Trump 2.0: Why a second presidential term could lead to a new financial crisis

Australia has already dealt with a Trump presidency — but what could it look like the second time around?See all 5 stories.

There are two distinct views on what a second Donald Trump presidency would mean to the global economy.

Trump recently declared in an interview with Time magazine that he had “the greatest economy in history” during his first time running the United States. A second term would be a chance to “rebuild the greatest economy in history”.

But others, looking over his plans in areas from tariffs to America’s central bank to government debt, are not nearly as optimistic.

Donald Trump’s term as president coincided with falling interest rates and low inflation. A second term would be vastly different.Credit: AP

“I think there’s a serious chance of a financial crisis if he wins,” renowned Australian economist Warwick McKibbin notes.

There are five main elements to Trump’s economic agenda.

Tariffs

The best-known aspect of Trump’s plans is to impose tariffs across all parts of the economy in a bid to protect US business from nations he claims “steal our jobs and they steal our wealth”.

He has promised a 10 per cent tariff on imports from all nations (including those, such as Australia, which have a free trade agreement with the US) and a 60 per cent tariff on imports from China, but he has also left the door open to even higher imposts.

Trump calls the tariffs a “ring around the country”. Studies of the tariffs on steel he introduced during his first term show they lifted domestic steel production by just under 2 per cent, but led to a $US3.4 billion reduction in the use of steel by downstream manufacturers.

His tariff war with China cost more than $US60 billion in payments to American taxpayers who were hurt by Chinese imposts on US produce.

Trump has argued that tariffs are paid by the country exporting its goods into America, at odds with almost every economist and the lived experience of trade liberalisation over the past 40 years.

Tax cuts

The tariffs are closely linked to Trump’s agenda for tax cuts.

Large tax cuts that heavily favoured high-income earners, which were part of Trump’s first presidency, are due to end in 2025. Trump, and his supporters, are keen to extend them, with the Congressional Budget Office estimating they would cost $US4.5 trillion ($6.7 trillion) over a decade.

Those tax cuts also included Trump’s sharp reduction in the business tax rate. His business supporters are keen to see the corporate rate reduced even further, to around 18 per cent.

State of the budget

Until the COVID-19 pandemic, the American economy under Trump was flying – due in part to falling interest rates (both market rates and those on government debt). That was vital, as Trump paid no heed to the state of his budget.

In 2019, the federal budget deficit had reached almost $US1 trillion despite super-low unemployment. Spending in the first three years of the Trump presidency had climbed by more than $US500 billion, or 15 per cent. Revenues over the same period increased by less than $US200 billion, or 5.9 per cent.

COVID exploded the budget deficit and total debt. The deficit for 2020 was a record $US 3.1 trillion, while debt lifted beyond $US21 trillion. The impact on the budget was muted, however, as interest rates fell to zero.

But the combination of all that spending, low interest rates and supply-chain issues around the world has delivered an interest-rate problem that will hound Trump, who has offered no ideas on how to cut spending.

The interest bill on American government debt is now beyond $US1 trillion, while the pile of debt is growing by $US1 trillion every 100 days.

Federal Reserve

Like Australia, while the federal government often claims complete control over the economy, the day-to-day operation is left to the US’ central bank.

Donald Trump has been at loggerheads with Federal Reserve chief Jerome Powell (left).Credit: Bloomberg

Trump has been engaged in a running battle with the chair of the Federal Reserve, Jerome Powell, for his handling of interest rates, which the former businessman claims are too high. Powell, whose term ends in 2026, was appointed by Trump.

The candidate’s open attack on the Federal Reserve has prompted real concerns that the institution – already dominated by Trump appointees – will run easier monetary policy or break from economic orthodoxy if Trump is returned.

In the dying days of the first Trump presidency, the Senate rejected Trump’s nomination of Judy Shelton to the Federal Reserve. Shelton had supported the gold standard while openly questioning the need for a central bank.

Deportations

One of the biggest possible shocks to the American economy under a second Trump presidency could play out in its labour market.

Trump has said he will undertake mass deportations of “illegal” migrants, many of whom work in the construction, agricultural and services sector.

In his Time interview, Trump said there were between 15 million and 20 million illegal migrants within the US, with “many of them from jails, many of them from prisons, many of them from mental institutions”.

According to Trump, he will shift these people back to their nation of origin (or perhaps just to Mexico). Legal immigration would also be made more difficult.

These five interconnected policies – many of which remain hazy – have prompted plenty of research into what they might mean for the US economy.

Two analysts from the Peterson Institute, Kimberly Clausing and Mary Lovely, in May estimated the planned tariffs would generate extra costs to consumers of $US500 billion a year, five times the impact of Trump’s pre-COVID tariffs.

Oxford Economics has examined two separate scenarios, what they termed a “limited Trump” and “full-blown Trump”.

Under “limited Trump”, which assumes the extension of the 2017 tax cuts, higher government spending, reduced immigration and targeted tariffs on China and Europe, real economic growth is about 0.6 per cent higher by 2027.

But the stronger growth means higher inflation by late 2027, which prompts the Federal Reserve to slow its planned cuts in US interest rates to the point they hold them steady.

The “full-blown Trump” is, as the name suggests, an unconstrained second presidency. This means extension of the 2017 personal income tax cuts plus a separate set of cuts for corporate America. Immigration is restricted even more tightly, and all of America’s trading partners face across-the-board tariff hikes.

Under this plan, Oxford estimates the US economy could be up to 1.8 per cent smaller by 2027. But because of the inflationary impact of full-blown Trump, expected interest rate cuts are paused.

Not only would there be a direct impact on the economy from full-blown Trump, affected nations could be expected to retaliate.

According to Oxford, if China restricted its tourists from heading to the US, reduced spending by these tourists would amount to almost $US12 billion in 2026 and reach about $US16 billion by 2023.

America’s clean energy industry, which is supporting the US economy at present in much of the south of the nation, including in Republican “red states” such as Texas, would struggle under Trump.

Under Biden’s Inflation Reduction Act, it had been assumed renewables would account for 68 per cent of US electricity production by 2050. Under limited Trump, this falls to 63 per cent, while full-blown Trump drags it down to 58 per cent.

McKibbin, a former Reserve Bank board member who is one of the world’s most respected economic modellers, will soon release analysis on what Trump will mean to the US and global economies.

Expert economic modeller Warwick McKibbin says there is a chance of a financial crisis due to Trump’s policy agenda.Credit: Alex Ellinghausen

He says that work suggests Trump’s planned tariffs on China have a direct negative impact on Australia, with the economic output permanently reduced by 0.3 per cent of GDP, or $8 billion a year. In other words, Australians become poorer because of a Trump trade war with China.

But Trump’s actions beyond tariffs could have much more far-reaching economic consequences.

McKibbin says tariffs drive up operating costs for US businesses, while deporting at least 1.4 million people would drive up wages.

Both are inflationary, driving up interest rates.

When Trump was last in power, interest rates around the globe were falling and, in real terms, at negative levels.

Now interest rates are much higher and Trump has shown he will continue to run huge budget deficits. Interest rates on 10-year US Treasuries fell below 0.7 per cent in 2020, while today they are around 4.1 per cent.

“The US is generating $1 trillion of additional debt every 100 days. The interest on that debt is now larger than the defence budget,” he said.

“You can’t keep doing this and generating these free lunches forever.

“Without cutting spending or pushing up taxes, this has to create inflationary pressures.”

A growing concern is whether Trump, who has long advocated low interest rates, will interfere in the operation of the Federal Reserve. The Wall Street Journal earlier this year reported that Trump allies were arguing for the president to have the final say on rate settings.

McKibbin’s greatest fear is that the combination of higher inflation, a compromised Federal Reserve and growing debt will shake the global financial system.

He noted the Clinton administration was able to reduce the debt left by Ronald Reagan and his huge budget deficits due to a resurgence in productivity driven by the advent of personal computers across the economy.

“There’s a chance that artificial intelligence could bail out Trump, but that would be a miraculous outcome,” he said. “There’s a very low probability of a miraculous outcome and a much higher probability of a global financial crisis.”

EY Australia’s chief economist, Cherelle Murphy, said if Trump was re-elected, there may be a lift in business and consumer confidence across the United States.

She said that during Trump’s first term there was an increase in confidence and there was every chance that could be replicated, providing a bump to overall economic growth.

But like many other economists, she noted Trump had shown little interest in bringing the budget under control.

EY Oceania chief economist Cherelle Murphy says business and consumer confidence could rise in a second Trump presidency.Credit: Alex Ellinghausen

“There will be a continuation of large budget deficits. It’s simply passing on a problem to the next generation. That generation is going to be asked to solve a growing issue,” she said.

Murphy also noted that while there was a heavy focus on Trump’s approach to the economy, other issues – such as the ageing population, decarbonisation and the private sector – were likely to have a bigger impact than the occupant of the White House.

“There’s a lot of sound and fury around economic policy, but there are much bigger drivers of the economy than the federal government,” she said.

RSM’s United States chief economist Joe Brusuelas, who recently visited Australia, told this masthead that the first Trump administration was more “bluster than substance”. He does not hold high hopes for any change if Trump wins again.

“I don’t expect that much to get done by a new Trump administration,” he said.

Brusuelas said the main economic issue would be the pressure to extend the 2017 personal tax cuts. The argument over those cuts would depend largely on whether the Republicans held the House and gained control of the Senate.

“The tax cuts are going to be the main preoccupation of Washington,” he said.

Brusuelas noted another flashpoint would be efforts to strengthen America’s manufacturing sector, but in a way unlike Joe Biden and his Inflation Reduction Act, which had driven huge investment in green energy and technology.

“Pre-COVID, about 13 per cent of international capital moved into the United States. Now it’s above 30 per cent,” he said.

The actions of former British prime minister Liz Truss prompted the coining of the term “moron risk premium”.Credit: AP

Allianz economists earlier this year noted that extending the tax cuts, on top of the large budget deficits left by the Biden administration, higher interest rates on government debt and an economy more prone to inflation, could all end in tears as financial markets worried about the sustainability of the US budget.

“As a cautionary tale, Liz Truss lasted only 50 days as UK prime minister in 2022 after bond and currency markets reacted adversely to her plans for big deficit-financed tax cuts,” they warned.

Economists coined the term “moron risk premium” to describe the fallout from the Truss budget experiment. The premium was the higher interest rate on British government debt demanded by investors worried the then government was a risk to itself, creditors and the broader economy.

The British economy is the sixth largest in the world. But it is just 12 per cent the size of the US economy.

The greatest economy in history may make history of a very different kind if the second Trump presidency does not go as planned.

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