A cut-out of president-elect Donald Trump is displayed on the floor at the New York Stock Exchange in New York's Financial District on Jan. 2.Seth Wenig/The Associated Press
John Rapley is a contributing columnist for The Globe and Mail. He is an author and academic whose books include Why Empires Fall and Twilight of the Money Gods.
Donald Trump’s “flood the zone” strategy looks politically ingenious. The man repeatedly knocks his punch-drunk opponents off balance, and before they have a chance to respond he lobs another grenade. Although many of his executive orders will be struck down by the courts or fail to reach liftoff, in the meantime his allies are remaking the state in his image, shutting down opposition and moving ahead with bold plans to slash the state, cut taxes and launch a trade war.
Yet while it delights his followers, his chaos may be sowing the seeds of his downfall – not because the opposition will rise up and stop him, but because markets, and eventually the wider economy, may do so.
That would be ironic, because Mr. Trump views the stock market as a proxy for his approval ratings. There’s a school of thought that the 25-per-cent tariffs on Canada and Mexico were paused on day one largely because the markets tanked. The stock market is the last thing Mr. Trump still holds sacred – but now he is set to desecrate that temple as well.
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At first glance, it’s hard to see much evidence of discontent with Trump 2.0 among investors. The stock market is hovering near its all-time high, and analysts are reacting favourably to Elon Musk’s slash-and-burn cutbacks to the state. But peer a bit deeper and you see symptoms of future troubling multiplying. Following years in which U.S. stock markets soared above the rest of the world, sucking money out of European, Asian and emerging markets as the American indices reached new heights, quietly but inescapably the flow recently began to go into reverse.
European stock markets are now outperforming U.S. ones by widening margins, and the U.S. dollar has begun to weaken. Perhaps most tellingly, after a couple of years in which the AI bubble suggested the U.S. would dominate the economy of the future, the DeepSeek breakthrough has seen Chinese tech stocks significantly outperforming U.S. ones, making the Magnificent Seven last season’s fashion trend. If this continues, it would suggest investors are starting to lose faith in the American economy.
In the deeper currents of the markets, things look even more worrying. Mr. Trump’s keep-’em-guessing modus operandi may rattle his opponents, but it’s having the same effect on businesses. With so little certainty about what lies ahead, and in particular what tariffs will be placed on whom, businesses are putting investment plans on hold. Meanwhile, U.S. deal-making has slowed, and private-equity exit activity – the process by which private investors in a startup cash in by floating the company’s shares on the stock market – is slowing. Should it continue, this blockage in the pipeline will crimp future investment, slowing both the economy and productivity growth.
For its part, the job market has begun sending mixed signals that could warn of trouble to come. Last month’s report revealed lower job creation numbers, pointing to a slowing economy. Yet wage growth accelerated and the unemployment rate fell, suggesting a tightening labour market. The most recent survey by the National Federation of Independent Business confirmed that small-business owners are having an especially hard time filling job vacancies. It seems the immigration restrictions the Biden administration started implementing last year, and which Mr. Trump is now turbocharging, are starting to constrain the labour supply.
Put it all together and the U.S. economy may be brewing a potent mix of trouble. If investment and job creation slow, so too will the economy. But if labour productivity declines as a result of stalled investment, while wages pick up, the U.S. could face the troublesome combination of a slowing economy and rising prices – stagflation.
Were this scenario to materialize, asset prices would likely fall. This might not happen for another few months, though, because investors are still discounting Mr. Trump’s tariff threats, betting that he will keep backing off from implementing them. Equally, there still remains some optimism that Mr. Musk’s razing of the public sector will free up money for tax cuts.
But this itself portends trouble. In more than half of American counties, public transfers of some form now account for more than a quarter of people’s incomes. If Mr. Musk really succeeds in eliminating them, the economy will probably go into recession. And that could be just the start. Were a genuine crisis to erupt, be it a market crash or another epidemic, the capacity of the U.S. state to respond as quickly as it has in the past might be impaired, precisely because it will have been so eviscerated by the Musk wood chipper. Slow and ineffectual policy responses might then deepen the resulting recession.
The slowing growth in U.S. stock markets and the continuing rise of gold and other markets suggest investors are starting to hedge against this eventuality by moving their money elsewhere. So while Mr. Trump’s fans in the front rows are cheering wildly, it appears the ticket-buying audience may be quietly slipping out the back doors.