.
If the world’s biggest economy productively boosts infrastructure spending and appropriately reforms its tax system, growth will win. But if protectionism hurts global trade and the government must borrow heavily to fund a military buildup, then debt wins. That will have serious consequences for anybody aged 40 and below looking to work and save, for it would lead to a higher risk of the twin pests of stagnation and inflation, or stagflation.
Mohamed A. El-Erian (right) and Michael Heise (left)
MICHAEL HEISE: In the short term, military spending may boost the economy. But in the long term, this is not a benefit, especially for the younger generation because there is no financial return to military equipment and facilities and the debt has to be paid back by future generations.
MOHAMED A. EL-ERIAN: The current policy proposals put economic prospects in a race between debt and growth. This is important. If growth wins, people are better off, with greater potential for both current and future prosperity. But if debt wins, people, and particularly the younger generation, would be worse off having to carry a larger payment burden without a commensurate increase in income and earning potential.
Right now, several pro-growth policy proposals have been put on the table by the new administration of President Trump: More fiscal activism, of which military spending is but one element; changes to a tax regime that has not been comprehensively reformed since the mid-1980s; infrastructure spending and efforts to enable productive private sector activities; and deregulation. If these policies are well designed and implemented in a sustainable manner, growth would stand a good chance of winning the race. But there is a second set of proposals that are anti-growth. Indeed, they are stagflationary, meaning they would cause growth to stagnate while raising inflation. Stagflation is a bad scenario. Protectionism would lead to this. If these proposals were to prevail, then debt would win the race.
MOHAMED A. EL-ERIAN: History teaches us that regulation tends to swing like a pendulum – importantly, past the balanced point. After having gone from under-regulation in the run-up to the 2008 global financial crisis to certain over-regulation, the pendulum is now in the process of swinging back.
MICHAEL HEISE: There is also a pendulum for international cooperation in regulation. After the financial crisis, the G20 led moves to create a level playing field internationally. Now there is a movement toward individual national regulation, which will lead to fragmentation of the financial markets. This is definitely not in the interest of millennials or savers. It reduces the stability of the financial system and it creates the opportunity for arbitrage, where businesses move to countries where they have the biggest advantage. It’s quite disappointing.
The lesson of the financial crisis was that we need more coordination and regulation of the international markets because finance is a global business. This lesson seems to have been forgotten.
MOHAMED A. EL-ERIAN: It was clear at the latest G20 meeting that opposition to protectionism no longer commands universal support there. That is new. But I’m not sure that the rhetoric will translate into what young people fear, which is a permanent step-away from free trade arrangements and globalization. If the new administration were to dismantle Nafta, put high tariffs on China and Mexico, and end the free trade arrangement with Korea – all of which was mentioned during the presidential campaign – it would deliver a big blow to global growth because these steps are stagflationary in nature.
But if reason prevails, then I believe this won’t come to pass. Perhaps it will lead to some renegotiation of certain agreements but probably not a trade war.
MICHAEL HEISE: Protectionism would have a severe adverse effect on the European economy. We cannot rule it out, but it is not a very likely scenario, as it would be enormously difficult for a U.S. President to implement measures that would harm the American consumer, and protectionism would do just that. Tariffs on Mexican and Chinese products would make a lot of consumer goods a lot more expensive in the United States – everything from apples to Apple. So I also think that rational behavior will prevail.
MOHAMED A. EL-ERIAN: The U.S. economy will either be a lot better or a lot worse!
On the positive side, there is potential to lift the gridlock in Congress that has blocked virtually all economic policy for some seven years. This would help unlock capital and activity, and the outlook would be brighter for both actual and potential growth. However, if we slip into protectionism, political paralysis would return as the Republican Party fragments. The Federal Reserve is not in a position to support growth as it has done in the past.
The road we have been on – low but stable growth and central banks repressing financial volatility – would be hard to maintain. We will tip. Right now, however, there is simply not enough data to say which way it could tip.
MICHAEL HEISE: There is also a rather positive scenario for the U.S. and European economies, where infrastructure plans are pursued and the problems in the U.S. tax system are fixed in a sensible way, which will stimulate private investment and lead to higher growth. This would also help the European economy. But the U.S. government must find the right balance. In fact, there is the risk of too much stimulus that could turn a boom into a bust. This could be triggered by very expansionary fiscal and monetary policies accompanied by deregulation. You would see overheating. We think this risk is larger than outright protectionism.
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