In business and the markets, there exists a power play between two opposing forces and the people behind them. Seldom seen in the open, it is the battle between inflation and deflation.
Inflation means rising prices for everything. Its backers are fully invested businesses, speculators, homeowners, and workers, as well as debt holders, who can pay back their borrowings with cheaper dollars.
On the side of deflation, or falling prices, are creditors who can re-possess bankrupt businesses and take control of assets. Businesses that haven’t invested all their capital can snap up assets on the cheap from distressed buyers, and savers can buy more with their money.
Real estate benefits from inflation and Donald Trump, as we all know, is a real estate mogul. Paul Brodsky of Macro Allocation Inc. says Trump’s background and training may influence future policies.
“There will be an overwhelming emphasis on nominal GDP growth through government spending. … As a real estate developer, he has always been ‘a nominal guy,’ not caring about real (inflation-adjusted) returns, only returns that ever more debt can bring,” Brodsky wrote in a note to clients.
In real estate, you can borrow at a fixed interest rate. The higher that prices and rents rise, the more money you make.
Perhaps it is not a coincidence Trump has policies that almost exclusively fall in the inflationary camp.
He wants to increase government spending for infrastructure ($1 trillion) and increase tax cuts, which could lead to higher revenues at a later time. At the beginning of the tax cuts, there would be an increase in government debt, which is inflationary.
“The results mean that there may now be a big fiscal expansion, which adds to the downside risks for bonds for at least two reasons. First, it would increase their supply. Second, we think it would mainly boost inflation rather than growth,” research firm Capital Economics wrote in a note to clients. Since bonds pay only fixed interest rates, they lose value if general price inflation ticks up.
Of course, inflation—and economic growth—is something the previous administration and the Federal Reserve tried to stimulate in vain for eight years after the economic crisis. There is a fair chance Trump’s pro-growth policies will kick the economy out of its slumber and inflation will be contained at the Federal Reserve’s target rate of 1 to 2 percent.
Trump’s other two signature policies, trade protectionism and the restriction of immigration, reduce both the supply of goods and of labor and are therefore also inflationary, as the same amount of money chases fewer goods and workers. Over time, however, the economy can adjust and produce more goods domestically and more domestic workers can be released from the pool of the long-term unemployed. Also, the inflationary impact may subside after an initial burst.
Unlike bonds, stocks bounced after an initial sell-off, as they benefit from inflation, at least at the beginning.
“Stocks tend to do well in the initial stages of inflation because corporations … have low fixed costs or they have locked in some of their liabilities at a fixed rate,” said James Rickards, author of “Currency Wars.”
But then the fun stops, for equities as well: “Labor starts to demand higher wages, inputs go higher, and eventually inflation destroys capital formation,” said Rickards.
Banks both lend and borrow money, so they are less impacted by inflation but do benefit from rising interest rates, which increase their profit margins.
One reason they did relatively better than other stocks is because of speculation that Trump intends to replace Janet Yellen at the helm of the Fed, said trader P.D. Shah. “Financials did particularly well, as investors see increasing debt issuance as well the appointment of a new Fed chair who is decidedly more hawkish than the current one.”
So what about gold? Gold, which normally acts as an inflation hedge, dropped in value in the days after the election after a brief initial spike. However, gold becomes less valuable as the economy rebounds and productivity increases. Maybe the market thinks Trump’s tax cuts and deregulation policies can do just that.