Financial market hate surprises, and only a year ago they were looking forward to one of the more predictable presidential elections in memory.
Instead, they got a crushing defeat of the "inevitable" Republican nominee Jeb Bush and emergence of populist Donald Trump, a candidate with no political experience, team or program.
On the Democratic side, meanwhile, Hillary Clinton has run into a challenge from socialist Bernie Sanders; while she is likely to see it off, the party may be pushed further to the left.
The Republicans and the Democrats are nervous, business leaders are apprehensive and America's trading partners are horrified, but Wall Street has shrugged off all concern. Stocks are reacting to China and oil prices, not to developments in America's own backyard. But will it last?
Ignoring Washington
The U.S. government has been dysfunctional for the past eight years but while investors initially reacted negatively to news from Washington, they soon learned to shrug off assorted government shutdowns, threats of debt default, sequesters and lack of legislative action.
They have actually discovered that gridlock is good for business. At least no major changes can be made to policy and no new taxes or regulations imposed.
Wall Street now anticipates more of the same come January 2017, i.e., continued recriminations and inaction in Washington for four more years. Each candidate may be scary when taken on his or her own merits, but they will be inevitably neutralized by sharp ideological divisions once one of them gets to the White House.
This may prove an overly optimistic assumption. The rise of highly unusual candidates in the election cycle reflects deep changes in American society. Voters whose imagination has been captured by anti-establishment candidates like Trump and Sanders are not going to go away.
Their newfound passion testifies to their determination to be heard. This will have major implications for the political system and, eventually, for financial markets.
It is conventional wisdom that the country is split down the middle, with the conservative half supporting low taxes, pro-business policies and traditional values, and the liberal half stressing the role of the government in the economy and the lives of ordinary citizens, and expressing preference for more inclusive, multicultural policies. However, this election cycle has laid bare very different divisions, which turned out to be not so much political or ideological as economic, reflecting radical changes in the U.S. economy.
Post-Revolution America
Economic changes have long been gathering momentum, but they are only now coming to the fore. Just as technologies developed in 1900–30 (notably, the internal combustion engine, electricity, radio, cars and airplanes) and the Great Depression altered the U.S. economic model, so the IT revolution began reshaping the U.S. economy in the 1990s, and those changes were solidified by the Great Recession of 2008–09. What we are seeing in Election 2016 is a search for a political system that could accommodate the new economic reality.
The technology that came into being a century ago was based on several major technological breakthroughs that brought to life large-scale enterprises — mines, steel mills, manufacturing plants, rail networks — involving massive, geographically concentrated workforces. Operating machinery and equipment demanded a considerable level of literacy and training. Innovation was slow, such that three or four generations of engineers and industrial workers did essentially the same work.
The post-industrial economy, on the other hand, is based on ideas and requires entrepreneurial skills and flexibility. Change is lightning fast and moves in unpredictable ways. Innovation calls for more openness and inclusiveness. Even though centered on Silicon Valley and the Nasdaq market, the innovation economy is remarkably international, drawing on the work of scientists and engineers in China, India, Israel, Russia and elsewhere.
Manufacturing also has changed. Information technology allows managers to coordinate production across the globe, benefiting from the division of labor and creating highly efficient worldwide supply chains. Moreover, production, which used to take the lion's share of profits in the 1950s and 1960s, has become a race for the bottom. The case of Apple, which gets over 90% of all profits from iPhones, may be extreme, but it illustrates the weak bargaining position of manufacturing.
And yet, we may soon look back at this as a golden age of manufacturers. On the one hand, robots are replacing humans not only in mechanical tasks, but intellectual ones as well. They are even starting to design other robots. On the other hand, the economy is shifting to the Uber model so that even a workforce in a traditional sense may become a thing of the past.
Large-scale technological changes are bound to cause economic dislocations. Hence the Great Recession. We would have had another Depression on our hands had it not been for the central banks' ability and willingness to print money. The nearly $4 trillion that the U.S. Federal Reserve pumped into the banking system — along with the money other major central banks did — has cushioned the shock, at least for now.
