Grudge Match 2017: Trump vs. Yellen

Looks as if it’s game on — Trump versus the Deep State.

“Deep State” is a term that originated in Turkey to describe certain actors within the structure of government who were unseen but who wielded the real power irrespective of who won elections. A few years ago, a retired congressional aide named Mike Lofgren appropriated the term to describe a similar phenomenon here in the United States. Others, including Agora founder Bill Bonner, find it a useful prism through which to view the passing scene.

As you’re likely aware, President-elect Trump has expressed skepticism about the “Intelligence Community” and its claims that Russia “interfered” in the 2016 campaign for purposes of electing Trump.

On Monday night, the Deep State struck back — using Senate Minority Leader Chuck Schumer as its messenger. “Let me tell you, you take on the Intelligence Community, they have six ways from Sunday at getting back at you,” he said on MSNBC. “So even for a practical, supposedly hard-nosed businessman, he’s being really dumb to do this.”

This week brings word Trump plans to reorganize both the Office of the Director of National Intelligence and the CIA. “The view from the Trump team is the intelligence world has become completely politicized,” said an anonymous person The Wall Street Journal describes as “close to the Trump transition.”

Grab the popcorn…

And then there’s Trump versus the Deep State’s most powerful economic cell — the Federal Reserve.

Wednesday afternoon, the Fed released the “minutes” from its meeting last month. While the name “Trump” appeared nowhere in the document, it nonetheless conveyed a veiled threat.

The key passage was this: “Many participants [in the meeting] commented that a more expansionary fiscal policy might raise aggregate demand above sustainable levels, potentially necessitating a somewhat tighter monetary policy than currently anticipated.”

Translation from Fed-speak: If Trump cuts taxes, we’re jacking interest rates even higher than we’ve already said we will.

“The new Trump administration will confront the Fed,” says Jim Rickards in his first big forecast of 2017, “and insist on accountability and rule-based decision making. The confrontation will present enormous risks and opportunities to investors.”

Recall that during the campaign, Trump declared he would fire Janet Yellen as Fed chair — although the president possesses no such power. “Trump also claimed that Yellen was keeping interest rates artificially low in order to pump up the stock market and help elect Hillary Clinton,” Jim reminds us.

Yellen began to strike back at her press conference right after the December Fed meeting. As Jim pointed out the day after, she said she might stick around on the Fed Board of Governors even after her term as chair is over in early 2018 — a lingering thorn in Trump’s side.

But she also hit out at Trump’s economic plan. When it comes to “stimulus,” Yellen is fond of tax credits for education, worker training and certain infrastructure. Across-the-board tax cuts that would most benefit the wealthy? Not so much.

Seen in this context, yesterday’s Fed minutes could be a way to turn up the heat on Trump: Yo, Mr. Big Talker, you wanna cut taxes for the rich? We’ll just ratchet up interest rates some more. We’ve been all about easy money these last eight years, but we’re gonna choke off Trumpflation at the first sign of it, bub. Remember who’s in charge here!

Or as Jim puts it, “The Fed expects to ‘lean in’ against the Trump stimulus and to avoid letting the economy run hot.”

But what if the economy doesn’t run hot, despite the Trump stimulus?

That’s a possibility Jim’s been entertaining for weeks now. “The problem with the Fed’s assessment,” he elaborates today, “is that the Trump policies may not be nearly as stimulative as the Fed expects.”

For one thing, the Republican leadership in Congress wants the tax cuts to be “revenue neutral.”

“This means,” Jim explains, “that for every cut in tax rates, there must be an offsetting revenue increase from some other source, such as the elimination of tax deductions and credits, conversion of capital gains into ordinary income, repeal of Obamacare or reductions in entitlements. Trump has already said entitlement cuts are off the table.”

In addition, Jim says, “It will be difficult for Republicans suddenly to become the party of big spending and higher debt ceilings without extensive criticism from the Democrats, the media and parts of the Republican base. Increased spending is in the cards, but it may be far smaller than both Trump and the markets expect.

“In short, the Trump ‘stimulus’ may turn out to be far smaller and far less stimulative than markets currently anticipate,” Jim concludes.

“The reflationary Trump Trade of higher stock prices, a stronger dollar, higher interest rates and a declining dollar price of gold may soon run into a brick wall of congressional opposition and budget realities. The rally in stocks and the dollar and the head winds for bonds and gold all seem overdone. The Trump Trade may continue for a few more months, but by the spring of 2017, reality will set in and a sharp reversal of market trends will be in the cards.”

And if the Fed keeps tightening policy at a time the Trump stimulus isn’t delivering the goods? “The Fed may cause the recession it has worked so hard to avoid.”

In the meantime, other elements of the Deep State will continue their own scheming. The International Monetary Fund convenes its next big meeting on April 21 — at the very time Trump’s first-hundred-days agenda would be hitting the wall.

Then what?

Dave Gonigam
for The 5 Min. Forecast