Global Monetary Uncertainties
Many comments and analyses have been made on the latest global developments ahead of and after the inauguration of US President Donald Trump. Beyond the predictable assessments from both camps that support and oppose the new administration’s policies, there is growing collective sentiment that, at least in the short term, the world will head into an era of increasing uncertainty in many aspects of life.
Generally, policymakers and industry players dislike uncertainties as they make their jobs more difficult. Industry players, who often face risks in many forms and sizes, are helped by scientific and technological advances to calculate and make the effort to manage these risks and avoid, or at least reduce, their adverse impacts. Uncertainties, however, are different from risks and they are unpredictable.
In the world of finance, risk is a normal thing. In finance, industry players race one another to tame these numerous risks in the hope that the one who best tames the risks will gain the biggest benefits. However, uncertainties exist beyond these calculations and there is no science to tame them. John Maynard Keynes, a father of the modern economy and a statistical probability expert, warned us early on that uncertainties are things we will never truly understand.
Only arrogant people feel they can overcome uncertainties by mistakenly thinking that uncertainties are similar to risks, only occurring much more rarely. These people call uncertainties “black swans”. This is unjustifiable and such mistaken ideas will only lead to financial turbulence and even crises. Many experts say that the 2008 global financial crisis that was followed by a prolonged recession – known as the great recession – took place because of such hubris.
Analyses based on this understanding do not believe that there are uncertainties in the market. Everything is seen as a calculable and manageable risk that will result in equilibrium. Belief in the effectiveness of market mechanisms to reach equilibrium is known as the effective market hypothesis.
As it is believed that market mechanisms always result in equilibrium, then imbalances or even crises can never occur. It is only when crises do occur that these people realize their own unjustifiable hubris. As explained by the Keynesian dictum above, uncertainties are things we will never truly understand but they do exist in a market-based economic system.
The question now is whether or not global uncertainty is increasing after the election of billionaire Donald J Trump as the president of the world’s largest and wealthiest economy? It surely seems like it. Many experts have talked about this increase in uncertainty, both directly and indirectly. Trump’s campaign programs and statements, his presidential policies, his cabinet appointments and his recent executive orders all have aspects that may potentially increase global uncertainty.
Surely, Trump’s supporters greet all of this as proof of Trump’s consistency and bravery in making the decisions that they want him to make. The problem is that economic and trade policies that put one’s country first without paying attention to the interests and reactions of other countries clearly run against what must be the standards of national policies at a time when nations are becoming more interlinked and dependent on one another.
Sure there is consistency, but populist policies that are protectionist, mercantilist, unfriendly to other nations and even anti-globalist clearly bring forth the implication of increasing uncertainty in international relations.
Trump feels as if he has received the mandate to enact changes. However, what is the direction of this overhaul when what is being overhauled is the order that has been established by previous administrations? This involves not only the order that was built during the Obama years, but one that had been constructed at least since the era of President Franklin D Roosevelt, before World War II. Is this what Trump see as his mandate? Many surely will disagree. What I want to emphasize here is that this has brought about, and will continue to bring, uncertainties.
Latest development
The latest development that has absorbed the world’s attention is President Trump’s swift actions in issuing a number of executive orders to implement steps that will repeal the Affordable Care Act, or Obamacare, build a wall on the border with Mexico, pull the US out of the Trans Pacific Partnership (TPP) and the North American Free Trade Area (NAFTA), as well as halt the entry of immigrants from seven countries into the US.
I will not make any comment on these issues, other than expressing my shock and disbelief that such reckless actions were made by the President of the US – or of any country, for that matter.
In economics, finance and trade, other than what has been said above, the market and the business world in general seem to have a positive response to President Trump’s plan to increase spending on infrastructure and military investments, cut corporate taxes and implement deregulatory steps to ease business activities and boost economic growth.
The positive response from the market and business world is apparent from the Down Jones index surging beyond 20,000, the strengthening of the US dollar against many global currencies and market optimism in general.
Perhaps in fear or in support of Trump’s policies, many business giants, such as automobile company Ford and refrigerator producer Carrier, have cancelled their foreign investment plans in Mexico and promised to expand their businesses in the US. As is the case with many populist policies laden with brand-building, such incidents are then campaigned as success stories without thoroughly analyzing the impacts and implications of such sporadic acts, without any deep thought, often resulting in a mismatch between micro and macro policies and between short-term and long-term goals.
In the monetary and financial world, other than developments and reflections in the real sectors, implications from such moves must also be observed. In this issue, Trump’s apparent dislike of the strengthening value of the US dollar as this is deemed to be detrimental to US export competitiveness and should be a cause to be alert for developing countries such as Indonesia.
Beyond that, possible monetary policies that will be implemented by The Fed must also be examined to determine the best way to manage them. Increased infrastructure and military spending in the US under Trump, which will most likely be supported by Congress (as Republicans control the majority in both chambers), will also have monetary implications that we need to watch out for. An increased budget or public spending from tax cuts in a near-to-full-employment economy will surely push down inflation. If Congress supports an increase in government loans as funding, an interest rate rise will surely occur in consequence.
Under such conditions, The Fed will balance things out by increasing the fed funds rate. This underlines what The Fed conveyed by increasing its interest rates in December, and will be followed up several times (three times, to be precise) with interest rate increases in 2017. The potential interest rate increases will surely be higher than those of last year.
This means that there is an increasing possibility of a rising interest rate in the US. Developing countries experienced a taper tantrum in 2013 when The Fed announced that it would cease its quantitative easing program. Now developing nations such as Indonesia are facing similar possibilities with rising US interest rates that encourage the reverse flow of capital back to the US.
Beyond this, Trump has, since his presidential campaign, criticized government meddling and stated his wish to deregulate. Trump has also harshly criticized the tight regulations of the finance industry. As is understandable as part of the US’ efforts to resolve the 2007/2008 financial crisis, the US organized and implemented a new financial architecture to change and refine its finance system in what is known as the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
If Trump is consistent in this sector as well, it is highly likely that the finance industry will return to a state of minimum regulation – in the form of light or self-regulatory finance – as was the case when The Fed was led by Alan Greenspan, who was criticized as the cause of a highly leveraged economy that ended with the 2007/2008 subprime mortgage crisis.
People walk by the New York Stock Exchange (NYSE) on Feb. 6 in New York City. As President Donald Trump made moves to scale back regulations on the financial industry, the Dow Jones industrial average rose over 180 points last Friday but opened slightly down on Monday morning.
Return to eclecticism
Hubris, as discussed above, is something we all need to avoid in facing a world filled not only with risks but also with uncertainties – especially if they are used as reasons to refuse to make any decisions due to a false sense of security. Business as usual never exists. What there is, is surprises that can happen at any moment.
This may sound like a cliché, but I am forced to repeat an old message I used to convey in all my writings and occasional speaking engagements – that, in the face of rapid change, increasingly high risks and uncertainties, we need to be wary. We need to return to the elementary behavior of doing everything we can, be introspective and be ready to close our ranks and reposition ourselves at all times. Especially in monetary and financial aspects, we should not create more uncertainties through breakthroughs but instead implement steps that we are sure of with a clear and measurable direction based in eclecticism.
J SOEDRADJAD DJIWANDONO
Professor Emeritus in economics, University of Indonesia and Professor of International Economics, RSIS – Nanyang Technological University
