The Stock Market Is Reacting to Trump's Erratic Policies

December was the worst month for the stock market since 2008. And the volatility makes you dizzy as the Dow Jones Industrial Average has fluctuated over 1,000 points within a day. Not only does it complicate financial decisions by firms, but anyone with plans to retire soon is scared to open the 401k statement.The weakness and erratic behavior in the market is puzzling given positive economic news like the recent jobs report. But the market is forward looking, which means it's not only current economic activity that determines price changes, but also the expectation of what may happen in the future. Fears of a recession drive prices down even when the economy is humming along nicely. And increasingly, uncertainty regarding economic policy makes investors nervous.In 1968, future Nobel laureate Milton Friedman spoke to the annual meeting of the American Economic Association to outline his prescription for how monetary policy should be applied. He suggested policy makers keep the economy stable, but be prepared to offset major economic disturbances. Also, he admonished them to avoid major policy swings that confuse economic participants. While his focus was on monetary policy (duties of the Federal Reserve) these ideas also apply to government responsibilities such as trade and fiscal policy.Trade policy is current news due to decisions by the Donald Trump administration. Against the advice of most economists, myself included, the administration took actions that negated existing and pending treaties. When new tariffs were applied on imported goods, predictably the response from trading partners was to increase tariffs on exported American goods.This placed firms who either import goods to the U.S. or export American goods in a bind. They have no good options. Either pass the increased cost to their customers and watch their sales decline, or leave prices alone and watch their profit margins fall. Both actions lower expectations for future earnings, which investors take into consideration when pricing the stock.Rather than keeping the economy stable, as Friedman recommends, the trade policy does the opposite. Plus, it's a major and unexpected swing in trade policy from that of previous administrations, Democrat or Republican.Adding to the turmoil is a dysfunctional fiscal policy that predates the current administration. Fiscal policy is the taxing and spending powers of the government. Ideally, tax receipts should equal or come close to our spending obligations. Beginning with the Bush administration, the combination of tax rate reductions, unfunded wars, a new Medicare benefit and the largest recession since the 1930s created debt now exceeding $21 trillion. Ultimately, that debt will drive up interest rates and may damage the U.S. credit rating, further increasing rates. High interest rates spook investors because the debt market is an alternative for investment capital. For firms that borrow money, high interest rates increase costs, which diminishes profit. Future expected earnings are now lower, so investors decrease their estimate of what to pay for the stock.Another consequence of high debt is weakening the government's ability to respond to economic disturbances. Once the 2008-09 recession became evident, the combination of fiscal stimulus and aggressive monetary action arrested the decline, initiating the slow climb to an expanding economy. But our current level of debt and the politicization of fiscal policy generally make it less likely this tool can be effective in the future.Solutions to our policy troubles are both obvious and difficult. For trade policy, we simply need to stop the brinksmanship with our trading partners and return to actions that encourage free trade. But this policy originated with boasts made during the 2016 presidential campaign, so recommendations from experts are ignored.Likewise, fiscal policy is equally doomed. The fix is an increase in taxes, reductions in federal spending or a combination of both. It's hard to imagine that happening.Economic policy should be boring and non-controversial. For this to happen, we need leaders whose objective is the nation's benefit rather than scoring points on TV or needlessly attacking an opponent. That outcome is beyond the discipline of economics. Economists can advise based on empirical research. But our leaders should lead, not posture.Kevin Simmons is an economics professor at Austin College in Sherman. He wrote this column for The Dallas Morning News. What's your view?Got an opinion about this issue? Send a letter to the editor, and you just might get published.  Continue reading...

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