A brief guide to deregulation and ‘Trumponomics’

by Jan 12, 2017

Deregulation was a key buzzword throughout the US presidential election campaign. Donald Trump made it clear that he intends to roll back regulations, especially those in the financial sector.

But what is deregulation?

Deregulation is when a government reduces industry restrictions placed on sectors and businesses that limit them, in order to increase the ease of conducting business and to increase business competitiveness.

Governments often try to regulate the behavior of companies by placing rules on how they conduct their affairs. These rules often restrict the activities of companies by restricting what they can do or how they can do it. Deregulation is the removal of these rules, with the aim of improving the competitiveness of the companies involved.

Why regulate?

There are upsides to regulation – it can protect people. Businesses do not always play fair, and many consumers and investors in the marketplace have been taken advantage of and fared badly from a lack of rules and regulation in some industries. The obvious example is the 2008 financial crisis, where the government had to step in to regulate the free market.

R.J Matson’s cartoon above encapsulates the change that occurred in the US financial sector due to deregulation, which led to the government having to step in and clean up the mess.

The financial sector in the United States had become less and less regulated under administration’s from the 1980’s onward, including Bill Clinton and George Bush. With the help of the Federal Reserve (America’s Central Bank), banks and other institutions were allowed greater freedoms than ever before.

Aided by deregulation, the financial sector grew into one of America’s largest industries. Banks began using people’s money in riskier ways and also borrowed huge sums, after restrictions on leverage ratio’s (the amount of money a bank was allowed to borrow) were softened – a prime example of deregulation. Many investors were defrauded by banks who were selling them toxic assets. These sometimes had close to zero real value. If the financial sector had been more actively regulated and stricter standards were enforced, excessive risk-taking by these firms could have been avoided, and we might have avoided a crisis which ended with taxpayer bailouts.

Why relax the rules?

On the flip side – deregulation can increase the growth of an economy. As previously mentioned in the example of America’s banking industry, deregulation leaves business to govern itself, rather than the state. When rules are relaxed, businesses are encouraged to compete. Cutting ‘red-tape’ and bureaucracy can also encourage foreign investment into countries as well, because this makes it easier to do business. Some argue that governments don’t make good business managers,  that they are influenced by political pressures instead of sound financial planning. In this way in theory, business can operate better (make higher profits) on it’s own with less state interference. When companies are less restricted and encouraged to compete, this can also lead to new innovations, which can help an economy grow.

What might Trump do?

Trump has said explicitly that he wants less regulation. His idea was that for every new regulation in government, two would be eliminated.

With regards to the energy sector, he’s explained his intentions in a video outlining his administrations changes for the first 100 days in office, saying “On energy, I will cancel job killing restrictions on the production of american energy including shale energy and clean coal, creating many millions of high paying jobs, that’s what we want, that’s what we’ve been waiting for.”

He is allegedly intending to streamline the process that takes place when oil and mining companies among others apply to be able to carry out their activities. This could make it easier for energy companies to extract fossil fuels from public lands. Trump’s words on energy have not been a hit with environmentalists who argue that he is in denial of climate change. Indeed, climate-focused groups are apprehensive that environmental quality standards could be eroded under his leadership, due in part to deregulation of the energy sector.

He’s also said he plans to alter (or possibly repeal) the Dodd-Frank Act, a bill that was passed by Barack Obama in order to increase regulation for the financial sector.

Trump said in 2016: “Dodd-Frank has made it impossible for bankers to function”. He added, “It makes it very hard for bankers to loan money for people to create jobs, for people with businesses to create jobs. And that has to stop.” Doing away with barriers for businesses can be a welcome change to an economy, but it was deregulation that allowed banks to make many predatory loans that were not viable in the past.

We have already seen bank stocks rally (rapidly increase) in the weeks post-Trump’s election because they expect he will start deregulating their industry. This could mean they get to make more loans and become more profitable – but the worry is whether this might lead to a market boom and then a bust, just like in the mid 2000‘s. Some people are understandably worried about rolling back regulations for Wall Street. We will have to wait and see whether he intends to make good on his initial ideas. The US economy could gain from softening it’s approach to certain sectors, but arguably the more cautious approach to the economy from the Obama administration (as opposed to Trump) has kept the economy on an even level. The plan’s proposed from Trump in contrast, are not without risks, especially in terms of increasing the national debt.

 What could this mean for investors?

If deregulation does come into effect, we could see increased competition in the energy and financial services sectors to name but a few. Leading on from this, we could see higher investment and activity in financial markets, especially in stocks, pushing up share-prices, leading to further gains in equity markets globally. The barriers to entry into industries for businesses could be lowered, and increased competition in the markets could lead to lower prices for goods for consumers, as well as more business innovations.

This is in theory, however one problem is that Trump’s figure looms large over markets and his words carry great weight. That mean’s that if he continues to call out certain industries like the Biotech sector (as he did in his first press conference since being elected), this could send stocks downward and destabilize areas of the economy which could stand to gain from deregulation in the first place.

Everything hangs on what the full details of his economic plans will be. The markets are still waiting with baited breath for more updates on Trumponomics.

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