The Dark Side of “Trumpflation”

Does Trump mean a return of stagflation?

A ghastly portmanteau of stagnation and inflation, the word conjures the darkest days of the disco era — stalled growth… high unemployment… soaring prices… bell-bottoms.

And some think it’s coming back for another ride in the saddle. Business Insider:

Since the election of Donald Trump, economists and analysts have once again begun to bring up the idea of stagflation hitting the U.S. economy. The combination of government spending and trade policies, coupled with an uncertain growth picture, have brought the disastrous specter of the late 1970s back into the economic discussion.

Ben Laidler, HSBC chief global strategist, with more:

A more “populist” Trump could see a dramatic disruption to trade which would weigh heavily on the global growth outlook, while a much tighter immigration policy could ultimately push the U.S. toward stagflation.

Trade barriers drive up the cost of imports. Immigration restrictions increase the cost of labor. Both drive up consumer prices. Some are calling the whole thing “Trumpflation.”

But it’s the government spending part that commands our attention today…

Fiscal stimulus promises to turn a cup of water into a gallon of wine. This through the conjuring power of the “money multiplier.” Every buck the government throws at a road or bridge does double-duty by generating another spent on widgets, gewgaws and all manner of services. That’s the theory.

But the money multiplier itself came in for hard sledding under the stagflation of the ’70s.

The ’70s saw the higher prices. So much so that Paul Volcker had to raise interest rates all the way to 20% in 1981.

But they didn’t see the growth that the “virtue” of rising prices promised. And the ’70s saw unemployment galore. Hence, stagflation.

Only when Volcker lassoed inflation did the Reagan boom commence in the early ’80s. And it was the end of the chapter for the money multiplier. Or so many thought…

Now the money multiplier, long dead and buried, is climbing out of the grave. The zombie’s parading as a hero, no less, now that eight years of monetary policy have proved a bust. Fiscal policy is the new (old) solution to get the economy jumping again.

But the zombie masked as hero could be Trump’s undoing…

In an economy unburdened by crushing debt, the money multiplier could make a case for itself. One dollar of fiscal stimulus might turn the cup of water into that gallon of wine when the vat is empty. But as the debt mounts, each new drop of water yields less and less wine. Ultimately comes the point where a drop of water not only gives no wine at all… it actually turns the whole thing to vinegar…

Evidence shows that when the debt-to-GDP ratio exceeds 70%, the money multiplier goes into reverse. And real GDP declines. Economist Lacy Hunt:

Based on academic research, the best evidence suggests the [government expenditure] multiplier is -0.01, which means that an additional dollar of deficit spending will reduce private GDP by $1.01, resulting in a 1 cent decline in real GDP.

It’s true, the wine may give GDP a temporary buzz. But then cometh the hangover:

The deficit spending provides a transitory boost to economic activity, but the initial effect is more than reversed in time. Within no more than three years, the economy is worse off on a net basis, with the lagged effects outweighing the initial positive benefit.

So Trump’s infrastructure and tax cuts could be heady wine in the short run. But if this Hunt fellow is right, it wears off within three years.

That means the headache starts when Trump’s seeking re-election.

Remember, evidence shows the money multiplier went kaput when the debt-to-GDP ratio exceeded 70%. Today… the U.S. debt-to-GDP ratio is 104%. So the country’s been getting negative bang for the buck.

And the Congressional Budget Office (CBO) projections already indicate debt-to-GDP could push 150% by 2025. That’s without an ounce of infrastructure. Medicare, Social Security and Obamacare are the culprits. And it’ll likely get worse. Lacy:

The multiplier is likely to become more negative over time since mandatory components of the government spending will control an ever-increasing share of budget outlays… Federal borrowing to sustain these programs does not generate an income stream for the economy as a whole to pay for these programs. As history has evidenced, the continual taking on of this kind of debt will eventually cause bankruptcy.

If the money multiplier turned negative when the debt-to-GDP hit 70%… how about when it’s 150%?

We wish Trump all the best. But the math might have him in handcuffs from day one. “Trumpflation” could well become stagflation.

And unfortunately, stagflation could just be the beginning of something far worse…


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning