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With Donald Trump, the buck always stops somewhere else. Yet investors now worry the real, actual buck will get trashed amid Trump’s desperate attempt to cling to the US presidency.
After four days – four days! – of vote counting there is still no decisive result. Democratic Candidate Joe Biden seems on the verge of victory in the November 3 election but Trump isn’t simply refusing to concede. He’s preparing an epic scorched-earth legal battle that may take world markets down in his wake.
This last week was traumatic enough for markets around the globe – particularly those of the emerging variety. Concerns about Covid-19 second waves, debt sustainability, geopolitical tensions and a possible bubble in tech shares made for uniquely volatile trading.
But none of these risks comes close to the ways in which Trump is about to stress test the global economy. In his desperation to secure a second term, Trump seems willing to throw the dollar and US Treasury securities, the two linchpins of global finance, under the proverbial bus.
Markets hate uncertainty, and global, uncertainty and related domestic political tensions, could continue through to January.
“The uncertainty could last for much longer – perhaps even months – implying serious risks for the markets,” says Nouriel Roubini of New York University.
Roubini, one of the few economists to predict the 2008 subprime crisis, notes that a “highly contested election would cause further damage to America’s global image as an exemplar of democracy and the rule of law, eroding its soft power.”
The unfolding debacle
In a sense, Trump would be pushing at an already open door, with years of chaotic policies at home and efforts to wreck alliances abroad.
“Particularly over the past four years,” Roubini says, “the country has increasingly come to be regarded as a political basket case. While hoping that the chaotic outcomes outlined [earlier] do not come to pass, investors should be preparing for the worst, not just on election day but in the weeks and months thereafter.”
A full-blown constitutional crisis, says strategist Daniel Ahn of BNP Paribas, would ensure the “loss of political credibility and standing of the United States as a stable country.” That “could threaten its status as a safe haven with unfathomable consequences for the economy and for markets.”
The drip, drip, drip of legal challenges – and Trumpian Twitter insanity – will keep markets on edge. The 78 days between the election and the date when Trump would, in theory, vacate the White House, could be its own dumpster fire.
Trump will almost certainly blame his loss on China and the coronavirus that began in Wuhan. That could mean new tariffs, additional steps to tackle mainland tech giants Huawei, Tencent and Ant Group, a longer “entity list” of Chinese companies banned from doing business in the US, new visa restrictions, freezing the assets of Communist Party members.
Might Trump use these 11 weeks to depreciate the dollar or cancel parts of the debt Washington owes China? He has mulled both steps.
Trump might sabotage the US economy just as earlier stimulus moves are wearing off. “Will Trump sign a new stimulus bill?” asks analyst Louis Gave of Gavekal Research. “Or will he instead channel Louis XV and declare ‘après moi le deluge’ [“after me, the flood”)?”
In Trumpian terms, that would mean going all out to hurl wrenches into the machinery of government, making a Biden White House’s job even more difficult as it picks up the pieces.
There is a genuine risk that credit rating companies who’ve sat out the last four years might revisit Washington’s AAA status. When S&P Global downgraded the US to AA+ in 2011 it was over a now seemingly tame battle over raising Washington’s debt ceiling, or latitude to borrow.
As credit risks go, a full-blown leadership crisis is several magnitudes greater. Trump, it’s worth noting, has literally erected walls around the White House in recent weeks. Hardly the actions of a man confident he’ll win the election – or who will vacate the manse willingly.
This is the second time in 12 years that the US has shaken the global economy to its core. Asia is still traumatized by the 2008 “Lehman shock.” Thankfully, Wall Street’s subprime crisis didn’t devastate Asia as feared back then.
Asia had managed to draw from the lessons of its own regional meltdown in 1997. Back then, many governments acted assertively to modernize financial systems, increase transparency and amass foreign exchange reserves to act as shock absorbers.
At the same time, China largely held its ground. Beijing wisely resisted the urge to devalue the yuan, which would have sent fresh shockwaves across the region. China also provided a sizable market for neighbors looking to export their way to recovery.
But now America faces something worse – even before factoring in the election drama.
American weakness, Asian risks
Whereas 2008 was a banking crisis, today’s features a pandemic that is causing the human equivalent of a credit crunch that could trigger another banking rout at a moment when global markets are already ailing.
And there were existing fault lines. Trump’s pre-Covid-19 boasts about “the greatest economy in the history of the world” ignored the widening cracks below the surface.
Those cracks showed national debt blowing past the $20 trillion mark; crumbling infrastructure; worsening inequality; falling productivity; a China investing trillions in where it wants to be in 2025 amid Washingtonian gridlock; and a trade war raising costs for consumers.
Even before the pandemic, Trump was turning America more China-like as his Federal Reserve effectively nationalized the stock market. By pushing its balance sheet well beyond the $5 trillion mark, the Jerome Powell-run Fed ostensibly became part of Trump’s re-election campaign. Today’s Fed seems no more independent than the People’s Bank of China.
Now that a contested election is a reality, it is hard to see S&P, Moody’s Investors Service and Fitch Ratings staying quiet.
In August, Fitch downgraded its outlook on US government debt as Trump’s White House effectively surrendered to Covid-19.
“The outlook has been revised to negative to reflect the ongoing deterioration in the US public finances and the absence of a credible fiscal consolidation plan,” Fitch analysts warned.
Today, August seems a lifetime ago. Not just because America’s Covid-19 caseload has since zoomed toward 10 million, but because Trump seems willing to strangle the globe’s biggest economy just to save face. This puts export-reliant Asia in a very bad place.
This region lacks two of its 2008 trump cards.
For all the heavy lifting on reforms since the 1990s, Asia is still too dependent on selling goods abroad. And while China is stabilizing and may grow about 2% this year, its outlook remains uncertain in Trump-adjusted terms. Trump, remember, has 70-plus days to try to further ruin President Xi Jinping’s 2020.
Bonds in peril
Fresh Trumpian chaos will imperil the dollar’s stability, put upward pressure on US Treasury debt yields and spook stock punters.
Ten-year Treasury bonds yield just 0.8%. An increase to, say, 2% would shoulder-check world markets. Volatility in US assets could prove particularly destabilizing – and hard for Powell’s Fed to paper over with new liquidity.
A key reason the Bank of Japan maintains debt market calm is that roughly 90% of government IOUs are held domestically. As such, Tokyo avoids capital flight risk.
The US has the opposite challenge: Tokyo and Beijing alone hold a collective $2.4 trillion of US debt.
A run on the dollar would dovetail with Xi’s long-term aspirations for the yuan to replace the dollar as reserve currency.
But such chaos heading into 2021 is the last thing the global economy needs as a pandemic savages growth and living standards. This mutually-assured-destruction dynamic explains why the fallout from a US downgrade would be exponentially greater than S&P’s action in 2011.
That episode made former Chinese Premier Wen Jiabao look like quite the seer. Two years earlier, in 2009, Wen issued a public plea to Washington to be a better steward of the more than $1 trillion of Treasury securities Beijing holds.
At the time, Wen said: “We have made a huge amount of loans to the United States. Of course, we are concerned about the safety of our assets. To be honest, I am a little bit worried.” He urged the US “to honor its words, stay a credible nation and ensure the safety of Chinese assets.”
The Trump era has given Xi’s government exponentially more reasons to worry about the safety of Chinese state money.
And now, with Trump going all-in on electoral chaos, Xi’s debt managers won’t be getting much sleep.
Trumpian plots, gamed
This scenario is not a “Black Swan” in the Nicholas Taleb sense. The idea of a contested election, notes analyst Ehsan Khoman, “is far from a tail risk” – ie when a low-probability event suddenly happens and shocks markets.
Political scientists have been gaming this out all year. In July, military historian Max Boot spelled out the MC Escher-like maze of possible ways a close electoral college win could generate legal challenges.
In a July Washington Post column plotting election scenarios, Boot sketched out one remarkably similar to where the US finds itself now. Though Biden is close to the 270 electoral college votes needed to win, there could be recounts and legal maneuvers that end in a narrow win of, say, Biden at 278 and Trump at 260.
That could result in any number of legal efforts to keep Trump in power. Generally, the governors of the 50 states simply certify election results. Team Trump points out that there’s scope for a state legislature to vote a different way.
One scenario to which Boot and others point dates back to the 1876 presidential election, when the popular vote was contested in three states. Congress stepped in, voted along partisan lines, and swung the presidency to Republican Rutherford Hayes, making Democrat Samuel Tilden a historical footnote – and a cautionary tale for 2020.
Few US leaders have enjoyed the blind loyalty Trump does from his attorney general, William Barr. After burying the 2019 Mueller report, it’s not hard to imagine Barr acting on Trump’s behalf to try to invalidate the election. Might Barr allege China intervened in the vote of left-wing activist Republicans call “Antifa,” or some other conspiracy theory? Trump, meantime, has three direct picks on the Supreme Court to do his bidding.
All this means markets hoping for clarity in Washington could be in for a long, stressful and financially turbulent Trumpian wait.