Financial market hate surprises, and only a year ago they were looking forward to one of the more predictable presidential elections in memory.
Instead, they got a crushing defeat of the “inevitable” Republican nominee Jeb Bush and emergence of populist Donald Trump, a candidate with no political experience, team or program.
On the Democratic side, meanwhile, Hillary Clinton has run into a challenge from socialist Bernie Sanders; while she is likely to see it off, the party may be pushed further to the left.
The Republicans and the Democrats are nervous, business leaders are apprehensive and America’s trading partners are horrified, but Wall Street has shrugged off all concern. Stocks are reacting to China and oil prices, not to developments in America’s own backyard. But will it last?
The U.S. government has been dysfunctional for the past eight years but while investors initially reacted negatively to news from Washington, they soon learned to shrug off assorted government shutdowns, threats of debt default, sequesters and lack of legislative action.
They have actually discovered that gridlock is good for business. At least no major changes can be made to policy and no new taxes or regulations imposed.
Wall Street now anticipates more of the same come January 2017, i.e., continued recriminations and inaction in Washington for four more years. Each candidate may be scary when taken on his or her own merits, but they will be inevitably neutralized by sharp ideological divisions once one of them gets to the White House.
This may prove an overly optimistic assumption. The rise of highly unusual candidates in the election cycle reflects deep changes in American society. Voters whose imagination has been captured by anti-establishment candidates like Trump and Sanders are not going to go away.
Their newfound passion testifies to their determination to be heard. This will have major implications for the political system and, eventually, for financial markets.
It is conventional wisdom that the country is split down the middle, with the conservative half supporting low taxes, pro-business policies and traditional values, and the liberal half stressing the role of the government in the economy and the lives of ordinary citizens, and expressing preference for more inclusive, multicultural policies. However, this election cycle has laid bare very different divisions, which turned out to be not so much political or ideological as economic, reflecting radical changes in the U.S. economy.
Economic changes have long been gathering momentum, but they are only now coming to the fore. Just as technologies developed in 1900–30 (notably, the internal combustion engine, electricity, radio, cars and airplanes) and the Great Depression altered the U.S. economic model, so the IT revolution began reshaping the U.S. economy in the 1990s, and those changes were solidified by the Great Recession of 2008–09. What we are seeing in Election 2016 is a search for a political system that could accommodate the new economic reality.
The technology that came into being a century ago was based on several major technological breakthroughs that brought to life large-scale enterprises — mines, steel mills, manufacturing plants, rail networks — involving massive, geographically concentrated workforces. Operating machinery and equipment demanded a considerable level of literacy and training. Innovation was slow, such that three or four generations of engineers and industrial workers did essentially the same work.
The post-industrial economy, on the other hand, is based on ideas and requires entrepreneurial skills and flexibility. Change is lightning fast and moves in unpredictable ways. Innovation calls for more openness and inclusiveness. Even though centered on Silicon Valley and the Nasdaq market, the innovation economy is remarkably international, drawing on the work of scientists and engineers in China, India, Israel, Russia and elsewhere.
Manufacturing also has changed. Information technology allows managers to coordinate production across the globe, benefiting from the division of labor and creating highly efficient worldwide supply chains. Moreover, production, which used to take the lion’s share of profits in the 1950s and 1960s, has become a race for the bottom. The case of Apple, which gets over 90% of all profits from iPhones, may be extreme, but it illustrates the weak bargaining position of manufacturing.
And yet, we may soon look back at this as a golden age of manufacturers. On the one hand, robots are replacing humans not only in mechanical tasks, but intellectual ones as well. They are even starting to design other robots. On the other hand, the economy is shifting to the Uber model so that even a workforce in a traditional sense may become a thing of the past.
Large-scale technological changes are bound to cause economic dislocations. Hence the Great Recession. We would have had another Depression on our hands had it not been for the central banks’ ability and willingness to print money. The nearly $4 trillion that the U.S. Federal Reserve pumped into the banking system — along with the money other major central banks did — has cushioned the shock, at least for now.
In the United States, all that free money sent the economy down two divergent paths. It spurred even faster development of the innovation economy while at the same time turning parts of the U.S. into a commodity-producing nation.
Good Morning, Caracas
Consider Donald Trump. Trump’s supporters are, by and large, those who by virtue of education, cultural attitudes and lifestyles find themselves on the losing end of the innovation economy. They are scared and resentful. What Trump is offering them is, essentially, a promise to get back at the winners.
He doesn’t so much talk to voters as he panders to a mob. His supporters cheer his every putdown and gang-up on protesters and journalists. What unites them is not shared values but shared hatreds. Abandoning the famed American can-do realism, they lap up slogans and empty promises: Trump will make America great again and that will require no work or sacrifice on their part. His campaign is like a pyramid scheme, a promise that everyone will win the lottery.
The reason Trump has been rejected by the American political establishment across the board is that he’s an alien phenomenon in the country’s political culture. To find his modern equivalents you need to look abroad, to such figures as Russia’s Vladimir Putin, Venezuela’s Hugo Chavez, Libya’s Muammar Gaddafi and other populists in oil-exporting countries.
In fact, Putin already has expressed his respect for Trump. Putin’s propaganda machine, which has been rabidly anti-American and nastily nationalistic, is all of a sudden busy endorsing Trump, presenting him as a lone warrior against America’s cesspool of decay and corruption. Seeing a kindred soul, Trump has praised Putin back.
Oil exporters are mostly a political and economic mess, starting with Algeria, Angola and Azerbaijan and going down the list in alphabetical order. During oil price booms, international oil companies pump oil out of the ground and pay the government billions of petrodollars. The money is distributed based on connections, not merit.
Oil exporters don’t tend to have democracy but are ruled by authoritarian demagogues. The people receive crumbs from the table and are angry and resentful. But they are placated by a mixture of populism, socialism, nationalism and religion.
The only oil producers that remain democratic are those that retain a solid industrial base, such as Norway, Britain and Canada. Mexico and Indonesia were ruled by authoritarians until they ran out of oil and started to develop an industrial economy.
The U.S. produces oil, too, but its commodity industry is integrated into its industrial base. What makes it more like Russia, Venezuela and other oil exporters is its ability to print dollars. This allows it to live above its means and creates a parallel economy in which a disproportionate share of the national wealth goes to those who are closer to the financial trough.
A study by the Peterson Institute for International Economics found recently that an increasing number of U.S. billionaires come from the financial sector, not Silicon Valley; moreover, America’s proportion of financial services billionaires is much higher than in other industrial countries.
The emergence of Donald Trump shows that there is now demand for the kind of political leaders and politics that predominate in oil-exporting countries.
Sanders represents another response to the challenges of the innovation economy. Even though he has captured the romantic imagination of many young people, he proposes to go back to the manufacturing age of his youth. Just like Trump, he wants to renegotiate trade deals and discourage U.S. companies from sending jobs overseas. He would support the revival of industrial trade unions, and his ideas on education hark back to the post-World War II GI bill.
Both Trump and Sanders are talking about bringing back high-paying American jobs. But compared to 2006, the economy has lost nearly 2 million manufacturing jobs despite the fact that production has been returning to the U.S. and the auto industry has undergone a major revival. The share of manufacturing jobs is down to 8.6% from 10.4%. Production is rising without creating new jobs, and, worse, the pay in new manufacturing jobs is not much higher than the minimum wage.
The Great Recession has not yet played out. The flooding of the banking system with money has delayed the transition to the new socioeconomic model, but it didn’t cancel it. Eight years later, the effect of massive liquidity infusions has worn out. We may be in for another leg of a double-dip slump.
But even without a major new downturn, there is still a need for a political system that can accommodate the new economic reality and the search for such a system will continue. Political divisions will persist and may become deeper and more violent. This will be felt in the stock market — perhaps in the same way the social turmoil of the 1960s caused the Dow Jones industrial average to stagnate through the following decade.