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U. S. tax reform generates global growth hope

Economic Spotlight
By Peter Lundgreen

Teaser: US President Trump got a tax reform as Christmas gift, but it remains a challenge for the financial markets to assess how much it will lift the GDP growth in 2018.

If one looks into the crystal ball after new global economic impulses, it’s unfortunately modest. It does not mean that 2018 will be sluggish, but the question is always whether one can see new positive developments that are not yet priced in by the financial markets.

I estimate that Asia continues to offer the best opportunities in general because the high GDP growth creates an economic environment that fosters opportunities. In addition, I expect corporate earnings in many Asian countries to continue to manifest upbeat results during 2018. However, China will not surprise positively with a higher growth than expected this year. India will explore an improved GDP growth, but in reality, the country just back on track after a period of surprisingly low economic growth? In 2017, Japan enjoyed a higher GDP growth than in 2016, which partly was due to real economic growth. However, the base in 2016 was low, meaning only a modest growth in 2017 made the growth numbers look good on a relative basis. As the Japanese growth isn’t accelerating, then I expect that this year will look just modest. One of the most dynamic and improving economies actually still remains the Philippine economy.

On a global scale for 2018, Asia remains the most interesting economic zone for investors. Conversely, Asia will not contribute with a jump to the global GDP growth in 2018. The same goes for another zone in the heavyweight class, namely Europe. The Eurozone, as usual, seems to be in the process of defining itself. Thus, the political energy is not spent on creating new improved conditions for economic growth and certainly not to make the growth jump forward.

Britain remains a joker as the effects of the Brexit decision have still not for real shown the consequences. Concerning this year then, Britain can go in all directions, which, from an investor’s point of view means an ongoing increased risk situation, but it also equals possibilities.

In third on the list of significant economic zones, the United States, a positive surprise could emerge this year. As the country is by far the world largest economy where an unexpected higher GDP growth of half a percentage point would be noticeable for the whole global GDP growth. If the scenario should materialise, then it requires that the new tax reform contributes positively to economic growth pretty soon.

As graph one shows the U.S. GDP growth has had an upwards momentum over a period. I estimate that the financial market has priced in a GDP growth of approximately 2.5 pct. in 2018. This corresponds quite well to the average of the expectations I have seen from a number of economists.

Since President Trump and his own Republican party for some months ago suddenly found each other and agreed about the tax reform, I have been focusing on how much additional growth the deal could actually generate? The question is still open, though my immediate assessment is that it depends on whether small and mid-sized companies and consumers will take the bite that is embedded in the reform.

The classical challenge with economic reforms in the U.S. is how the economic effects are calculated. Up to ten years of accumulated economic effects are included, which makes the short-term impacts more complicated to estimate. Further, the many changes are actually pretty comprehensive, taking up 708 pages of the full text. Personally, I chose to concentrate on a 165- page assessment. But despite the many pages and changes, there are three main elements that I focus on.

That the corporate tax is reduced from 35 to 21 pct. is well-known. This has already been priced in by the stock market a couple of times since President Trump was elected. It will probably continue to support the investor appetite for some stock sectors such as banks, airlines and the oil industry. However, I do not expect this pretty large tax reduction to contribute to the GDP growth in any large extend. As an example, I wouldn’t expect banks to make major investments, even though they pay less in taxes.

However, there are two other areas where there is a good opportunity for a positive effect on the GDP growth this year. The reform includes an option for companies already to invest in 2018 with a tax incentive despite the change formally starts the 1st January next year. This could result in higher corporate investments in 2018 than expected.

In addition, the tax rate is lowered most for private households in the middle-class income segment. However, a lot of other deductions and grants are changed, which gives the discussion about the real impact on the net household incomes. I lean towards the assessment that the net income for middle class household rises, but probably only for a period. Therefore, my main short-term scenario is that the current upswing in the U.S. retail sales (graphic two) will get additional fuel in 2018.

The American growth is back in an upward curve generating a positive and self-reinforcing effect. That is why I expect in particular small and mid-sized business and middle-income class households to take the bite i.e. to spend and invest more due to the tax reform. Probably enough to reach a GDP growth of 2.5 pct. this year but if it’s forceful enough to meet the magic 3 pct. is unknown. Though my expectation is that the United States has the best potential to contribute the biggest advancement of global GDP growth in 2018.

If I am right, then the expected kind of consumption and investments will be good news for exporters to the U.S. – including Philippine exporters. Though it also emphasises the need for rate hikes in the U.S., which for sure will come, and it adds the pressure on the Philippine central bank to follow. Another expected effect is a stronger U.S. Dollar during this year, which will drag the PHP higher towards the Euro – the growing export destination for the Philippines. As always, a change results in losers and winners.


Peter Lundgreen is involved in global finance and banking industry for the past 30 years with a special focus of expertise in financial markets and complex product risks in major markets. In 2009, Lundgreen founded Lundgreen Capital, a financial investment consultancy company based in Copenhagen, Denmark. Today, his company is Denmark’s biggest independent investment and financial adviser to Danish municipalities and local governments. He now wants to penetrate Asia, the world’s growth engine.

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