When thinking about Trumpism, it’s hard to come upon a unifying theme. But here’s a shot: inflation. Every one of Trump’s domestic policies should raise prices. Let’s recap:
- Throwing 2-3 million low-paid workers out of the country? Fewer workers should result in higher wages. Unless those workers return to their home countries to produce goods for export back to the United States. But that brings us to…
- Higher tariffs and “fairer trade”. Higher taxes on imports would result in higher prices. Tax something more, and it will cost more. End of story.
- Lower taxes without offsetting spending cuts. More deficit spending will lead to more consumption and higher prices, everything else being equal.
- Higher infrastructure spending. Again, government consumption of labor should, all else being equal, raise wages and inflation.
I imagine these policies are the reason markets are selling bonds and buying stocks. On their own, all these policies are inflationary and would result in higher interest rates and higher top lines for businesses. Holding cash or bonds becomes risky. Equities, less so.
But I don’t say all “else being equal” lightly. Because, as Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon”. Therefore, Trump and Congress don’t really get to decide if we have more inflation. The Federal Reserve does.
How will Yellen’s Fed react? The Fed has been pretty clear about following the dual mandate – full employment plus price stability. With the unemployment rate lower than 5% and inflation closing in on their 2% target, there is really no room for monetary easing under the current regime.
So what happens if we take away a whole chunk of the labor force, enact protectionist policies that raise the price of imports and issue a whole lot of government debt, but the Fed says inflation must stay at 2%? Interest rates will rise. They will rise because markets expect more inflation, and they will rise as the Fed tightens to offset the Trumpist push for inflation.
That begs the question, in the land of monetary offset, how can markets expect more inflation? Well, because Fed monetary regimes can and do change. It doesn’t happen often, but it is more likely to happen under political pressure, or when Fed officials are replaced. The chance of either of these happening has risen since Trump won the election. A President Trump has a few big Federal Reserve appointments to make during his term. And a President Trump wouldn’t likely fear the appearance of bullying supposedly independent arms of the government.
More political questions then arise. When President Trump and Republicans in Congress see that their inflationary policies are being offset by Chairwoman Yellen continually jacking up the Federal Funds Rate, will they discover their inner Keynesian? Will they succumb to the urge to grow the economy fast and win elections, or stick by their former hawkishness?
The rise of Trump in the first place suggests that the Republicans are perfectly willing to sacrifice their free-market, hard-money principles for the sake of reelection. After all, they are politicians, and the point of their whole existence is power. This makes for the extraordinary situation that, under a Democratic administration and supposedly dovish Federal Reserve inflation remained lower than 2%. Ironically, the bugbear of too-high inflation that conservatives warned about for eight years look far more likely now under Trump’s unified, Republican government.
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