In one week, the US will celebrate the peaceful transfer of power. President Biden will leave office and President-elect Trump will replace him.
The inauguration of a new president is a singular occasion for soaring rhetoric, broadcast from the Capitol across The National Mall in Washington, DC and around the world. Pomp and celebration follow.
Then comes reality.
Executive orders will be issued. Congress will take up its responsibilities for confirming presidential appointments and passing legislation. The machinery of government will shift into action.
In what follows, we assess the macroeconomic starting point for the new administration and, in the context of its campaign pledges, the outcomes—for better or worse—that are likely to ensue.
Biden’s legacy
Setting the stage, the Biden Administration is passing on a pretty good economy to its successor. Unemployment is low, growth is solid, real median household income is rising, productivity growth is accelerating, private sector borrowing levels are sound, the stock market is near all-time highs, and the US dollar is strengthening in the world’s foreign exchange markets.
Other metrics are less satisfactory. The US poverty rate, which had declined sharply from 2010 to 2019 (and then again during the pandemic courtesy of temporary transfer payments and tax credits), remains above 12% of the population. Income inequality, as measured by the US Gini coefficient, is near 65-year highs. Inflation, which has come down sharply from its pandemic peaks, remains too high for the comfort of the Federal Reserve. And the federal government budget deficit, at -6.1% of GDP, remains large, particularly for an economy at full employment. Thanks to a strong economy, however, the stock of US government debt as a share of GDP has fallen during the Biden Administration from a pandemic peak of 133% to 121% today.
Trump’s aims
Shortly, that economic legacy will shift to a second Trump presidency.
Trump campaign rhetoric was unabashed on economic policy priorities. Tax cuts, deregulation, tariffs, stricter immigration controls, and cuts in federal government spending are the key priorities of a second Trump term.
Even with a slim majority in the House of Representatives (and a larger one in the Senate), the Trump Administration can probably achieve much via legislation. Executive orders will also be important. But in some areas, desired outcomes will be more difficult to achieve.
Among the likeliest ‘wins’ will be tariffs, immigration curbs, deregulation, and tax cuts. Some policies, such as tariffs, immigration guidelines, and deregulation, can be achieved via executive order and administrative action (i.e., by leadership changes at agencies such as the SEC or FTC). Many will find support from a sympathetic judicial system. Tax cuts are always popular, and in some cases (e.g., raising the federal deductibility of state and local taxation) may even garner bi-partisan support.
But large spending cuts will prove difficult. DOGE ‘co-czar’ Elon Musk has already admitted that the goal $2 trillion in savings is overly ambitious, a first sign that the practicalities of Washington will prevail. Even achieving half that goal might only be possible under ten-year budgeting arithmetic, suggesting more plausible savings of some $100 billion per year in ‘waste, fraud, and efficiency’.
That might sound like a lot. But it is not. It amounts to just over 1% of total federal government spending.
The reality is that non-defense discretionary government spending (i.e., excluding military, Social Security, Medicare, and Medicaid outlays) amounts to less than 15% of total federal government expenditures. So, unless the Trump Administration and the Republican majorities in Congress are willing to cut defense or entitlement programs, the goal of significant spending reduction will prove elusive, particularly since many discretionary programs are also popular with Americans.
Accordingly, the likely contours of macroeconomic policy under the second Trump Administration are clear—tax cuts, tariff increases, deregulation, and immigration controls will be implemented. Spending cuts will fall short.
Economic and investment implications
Given this, what are the implications for the US economy and financial markets?
Tax cuts and deregulation will boost total spending (demand) in the economy. Higher disposable income is one reason. Lower taxes and deregulation will also spur business investment spending. Without commensurate cuts in government spending, tax cuts will also act as fiscal stimulus.
Lower taxes and lighter-touch business regulation will boost the supply side of the economy. But that takes time. Hence, the positive demand impulse will arrive before meaningful increases in productive capacity. As a result, rising demand relative to supply will push prices and wages higher.
Moreover, tariffs and restrictions on immigration are negative supply shocks. Directly (via higher taxes paid on US imports) and indirectly (by restraining the supply of foreign goods and workers), tariffs and stricter immigration controls will further boost prices and wages.
Alert to those risks, the US Federal Reserve has turned cautious. In the minutes of its December meeting (released last week), the Fed noted that inflation risks have risen. As a result, the Fed has paused its easing cycle and it is not fanciful to believe that the Fed could hike rates in 2025.
That is a key reason why the dollar has surged on the world’s foreign exchange markets. Its appreciation since election day has coincided with rising US bond yields, which are now up a full percentage point from their 2024 lowest levels. The dollar is also gaining strength on the expectation that the Trump Administration will impose tariffs against an array of US trading partners.
In short, the implications of ‘Maganomics’ are clear. They point to stronger domestic demand, higher business investment, higher prices, higher interest rates, and a stronger US dollar.
But that is not the end of the story. That’s because those outcomes are unpopular in ‘Trump world’.
Americans hate higher prices. Recall, that was the decisive factor in Trump’s November victory. Americans don’t like rising interest rates, which push up mortgage and new car borrowing costs. And a strong dollar is unwelcome because it makes US exports less competitive.
Trump is also likely to learn another inconvenient truth. By cutting taxes more than government spending, and by stoking business investment spending without slowing consumer spending, Trump policies will produce ever larger US trade deficits. That is not a forecast nor a theory. It follows from national income accounting.
Bigger trade deficits are not what President Trump wants. But they could be the direct consequence of his policies. And that could lead to an intensification of trade conflict and dollar strength.
Financial markets are beginning to worry. True, investors love lower taxes and less regulation. But US stock market valuations are stretched. Bond yields are rising. The onus is squarely on rising profits to keep the market afloat. But given that nearly a third of US S&P500 corporate profits are derived outside the US, the prospect of trade wars and a rising US dollar is making investors nervous.
Summary
In sum, President Biden is handing over to President Trump an economy in decent shape. Employment is high, inflation has fallen, and average living standards are rising. To be sure, the Biden economy is not perfect. The government deficit is too large, and poverty is too high.
President Trump is nothing if not ambitious. In the longer run, it is possible that tax cuts and deregulation will boost trend US GDP growth. But over the next year, his policies run the risk of demand outstripping supply. If so, prices, interest rates, and the dollar will head higher. The stock market will not like it.
Nor will President Trump.
But if that’s how things unfold, it won’t be someone else’s fault.
