As the Rip Van Winkle story goes, in order to escape his wife’s nagging, one day Van Winkle wanders into the mountains with his dog. Van Winkle sees a man wearing antiquated Dutch clothing and he is carrying a keg up the mountain and requires help. Together, the men and the dog proceed to a hollow where he meets silent, bearded men who are playing nine-pins. He joins them and begins to drink and soon falls asleep. When he awakens, he discovers that his musket is rotting and rusty, and his beard is a foot long. He returns to his village, where he recognizes no one. In the story, Rip Van Winkle returns just after an election, and people are asking how he voted. Never having cast a ballot in his life, Van Winkle proclaims himself a faithful subject of King George III’s, unaware that the American Revolution has taken place, and nearly gets himself into trouble with the townspeople until one elderly woman recognizes him as the long lost Rip Van Winkle.
We wonder what Mr. Van Winkle would say if he were to wake up in 2017. Which party would Mr. Van Winkle have proclaimed himself a faithful follower of? Would he be surprised when he found out that businessman Donald J. Trump had been elected president? We think so.
Over time as he returns to his daily routine, people would probably ask him how he is adjusting to his new life and what changes have struck him the most. One of the issues likely to come up is the lack of civility in the press, whether it is radio, TV, or newspaper. He would also point out that there does not appear to be a distinction between fact and opinion in many of the “news items.” He might have a tough time separating the facts from the opinion of the presenters. He would then mention that he longs for the days of Walter Cronkite. Cronkite never expressed his political views or opinion in his newscasts. His integrity and true news casting earned him the moniker of the “Most Trusted Person in America.” In fact, few people knew he was a Democrat.
Mr. Van Winkle would marvel at the accessibility of computers. Thanks to the accessibility of computers, their computing speed, and storage capacity, what used to be a herculean task is now routine and is easily performed in the comfort of one’s own home. Computers have allowed for the development of computationally complicated models to predict the economy, climate, and other issues. Mr. Van Winkle would argue that these models could be quite useful in the development and evaluation of economic or climate policy. Yet he would also express some concern about the use or misuse of these models. He would note that the point estimate forecasts produced by these models are taken as gospel. Confidence intervals or ranges of possible outcomes are neither reported in the press nor present during policy discussions. He would also reminisce about the good old days when a simple autoregressive model beat the forecast produced by more complicated structural models, such as the FRB-Penn or DRI models. He would argue that confidence intervals and forecasting track records of these models should be taken into consideration when making policy decisions based on these forecasts.
One other issue likely to be in Mr. Van Winkle’s mind is the apparent divergence between the narrative in the press and the actual economy. Would the administration be able to implement its economic policy agenda if they are in disarray or rudderless? How effective can the White House be while in disarray, where leaks abound and there is a management style that has been described by some as chaotic, make-it-up-as-you-go? He would wonder whether such a management style combined with the press accounts would weaken the resolve of the legislators, and thereby increase the likelihood of the president’s program being watered down (best case scenario) or be a complete policy failure (worst case scenario). Either way, it is a bleak outlook. But if that is the case, Van Winkle would also ask why the financial markets and the economy are performing better than the critics forecast? What is the president doing that his critics do not see?
One possible answer is that despite all the criticism by the pundits, the apparent disarray, and all the tweets, economic policy is moving in a pro-market direction. The regulatory apparatus seems to have been stopped in its tracks because of the executive orders. Whether President Trump will be able to implement his legislative agenda remains to be seen. However, there is no doubt that his legislative agenda promises lower tax rates and less regulation, and that is something the markets like. How much will this agenda be watered down by the political attacks? We do not know. What we do know is that these are progrowth policies and the market agrees.
Trump the Disruptor
The previous discussion suggests that President Trump has the potential of being a disruptor of the status quo. In many ways he is redefining many of the code words and concepts used in the political theater. Fairness is one of the concepts undergoing a redefinition. During the campaign, Trump’s opponents questioned the fairness of his tax proposal plan. One common criticism is that the tax rate will be a tax cut for the rich, suggesting that it is unfair. However, these critics never mention that the bottom half of tax filers pay little or no income tax. In fact, they pay less than 5%, while the top 1% pays about 40% of the total income tax take. The top 5% pays 60% and the top 25% pays about 90% of the total income tax take. Hence it stands to reason that since the top 25% pays 90% of the taxes, most of the tax rate cuts will accrue to the top 25% of the income earners. The bottom pays little or no income taxes and thus will get little or no income tax rate cut. That is Trump fairness.
Other examples that caught our attention are the proposed elimination of the deductibility of the state/local income taxes from the federal income taxes and the call for members of NATO to meet their national defense financial obligations. Both are being cast in terms of fairness. In the case of NATO, the president was very explicit regarding the majority of the NATO member countries failing to fulfill their obligations. He said that it was not fair to the American taxpayers. In short, he expected them to spend their fair share on defense spending. A similar argument regarding fairness is embodied in the president’s tax plan. By eliminating the deductibility of state and local taxes from federal income taxes, it automatically eliminates a subsidy from the low tax rate states to the high tax rate states. In some cases, the redistribution goes from poorer states to richer states. But more importantly, it also redistributes income from profligate states. That is the common thread between the call for more funding from NATO members and the elimination of the state and local taxes deduction.
NATO member countries will now have to increase their contribution to their national defense, which means one of three things: their economies have to raise taxes, reduce nondefense spending, or increase their deficit financing. The same goes for the high tax states under the Trump tax plan. If these economies choose the tax rate increase option, they will pay the price in terms of slower growth and perhaps even lower tax revenues, as the most productive factors leave their economies in search of higher after-tax rate of returns. Another option is to reduce spending, which will force these economies to either become more efficient or scale back the programs. Both the tax increase and spending cut options will force these economies to change paths. The lack of revenues may create an opportunity to reform many of the programs that have resulted in the eurosclerosis in these economies. That is why we believe that President Trump may be an economic disruptor. A third alternative is to continue borrowing as long as the markets finance the deficit. But that is a train wreck in the making. When the wreck occurs, the economies that pursued this path will be forced to take drastic steps. To the non-believers, take a look at Greece and Puerto Rico.
Are these groups feeling like Rip felt when he woke up from his sleep and went back to town? Or unlike Rip, are they trying to turn the clock back? Sadly, unlike Rip Van Winkle, many of the latter version do not seem too keen on the political outcome and have joined the resistance. In the context of the politics of special interest groups, it is natural to expect some resistance from the adversely affected groups. It is to the advantage of the disruptors to strike while the iron is hot. Otherwise the adversely affected will begin to resist the changes that the disruptor wants to implement. Sometimes the disruptor also adds unnecessary fuel to the fire, through his words, tweets, and policy ineptitude. These missteps embolden the resistance and make the implementation of his disruptive policies much more difficult.