Trump Threats Notwithstanding, the U.S. Inflation Outlook is Uncertain

Genevieve Signoret & Delia Paredes

(Hay una versión en español de este artículo aquí.)

Every time we tune into the financial news, we hear the narratives that Trump policies will be inflationary, and this is driving up long-term interest rates and the dollar against other major currencies. We’re not so sure, however.

First, because of inertia: the data show inflation rates on a sustained downward trend.

Second, Trump is unpredictable, and his power is bounded.

Trump is unpredictable: even Trump’s closest aides say they never know what he’s going to do until he does it; and sometimes he takes strong opening positions as a negotiating tack.

Trump’s power is bounded: he can’t do everything he promises by decree, and his party’s congressional majorities are paper-thin, he’ll need some Democrats to vote his way; powerful business interests will oppose aspects of his trade and immigration policies both; several of his plans will be challenged in the courts.

And third, even if Trump does actually enact all the tariffs and mass deportations he’s threatening to impose, it’s not clear that these policies would lead to inflation.

Take tariffs, for example. Inflation is defined as a rise in prices across the board, whereas tariffs would raise consumer prices only on manufactured goods, not on services. In other words, they would shift relative prices, not the general price level.

Moreover, tariffs are generally a one-off event. Goods prices would jump once, then stabilize. That’s hardly an inflationary spiral, and the Fed would “look through” it, not see it as a trend it must combat through higher rates.

Also, tariffs could lead to a narrowing trade deficit and thus dollar appreciation against the currencies of U.S. trading partners. A stronger dollar would help, not hurt, import prices.

Now consider deportations. Yes, all else being equal, a shrinkage in the work force would be a supply-shock driven inflation.  But all else would not be equal, because undocumented workers don’t just work, they also buy stuff. Mass deportations would weaken aggregate demand for goods and services, creating downward pressure on prices. So you have inflationary pressure from scarcer labor and deflationary pressure from weaker aggregate demand. What would be net effect? There’s no telling.

The Trump-policies-will-cause-inflation market narrative seems to be driving up long-term rates, the U.S. dollar, and bitcoin prices. Will this story in fact play out as investors seem to be assuming? Should we invest accordingly?

We advise caution. Let us watch actual emerging inflation trends. Wait to see whether these policy threats are in fact credible. And, especially, even assuming that they’ll all be carried out, avoid presuming to know what they’ll mean for future inflation.
 
 
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