Trumpeconomics. The Donald was elected owing to huge support from voters who feel disenfranchised, not just angry white male industrial workers in the Mid-West but also from other sectors of the population. Despite Hilary Clinton winning the overall vote as did Al Gore in 2000, it is clear there was a substantial swing to the Republican party overall and this should not be ignored. The Democrats were also guilty of complacency and seem to have misread the risks of a Trump victory. But that is history and the question now is whether Trump will deliver to those who elected him? There is something rather odd about Trump’s victory (as there was in the Brexit referendum). There has been an unholy alliance between the right wing Republicans and the traditional Democrat voting middle aged predominantly white small town voters. This alliance has radically upset traditional electoral paradigms. The question is whether this alliance can deliver for anyone bar the rich and so far the omens are not good. The tax cuts announced by Trump predominantly benefit the rich. The related fiscal stimulus is too much driven by tax cuts and is short of specific spending proposals which might benefit the less well-off. Plans for infrastructure spending are vague on detail. Policy on trade is haphazard and seems confined to deals for specific companies. Whilst there some workers may benefit, there is no mention of the costs to workers arising from increased trade barriers. Trade is seen as a zero sum game whereby a gain for Mexico or China means a loss for the US, whereas in fact it is a positive sum game which benefits all parties. All the circumstantial evidence is that Trump does not nor wishes to understand the economics of trade. There is no evidence that the working class as a whole will benefit from a more restrictive trade regime. In the meantime, equity markets have responded favourably to Donald Trump’s election. Why? The most obvious answer is the reflation trade. Trump has promised a fiscal stimulus which is what Keynesians have been asking for some time. The rise in bond yields suggests that the US economy at least may escape from the zero bound. That is the good news in the short run. But looking further into the future, it is hard to be optimistic. 2017 will be driven by ‘deals’; if you are on the right side of the deal, then all to the good; if not, tough. In terms of economics, that is the route to cronyism and corruption and benefits the favoured few. In terms of politics, Trump is assuming that he will get the best deals for America. He ignores that he is up against some tough and astute opponents who will exploit his weaknesses. I also suspect that his administration will be torn apart by infighting. Donald Trump has always exaggerated how good a businessman he is; the problem now is that we will all pay the price for his less than wonderful deals and US centric view of the world

Interest rates. There is an emerging consensus that monetary policy has gone as far as it can. With interest rates at zero and bond yields in Germany, Switzerland and Japan negative, central bankers are impotent. In fact it could be argued that current policy could lead to another banking crisis, because banks cannot make any money out of maturity transformation with rates at zero. The recent decline in Deutsche Bank’s share price is indicative of a fundamental malaise. This is not to criticise central bankers for what they have done since the 2008 financial crisis. They have done what they were meant to do, cutting interest rates to zero and providing stimulus. Money supply has continued to expand, thus averting the catastrophe that befell the American banking sector in the 1930s, as documented by Friedman and Schwartz. The problem is that the velocity of money has declined so obviating the expansion of the money supply. This decline has not really been explained away by monetarists. If monetary policy cannot boost growth, what can? The answer may well be fiscal policy, as described by Keynes and illustrated in classic IS-LM model which demonstrates the interplay of the demand for goods and supply of money. What Keynes highlighted was the failure of policy when the equilibrium interest rate was less than zero, or the so-called liquidity trap. This renders monetary policy redundant and requires a more active fiscal policy. The problem is in part political. There is a prejudice against using fiscal policy as a stimulus with arcane debates about ‘Ricardian equivalence’, the notion that consumers believe that any tax cut now will be financed by a tax increase in the future and so increase saving to pay for it. Another prejudice is that government spending is inefficient relative to private sector spending. Finally there is the worry that government debt levels are already at very high levels relative to GDP. 90% is seen as a key level as studies have shown that governments start running into funding problems when the ratio rises above that figure. The first two points are indeed ‘prejudice’ – Ricardian equivalence has never been proved and there is evidence that government spending can ‘add value’ in certain areas. The problem with the 90% figure is that the studies were done in periods when interest rates were higher than they are now and debt servicing was consequently a larger burden. This is no longer an issue and indeed interest payments as a percentage of government expenditure have not risen despite the rise in government debt. Generally there seems to be capacity for governments to use fiscal policy and issue debt because investors have a high demand for such debt. Returning finally to the problems with monetary policy, the Bank of Japan has tweaked its policy to managing the shape of the yield curve rather than simply buying lots of government debt. This does make some sense as the shape is important but it also smacks of desperation given the failure of the Japanese to stoke inflation. At least the Americans seem to be able to achieve this with the Federal Reserve now expected to raise rates before the end of the year. Sadly they should probably let things lie for the time being with inflation being more of a good thing than a bad thing, but the Republicans in the US do not see it that way.

Growth. Attempts to forecast the short term outlook for the global economy are futile and more than likely to leave the forecaster with egg on his or her face. As an example, I forecast a pick-up in activity in mid-year based on some of the monthly indicators but little materialized. Four months later, I am tempted to say the same again and I could be encouraged by the rise in bond yields and the performance of equities over the last two months. But attempts at such forecasts are missing the point. What the weekly and monthly statistics are telling us is that there little volatility in economic data, and that overall growth is weak to moderate with no inflation and low interest rates. JP Morgan’s PMI index declined gradually from a level of 54.0 in March 2015 to a low of 51.1 in May of this year and has risen to 51.7 since then. At no point did they suggest a decline in activity. The OECD lead indicator says much the same thing. The best answer to a forecast about growth is basically more of the same. Indeed, the real problem with OECD economies has not been growth per se but interest rates, particularly the structural decline in real rates. As equilibrium nominal rates have trended toward zero, monetary policy has become ineffective and attempts to boost growth through yet more monetary stimulus have largely failed. Slowly but surely OECD governments are waking up to the issue and it will be interesting to see if a greater fiscal stimulus will have more success in boosting growth.

Italy. There is a referendum looming in Italy where the electorate will vote on the Prime Minister’s (Matteo Renzi) reform package. These reforms are targeted at the way the Italian government is run and if passed should help improve productivity and Italy’s long run potential growth rate. If Renzi fails to get these reforms through, he has promised to resign and there is the possibility if not probability of a constitutional crisis. If a Euro-sceptic party gained control of the government, Italy may well follow the UK out of the EU. This would be doubly significant as an Italexit implies Italy giving up the euro and could be the beginning of the end for the euro. Sadly, Renzi is fighting the wrong war. There is no doubt that these reforms are necessary and will help the economy in the long run. But what they won’t do is solve Italy’s short run growth problems, which are primarily caused by Italy’s membership of the euro and Germany’s short-sighted austerity policies. Most of the Eurozone economies in the southern half of Europe are still struggling following on from the euro debt crisis of 2011. Italy’s real GDP is still 8% lower than it was 8 years ago and nominal GDP has only just surpassed what it was then. They badly need a boost from the stronger economies to the north who should be pursuing a policy of domestic expansion. Unfortunately Germany is doing the exact opposite by running large government budget and current account surpluses. This has imposed deflation on the rest of the euro area, for which there is no escape for a country like Italy (or Greece for that matter). Italy is well and truly caught in a debt trap. The inevitable conclusion is that another Eurozone crisis is highly likely. The above mentioned referendum in Italy may be a catalyst, or else it could be something else. The only thing that will avert it will be a looser fiscal policy in the stronger European economies and that is unlikely.

More on real yields and inflation. The world economy and global policy making is at a fascinating juncture at the moment. Policy making over the last 30 years has been characterised by inflation targeting, a policy that has been largely successful with inflation below 2% in virtually all industrialised countries. Up to 2008, that was associated with the ‘Great Moderation’, the low volatility of global growth, a source of great satisfaction to policy makers. The Great Recession of 2008/2009 shattered that satisfaction and revealed it to be more like complacency. Since then, the world economy has recovered somewhat but it has been a weak recovery and with interest rates at or close to zero around the world, monetary policy is increasingly seen as impotent. Keynesian economists has been largely correct in saying we are caught in the liquidity trap and that an increased emphasis on fiscal policy is the way out. I am not disputing the fiscal policy argument for a moment. But there is another policy response that is required and that is higher inflation, or a higher inflation target. Real yields are -2% and with an inflation target of 2%, nominal yields will be on average 0% and so we will be stuck in the liquidity trap for some time. Given that policy makers cannot influence real yields, if they wish to get out of the liquidity trap they need to raise the inflation target, say to 4% or 5%. This is what makes policy making so fascinating; policy makers are trapped by the 2% target. Because high inflation was a ‘bad thing’ in the 1980s (and it was), policy makers cannot envisage an environment in which more inflation is actually a ‘good thing’ even though the world is crying out for more inflation. Policy making needs to be flexible. What is right in one era may not be right in another. Keynes was right in the 1930s, but Keynesianism was not the right policy in the 1960s and 1970s. Milton Friedman was largely right in the 1980s and monetarism worked as a means of defeating the high inflation of those times. But again circumstances have changed and new thinking and strategies are required. So far, sadly, there is not much sign of that happening.

Real Yields The world economy is characterised by slow growth and the weakest recovery on record, There are four reasons given for this:- a) Global savings surplus b) Debt super-cycle c) Restrictive fiscal policies d) Secular stagnation All have their supporters and all are probably contributing to the problem. a) Many countries are running huge current account surpluses, a sign of excess savings, most notably China and Russia. These to some degree reflect capital outflows, certainly in the case of Russia. b) Debt levels are high and rising. Debt in itself is no bad thing as long as returns on the leveraged assets earn sufficient to pay off that debt. But following the financial crisis, corporations particularly banks and individuals found themselves with excess debt and so are saving to pay down that debt. c) There is no doubt that governments have been running tight fiscal policies because they are fearful of excessive debt to GDP ratios, at its worst in Southern Europe as a consequence of German inspired austerity rules following the Eurozone crisis in 2010. d) Finally there is secular stagnation, which basically says that the post WW2 economic boom has come to an end. The internet age may be delivering many new products and services but they are not resulting in a surge of spending. Demography too is not helping as falling birth rates post 1970 lead to an ageing population. In discussing the relative merits of each hypothesis, it would be useful to focus on one key metric, the decline in real yields. Using UK index linked government bonds as a proxy, real yields have fallen from roughly a positive 3% in the 1980s to a negative 1.5% today. With inflation at again roughly 1.5%, it is clear why we have hit the zero bound for short term interest rates and have entered the Keynesian liquidity trap. It is also clear that this has been a long run trend, and whilst the Great Recession of 2008/2009 may have exacerbated the trend, it did not cause it. This rather suggests that it is the fourth reason above, secular stagnation, that is the principal cause of our current problems. The other three reasons are probably the consequence of the secular stagnation hypothesis. For example, the rise in debt has been partly caused by the need to improve returns through increased gearing, which in the long run results in disaster as we found out in 2008. Similarly it is hard to believe that fiscal austerity has caused the fall in real yields over a 30 year period, albeit austerity since 2008 has not helped the weak recovery. As regards the savings glut, the fall in interest rates could reflect either a fall in investment demand (i.e. the demand curve shifts to the left) or a rise in savings supply (i.e. the supply curve shifts to the right). The first would reflect itself in a fall in investment and the latter in a rise in investment. The weakness in investment has only become apparent since the turn of the century so it is possible that the fall in real interest rates since the 1980s reflects in part a rise in savings certainly in the 80s and 90s and in part the secular stagnation kicking in since then. This fall in real yields has profound implication for monetary policy. Negative real yields and low inflation implies that the zero bound is permanently with us, so rendering monetary policy impotent, something that is now slowly dawning on governments. Given that governments do not have control over real yields, the only way out of the trap is to increase the inflation target, but if that sounds like a step too far, introduce a nominal GDP target of at least 5%, It is ironic that the introduction of inflation targets has been so successful that it is now an impediment to implementing the correct economics policies in today’s economic climate.

The EU Referendum The first point is that the debate must be nuanced; there is no cast iron argument for remaining or leaving the EU. There are perfectly good reasons for staying and some equally valid arguments for leaving. The second point is subtle; this is not a debate about joining the EU but one about leaving. The debates are not the same. Just because Norway and Switzerland cope perfectly well outside the EU is not an argument for leaving, but a better one for not joining. Leaving has a not inconsiderable cost in that treaties will need to be renegotiated, and the UK may not get the same terms as Norway and Switzerland currently have. Other countries have invested in the UK because we are in the EU and may move elsewhere (or they may not but that is a risk). The actual financial costs to the UK of membership are small if not trivial. The economic costs are somewhat larger due to the Common Agricultural Policy and Common Fisheries policy. The CAP has been a huge liability on all European economies for decades albeit less than it was. The CFP has hurt UK fishing communities hard though whether this is a ‘cost’ is more debatable. Some advocates for leaving argue that high external tariffs for the EU have a cost for the UK – for that to be valid one has to believe that UK tariffs post exit will be low. The other substantial argument against the EU is monetary union, which as a result of its poor design has exerted powerful deflationary pressures on Europe and elsewhere. Fortunately the UK avoided that the worst of that disaster so it is not very relevant to this debate. Ultimately, it is almost impossible to reach a convincing conclusion on the economic benefits of leaving; the most sensible one is that there will be short run costs with uncertain long run gains. Dissatisfaction with the EU is considerable and not just in the UK; a lot of Europeans are very unhappy with the EU but that is common to most political institutions and is not necessarily an argument for leaving. There is a lot wrong with most political institutions. The American constitution is often reckoned to be the role model for the rest of the world but that does not mean one has to admire the current state of US politics nor does it mean that individual states have the right to secede whenever they disagree with other states. Curiously the one area where the leavers have the most momentum is the one where they are wrong, i.e. immigration. There is no evidence that immigration ‘costs’ the UK and indeed probably brings a net benefit. Migrants are relatively young, of working age and work hard. They may use the social security system but relatively less than UK born citizens. They may put pressure on social services in terms of use, but they probably contribute more towards paying for these services. In other words, these services would have been struggling even more financially if it were not for the migrants. The other area where the leavers are on weak ground is the one of sovereignty and regulation. We all live in an interdependent and connected world and no bad thing either. The question of so called excessive EU regulation demonstrates this. There is no evidence that EU forces unnecessary regulation on the UK; much of the regulation that so many resent is actually UK derived in the first place and anyway being outside the EU does not mean the UK can ignore EU regulation. We would need to conform in order to trade whether we like it or not. There is one area where sovereignty is paramount and that is the UK’s ability to issue currency. And that is something we have not surrendered nor are we much likely to, whatever the EU might say. As I said at the beginning, if the question was one of joining the EU, the answer might well be no thanks. As long as the UK pursued sensible economic policies, and kept the economy open, it is probable that the UK would flourish outside of the EU. But that is not the question. Divorce entails costs and it is quite possible that these could be substantial. None of the UK’s allies want us to leave, most notably the Americans and any notion of a ‘special relationship’ with the US is delusional. Ultimately the answer is to beware of what you wish for.

Growth. There is a fair level of pessimism about the outlook for the global economy as the recovery from the Financial Crisis in 2008 remains weak and central banks struggle to get inflation up to their targets. This was compounded by the rapid fall in the oil price at the beginning of the year. In actual fact, the oil price had been slipping ever since mid-2014 but the fall seemed to accelerate to reach a low of $26 in January. Such a low price called into question the economics of new oil producing regions such as the oil shale in the US driving many companies into bankruptcy. This in turn caused credit spreads to widen prompting fears of another credit crisis. As it happens, this has not materialised and the worst seems to be past. In fact there is some evidence of a recovery. This is most obvious in the United States. There the leading index produced by ECRI has turned up significantly since its low in early February. This index may be more co-incident than leading but is good enough for our purposes. Another index produced by Economy.com has also turned up in the same time period. Given that they are produced on a weekly basis, these indices will have a lot of noise associated with them. The OECD lead indicator which is produced on a monthly basis is not showing any sign of recovery and continues to decline, so the leading indicators are inconclusive. Another indicator worth watching certainly in the context of a credit crisis is the St Louis Fed financial stress index. This too deteriorated through 2015 in line with the falling oil price reaching a nadir in February. Since then it has improved markedly also in line with the oil price, suggesting the worst is past. This optimism does not sit well this week’s concerns over growth. Both the UK and the US have produced figures showing slow growth in the 1st quarter of the year and many analysts are arguing that matters will not improve in the 2nd quarter. In addition, we have Japan falling back into deflation and a surge in the yen. In this context one would expect government bond yields to be hitting new lows. This has not happened and in fact, bond yields have risen which is odd. The fall in the oil price was most definitely a shock. In the very short run, the costs to oil producers outweighed the benefits to consumers. The result was a panic. But economics says in the long run the implicit rise in real incomes from a falling oil price will work through to consumer sentiment and produce a rise in spending. I would suggest we are now beginning to see this happening.

I have talked about how many analysts misunderstand what Abenomics is really about (the need for Japanese nominal GDP to grow), which is a reflection of inflation as much as of real growth. One key part of Abenomics has been to get the exchange rate down. This has got nothing to do with currency ‘wars’ but a lot to do with the price level. In a completely open economy, a 10% fall in the exchange rate should result in a 10% rise in the price level, all other things being equal. This is why some argue that devaluation of a currency does not work; any short run competitive advantage from a devaluation is lost through inflation. But in an economy such as Japan’s where there is no nominal GDP growth, this is irrelevant because it is nominal growth we want not real growth in order to escape the liquidity trap. Obviously as in an economy like Japan’s which is not particularly open, a 10% fall in the exchange rate will not lead to a matching rise in the price level, perhaps rather 3%. But the point is still the same. Initially Abenomics was very successful in this respect. The exchange rate fell from a peak of Y77 in the autumn of 2011 to a low of Y123 toward the end of last year. Since then it has risen to Y110. Quite why it has done so is a bit of mystery and it seems that the authorities are not concerned about this rise. This is a mistake. Not only do policy makers have to create inflation, they have to make people believe that this inflation is for real. The Japanese authorities have a bad habit of giving up on these strategies half way through the process and retreating back to the mantra that there is nothing more they can do. There are many countries where creating inflation is not a problem; just ask the Latin Americans for advice. Citing a poor real growth outlook due to an appalling demographic profile or declining productivity is to miss the point completely. Sadly this seems to be the case. If the yen continues to appreciate, then the bears of Abenomics will prove to be right and this will prove be yet another Japanese policy failure. It was the right policy with the failure lying in the implementation.

Japan. I continue to believe that many analysts completely misunderstand the Japanese economy and what Abenomics is trying to achieve. Obviously everyone agrees the need to end deflation which is primarily what Abenomics is about. But the key statistic in measuring deflation is not the CPI or any other measurement of prices but rather nominal GDP. To understand this point, let us look at a history of Japan's nominal GDP. This peaked in 1997 (!) at Y524tr, the year Japan went into its deflationary spiral and fell to Y499tr in 2003, a decline of almost 5% (real GDP rose by just over 2% in the same period, meaning that prices fell by 7% in total). It then recovered to Y513tr in 2007 but following the financial crisis fell to Y471tr in 2009. It has subsequently recovered back to Y499tr but it is still 5% below its 1997 peak. What this means is that money incomes in Japan were 5% lower in 2015 than they were 18 years previously. One can argue that this does not matter given real incomes were 11% higher but that ignores the rising real debt burden, a problem aggravated by deflation. There is a pressing need for Japan to raise the level of nominal GDP, and this is ultimately what Abenomics is all about. And the truth is that Abenomics is having some success in this with nominal GDP rising by 5% over the last 3 years. Given that the underlying trend in real GDP growth is c0.5% and with an inflation target of 2%, one would be looking for 8% growth in nominal GDP but at least there is some progress. Where I think Japan has not succeeded is in increasing inflationary expectations, something that economists are paying more attention to. Inflation might rise for a bit but if consumers do not believe it to be permanent, they will assume that falling prices will resume eventually. Listening to the pronouncements of many Japanese officials, one gets the feeling that their heart is not in Abenomics and that they are itching to abandon the policy and return to one of monetary conservatism. The recent rise in the yen is symptomatic of such thinking. Overall, most people remain somewhat bearish to downright bearish on Japan. There are certainly many headwinds, most notably demographics and deflation. The decline in working population is currently subtracting up to 1% off GDP growth. The real debt burden will increase as prices fall. There are some positives however. Abenomics is certainly the way Japan needs to go. The fall in the exchange rate from 80Y to 120Y to the $ was a move in the right direction. Nominal GDP is rising. The performance of Japanese small company funds is encouraging. The stockmarket is relatively cheap. And perhaps one can argue that whilst Japan may not be that encouraging in an absolute sense, it looks better value than most others.