Trump to focus on making free trade, not just free, but also fair – Mohamed El-Erian

SS: I'm wondering, will his presidency bring about the beginning of the end of globalisation? Because, while he was campaigning, Trump really emphasised on anti-globalist agenda, protectionist agenda - and with the House and the Senate in Republican hands, will he go for it, re-impose trade barriers?

ME: A couple of issues in response to that question. First, it's a tradition in the U.S. to pivot from campaign to governing, and often, promises and signals given at the campaign evolve as people assume office. The second element is while, yes, the Republicans now control the House of Representatives, the Senate and the White House, there are different types of Republicans. The Republicans that control House and the Senate tend to be more traditional Republicans. So, it is also going to be an issue of checks and balances within the Republican system itself. I would just say, it's early days, we should expect some evolution from the campaign - and don't forget that like Mr. Obama before him, Mr. Trump is going to have the way to work with Congress.

SS: Now, with the Trans Pacific Partnership officially dead, the Transatlantic trade pact - TTIP-  may also die, Trump promised to renegotiate NAFTA and even a trade pact with South Korea:

Donald Trump: "No longer we will enter these massive transactions with many countries that are thousands of pages long and which no one, from our country even reads or understands!"

SS: Will he be able to back out of free trade pacts completely?

ME: What we're seeing happen immediately is that any trade arrangement that hasn't been signed and sealed and delivered is unlikely to go anywhere, and you've mentioned the two: the TTIP between the U.S. and Europe and the TPP between Europe and Pacific countries. So any new trade arrangement is going to be really tricky. Existing trade arrangements - that's evolving. On NAFTA we've already seen both Mexico and Canada come out and say: "Well, maybe, we can re-open some of these arrangements" - I think, they realize the importance of giving something in order to maintain the overall NAFTA arrangement that has served countries rather well. So, you're going to see some negotiations. I, for one, do not expect a dismantling of existing trade arrangements - maybe, some tweaking, but I don't expect a dismantling.

SS: Will China now bring the Asia-Pacific region together with its own economic deal? Will the Trump presidency “let China write the trade rules” - something which Obama’s warned against?

ME: China has been working hard to increase regionalism within China. You see this not only in the bilateral relationships, but you also see it in the multilateral efforts that China has led. After all, China did lead the Asian Infrastructure Investment Bank - it was opposed by the U.S., at the end of the day, very few of the U.S. allies did not join. Most of them did join, and that bank is up and running. So, this has been a multiyear effort by China, it reflects a regionalisation of Asia and I expect that China will continue its efforts in this regard.

SS: During his campaign Trump accused China of “the greatest theft in the history of the world”, and promised to impose major tariffs on Beijing exports.

Donald Trump: "We can't continue to allow China to rape our country, and that's what they're doing. It's the greatest theft in the history of the world."

SS: With American exports to China at 165 bn $ -  can the country afford to get into a trade war with Beijing?

ME: I think a trade war with the two countries that were singled out during the campaign - China and Mexico - would be a lose-lose-lose. It certainly would be lose for those two countries, it would be lose for the U.S., because it would trigger stagflationary forces, that means lower growth and higher inflation; and it would also be a lose for the global economy as a whole. So, this 'crushing tariffs' that we've talked about on Mexico and China would not be a good outcome. I don't expect it's going to happen. I think what you're going to see is an evolution, just like you're going to see it on NAFTA, but you're not going to see "crushing tariffs" being imposed and you're not going to see a trade war as a result.

SS: Because, I'm thinking, didn't Trump's advisors tell him what you're telling me right now, that actually going into a trade war with Beijing would be a "lose-lose-lose" situation for everyone, for all parties involved? I'm sure someone warned him of that, but he still sort of went for that statement. So, I'm wondering if he's going to go for it at the end.

ME: He certainly was warned of the consequences, including, as you say, by his own economic advisors. Don't forget that the Republican party that dominates Congress right now is not 'for' a trade war, so I think when everything comes out, this element will be diluted quite a bit. As I said earlier, I do not expect the imposition of "crushing tariffs" by the U.S. on China and on Mexico.

SS: Now we have this Chinese government-controlled newspaper and it claims that Beijing could retaliate against Trump’s recklessness, by cutting sales of iPhones and U.S. cars - if the new president fulfils his campaign pledges, that is. If we were to, sort of, think "what if" - wow much damage can China inflict on the American economy?

ME: In a "what if" scenario... and again, I stress: that is not what I expect is going to happen - a trade war would be harmful not just to the countries directly involved, in this case China and the U.S., but to the global economy as a whole. You know, we live in a neighborhood and that neighborhood is very interlinked in terms of financial flows and trade. So if you try to dismantle it, it's actually very hard to continue to operate this neighborhood in an orderly fashion. Then you get a fragmented global system which means a less efficient, less prosperous global system. So, if we were to slip down that road of protectionism, trade war, the global economy as a whole would be worse off. I do not believe that he would go down that road.

SS:Yeah, but I'm really thinking American economy - could you, maybe, give me a "what if" scenario in numbers of the damage it would inflict on the American economy?

ME: So a trade war would be stagflationary to all economies, including the U.S., the stag- part of it is much lower growth,the -flation part of it is much higher prices to consumers. Having said that, the U.S. economy is more closed than most other economies in the world, and therefore, the impact in relative terms would be less severe for the U.S. - but in absolute terms, it still would be a stagflationary headwind.

SS:Trump also threatened to leave the World Trade Organisation  - if they don’t agree to renegotiate the relationship with the U.S.. Are those threats to be taken seriously? Can Trump really shake up the existing global financial system, force it to reform?

ME: I think what a Trump presidency will do is signal that it's not just about free trade, it's about free and fair trade. Whether it is the bilateral arrangements, whether it's the regional arrangements, or whether it's the multilateral arrangements, you're going to see much more emphasise on the fair element of trade. I think, that's going to be a very important component of the discussions going forward. What does that mean? It translates to worker's rights, it translates to standards, to regulation, it translates to a lot of things that are behind free trade and that ensure that free trade is not just free, but also fair.

SS:Trump was a big Brexit supporter - so is his win good news for the UK? While he tears up trade deals with other states, can he go for a pact with Britain, for instance?

ME:There's no doubt that this Transatlantic relationship, which is very long and deep and standing, is one that both countries are going to look to, especially as the UK starts exiting the EU. But, before we get carried away, I just want to say one important thing: Europe will remain a very large trading partner for the UK, so this is not going to become a complete revamp of how the global economy looks, but what you will see is the U.S. and the UK getting closer and this will be part of the general, gradual realignment of trading relations within the Western world.

SS: So, President-elect is businessman, has always been - it's something that never happened before in the White House. Can his ability to make deals translate into a pragmatic approach to foreign policy? Create a more stable international environment - and thus economic stability?

ME: What the market base is  expecting is a more business-friendly administration. In the first instant, that translates into three things: one - deregulation, including lowering excessive constraints to business, two - more infrastructure support, enabling the private sector to do more, and three - corporate tax reform that will be coupled by lower tax rates for businesses. That is what businesses are expecting, that is why the stock market has done so well after the election, and they attribute that to having a more business-friendly person. Then, it will be good for the global economy, but implementation is going to be absolutely the key.

SS:The Federal Reserve has yet to bring interest rates up from near zero - and Trump has previously blamed the Central Bank for creating a false economy with their policy. Will we see a standoff between the next President and the Fed? Who will win it?

ME: There are three elements to this potential standoff, as you call it. The first is one is what happens in a very short term. I think there we are converging to expectations that interest rates will go up when the Fed needs in December, they will probably grow up by 25 basis points. That makes sense for Fed, given its mandate, given that employment is doing better, inflation expectations are growing up, and that makes sense for Trump's view of monetary conditions. The second element is Fed leadership. As you know, before the election, Mr. Trump was very critical of Chair Yellen. As to the question whether that means that Chair Yellen steps down before her term ends in 2018, in January - I do not think that's going to happen. The third element, the most important one, is about respect for the political autonomy of the Central Bank. That's a key element in the institutional set-up of the U.S. and it's the one that has served the economy well. I think, at the end of the day, that is going to be adhered to and you're going to see that the political autonomy of the Central Bank will remain at its way. You will see changes - Mr. Trump has a number of appointments to make at the Fed and he will be putting people that are closer to his own philosophy about monetary policy.

SS: So you don't think that the Fed Reserve will lose its independence? Because Congress has long wanted the power to audit the Fed, and now Trump will influence the Fed’s board composition, like you've said. That doesn't spell the end for the Federal Reserve's independence for you?

ME: It doesn't spell the end of the independence. What it does point to, and thank you for pointing it out, it points to political pressures on both sides of the Atlantic, both in the U.S. and Europe, on Central Banks. Why? Because Central Banks have been “the only game in town”, they've taken on an enormous policy responsibility and one that has gotten them deeper and deeper into the implementation of the experimental policies. So, yes, politicians are getting more interested in what the Central Banks are doing. There will be greater political pressure on Central Banks, but I do not think that that's going to lead to a significant loss of the political autonomy and independence for these institutions.

SS: Trump’s win was welcomed by fossil fuel businesses with the President-elect calling for ‘complete American energy independence’. Oil billionaire Harold Hamm is saying that can be achieved by in the next 6 years -  are you as optimistic? Is Trump’s plan - getting rid of regulations and letting the oil industry do what it wants - actually going to work?

ME: There are certain sectors that are particularly impacted, either in a positive or a negative way. Traditional energy is one that is being impacted in a positive way. Why? Because the world expects - I think that's realistic - it expects the shift in emphasise from the White House. We have others too: banks are doing extremely well on the stock market right now. Why? Because people see another shift in emphasis on that. And then, traditional industrial companies are doing so well because emphasise has changed. So, yes, absolutely, within the overall picture, there will be some pronounced sector-specific shifts  - in traditional energy, finance, infrastructure related sectors will do a lot better than what was previously the fast growing ones, which were concentrated in technology.

SS: If the new president supports the American shale oil industry - Do you think that would derail OPEC’s plans to cut production and control the oil price?

ME: I think OPEC's plans are really focused on what is happening within the OPEC, and they recognise that outside a band of $45-55 a barrel, things get tricky. Above 55, you encourage a tremendous amounts of alternative production, and that alternative production eats away at your market share in a very significant way. Below 45, the revenue priorities become really important, and therefore, you want to limit the downside. So, I think if you are an OPEC producer right now, you're asking the question: "How can I for now stabilise prices between $45 and $55?" That is your goal - it doesn't mean you'll always succeed, but that is your goal and the only instrument you have is production in conjunction with discussions with other non-OPEC producers.

SS: Merrill Lynch is saying OPEC is now more likely to reach an agreement on the oil price - being forced to counter Trump’s energy policy. Can Trump’s victory forge consensus in OPEC, make its decisions relevant again? 

ME: So oil prices have fallen significantly, mainly on account of supply rather than demand and that is getting OPEC to focus again about the importance of adhering to production agreements and the importance of also bringing in large non-OPEC producers. That is what's driving all this. It's... oil prices are below $45 and as I've said earlier, that's a very uncomfortable level for some OPEC producers.

SS: About the tax cuts: Trump wants to pass huge tax cuts - the idea is that this could bring about faster growth. But coupled with promised infrastructure spending, wouldn’t that guarantee America’s 19 trillion $ debt only mounts higher? Can he spur economic growth enough to compensate for the spending?

ME: In his plan, he has growth going up to 4%. If that materialises, then the U.S. will be able to deliver both growth and sound finances. Now, these are ambitious targets. On the tax side, I think you've got to differentiate between household taxation and corporate taxation, and within that, you've got to differentiate between reform, which eliminates all sorts of loopholes and the rate of taxation. So, there's a way to design a revenue-neutral tax reform. Now, it wouldn't involve the sharp declines in tax rates that Mr. Trump has indicated before the elections, but it would certainly be pro-growth, if we are able to clean up the system. You know, we haven't had proper tax reform in the U.S. since the 1980s. That is a long time. The world has changed and the implementation of the tax system has changed. So, this sort of reform has been long overdue and in fact, there’s agreement on both sides of the aisle among Republicans and Democrats that that should be among the top priorities. Where the disagreement is - is on the rates.

SS: To lift the debt ceiling or to repeal the law that limits how much gov’t can borrow you need the approval of the Tea Party in Congress - will they block further borrowing and thus block Trump’s tax cuts?

ME: I don't think so. I think what you will see, is that you will see influences on the tax reform element. This is an environment that we haven't had for a while, whereby you have Congress and the President that are much more able to work together because they are not going to be perceived as collaborating with the other side of aisle. I don't think the Tea Party will block and will close the government, or will threaten technical default. In fact, I would go further: had Hillary Clinton been elected, I still don't think that we would've had that risk. Why? Because no one wants to repeat the experiences of 2011.

SS: Now, Trump touted himself as the ‘king of debt’, saying he understands it better than anybody - with America’s national debt at $19 trillion, could Trump provide an answer?

ME: I think what Mr. Trump has, he has a good sense for clever financial engineering. He has a good sense for the capital structure. He has lived in a world where he has operated with various elements of the capital structure, so he understands that you can optimise your asset liability approach. That is what he's bringing to the White House. Now, it wouldn't surprise me if that translates into a more responsive liability management policy, which means that re-visit how you issue bonds, re-visit whether there’s scope for buy-backs or not, re-visit how the corporate tax system is impacting the capital structure of different companies. So, you'll have a lot more focus on that in the White House. Ultimately, though, the tax burden and the debt burden for the country as a whole is going to be a function of how much growth can he deliver. That's the critical issue to focus on: growth, growth, growth.

SS: Despite his previous anti-Wall street stance, Trump is now talking about repealing the regulation put on Wall street in the wake of the 2008 crash - the lack of regulation already brought one crisis, won’t deregulation just cause another?

ME: Now, again, you've got to be really careful in terms of how you reflect campaign promises. Here, Brexit is a really good example. When on June 23rd UK citizens voted to exit the EU, the government did not rush to do so. The government did not trigger Article 50, the government didn't even start the processes. Why? Because they realised that you cannot replace something with nothing. If you try to replace something with nothing, you get disorder - economic disorder, financial disorder. So what you've seen in Britain is a go-slow process. Let's try to figure out what the replacement is before we start dismantling what we have, and that is, even though there was a very clear referendum. I think you're going to see the same thing when it comes to financial regulation. You're not going to see a Trump Administration rushing to dismantling stuff until they know what they want to replace it with. Why? For the reason you've cited: if you dismantle too quickly, you risk a financial crisis. What you're going to see is a go-slow process that makes sure that we have an alternative before we start dismantling what we have.

SS: Alright, thank you so much for this interview. We were talking to Mohamed El-Erian, chief economic advisor at the global financial services leader, Allianz, author of "The Only Game In Town" bestseller, talking about how the U.S. president-elect Donald Trump will transform the American and the world economy. That's it for this edition of SophieCo, I'll see you next time.