Resolving Trump’s Contradictions
Markets are holding their breath waiting for clarity from the Trump economic team. Right now there is something for everyone.
The current stock market rally is clearly attributable to the Trump mix of lower taxes, less regulation and more government spending. Post-election bond markets have indicated inflation expectations. And the drawdown in gold is clearly attributable to the expectation of higher interest rates.
Higher rates from the Fed drive the dollar higher. A low dollar price for gold is just the inverse of the strong dollar; it comes as no surprise. That much is clear.
What is not clear is how the contradictions in the Trump camp will be resolved…
The Trump loyalists from the “Make America Great Again” camp are pushing for huge infrastructure spending. Steve Bannon, for example, has spending plans that point to much higher deficits. But some advisers, such as David Malpass, favor fiscal discipline. Other advisers, such as Larry Kudlow and Art Laffer, favor tax cuts. Still other advisors such as Judy Shelton want to take a look at a gold standard which implies higher gold prices.
Higher spending and tax cuts will lead to much higher deficits. Laffer employs his “Laffer curve” to say the tax cuts will be self-financing. Tax cuts may help growth, but there’s little evidence to show that they are self-financing.
The contradiction between the fiscal discipline of Malpass and the fiscal stimulus of Bannon are not the only contradictions. Kudlow and Mike Pence favor free trade, while Malpass and Bannon agree on the need to renegotiate trade deals. And so on.
These contradictions will take months to sort out.
The Trump team overall seems to favor a strong dollar and higher interest rates. But the strong dollar is deflationary and pushes the Fed away from its inflation target. Fed rate hikes will do the same thing.
On the other hand, if the Fed is slow to raise rates while spending takes off, inflation could surge out of control. The truth is that Trump economic policy has not been set, and both inflationary and deflationary outcomes are in play.
Sitting on the sidelines and watching is the Fed. If the Fed accommodates big spending and higher deficits, then inflation is on the way, like I said. That’s great for gold.
But if the Fed raises rates to lean against inflation, they may cause a recession. That’s bad for gold in the short run but sets up a global recession and major debt default by emerging markets. That will lead straight to a global liquidity panic, which will put gold on an upward path again as part of a flight to quality.
We’ll have to await further information, such as the names of Trump’s appointees to the Fed board of governors and the results of the Dec. 14 Fed meeting, before reaching more definitive conclusions about the shape of things to come.
My early estimate is that Yellen will lean against inflation with preemptive rate hikes starting in December and continuing in 2017. Yet, this rate hike path could throw the U.S. into a recession.
On balance, markets look stretched. Stocks ran too high, too fast. Gold, bonds and the euro are probably oversold.
Faced with this uncertainty, it’s a good time to increase your cash allocation until we can get better visibility on the Trump plan.
Right now, both cash and gold have a place in your portfolio as insurance against the uncertainty coming from the Trump camp. As this uncertainty gets resolved, I’ll be watching and updating my scenarios with greater visibility. Gold wins either way (inflation or deflation), but the ride is bumpier and more volatile on the deflation road.
In either case, now is the time to buy gold and gold miners.