History tells us that as inflation accelerates, share price gains don’t keep pace
In 1987, for example, inflation hit 4% in August and the market crashed in October. In 2000, the dot-com bubble burst with inflation at 3.75%, while stocks hit their precrisis peak in October 2007, the month before inflation broke through 4%.
The serious contradiction in Trump’s views on the dollar
Regardless of what China does, experts say that Trump’s other policies could lead to a stronger dollar.
Among Trump’s biggest proposals are plans to cut taxes and spend more on infrastructure, plans that economists say would boost growth. But since the economy is already relatively strong, these measures would also translate into inflation. To head off inflation, the Federal Reserve would likely raise interest rates. These higher rates of return attract more international investors to buy the dollar to invest in the U.S., which in turn bids up the dollar’s price.
Trade measures that Trump has proposed, like tariffs or a border adjustment tax, could also strengthen the dollar, economists said. In the short term, the prospect of a trade war may unsettle markets and lead to flight to the safest asset in the world — dollar-denominated Treasury bonds, bidding them up.
.. “Ironically, the policies being advocated by Trump are likely to make the problem worse. The tax cuts (and possible spending increases), enacted at a time of full employment, will result in higher interest rates and this will boost the dollar,”
.. Furthermore, economists emphasized that the value of the dollar is not in itself a policy goal – but rather, the inevitable outcome of other factors, including the strength of the U.S. economy and global investment patterns.
“We don’t set the value of the dollar… it’s just a reflection of the goal of having a stronger economy, a better economy, a more dynamic economy, one that attracts global capital,” said Mark Zandi, chief economist at Moody’s Analytics. “[Trump] has very little control over the value of the dollar other than his policies that affect growth, and at the end of the day you want a strong economy and a strong dollar.”
.. Of course, if Trump did succeed in engineering a drop in the value of the dollar, he would be accomplishing something for which he has frequently criticized other economies. “The irony here is that we’re accusing other nations of manipulating their currencies, but if we want to solve that problem we’re going to have to end up doing the same thing,” says Zandi.
The Illusions Driving Up US Asset Prices
In the United States, two illusions have been important recently in financial markets. One is the carefully nurtured perception that President-elect Donald Trump is a business genius who can apply his deal-making skills to make America great again. The other is a naturally occurring illusion: the proximity of Dow 20,000.
.. the Dow had already hit nine record highs before the election, when Hillary Clinton was projected to win. In nominal terms, the Dow is up 70% from its peak in January 2000.
.. But these numbers are illusory. The US has a national policy of overall inflation. The US Federal Reserve has set an inflation “objective” of 2% in terms of the personal consumption expenditure deflator. This means that all prices should tend to go up by about 2% per year, or 22% per decade.
.. The Dow is up only 19% in real (inflation-adjusted) terms since 2000. A 19% increase in 17 years is underwhelming
.. The Fed, like the world’s other central banks, is steadily debasing the currency, in order to create inflation.
Larry Kudlow and Economics in the Trump Administration
Noah Smith (along with a fair section of the Internet) has some concerns about Larry Kudlow as chair of the Council of Economic Advisers: he’s overconfident, too much of a partisan, and fixated on nonexistent problems (e.g., inflation).
.. This is one of the important contributions that economics can make to public policy: the understanding that the world is complicated, and the dedication to uncovering rather than masking that complexity. In a presidential administration, you would expect this perspective to come from the Council of Economic Advisers.
.. What concerns me is that he has been working as an economist for decades—that is, he makes money by thinking and talking about economic issues—yet his conception of the discipline seems limited to the simple, theoretical relationships of Economics 101.
Most of Kudlow’s thinking about economic issues appears to boil down to three ideas.
- The first is that tax cuts increase economic growth—a mantra that conservatives have repeated for decades, yet is not supported by reviews of existing research.
- The second is that expanding the money supply will necessarily generate high inflation, on which basis Kudlow predicted a “major inflationary plunge” just as the Great Recession was beginning.
- The third is that an expensive currency—what politicians call a “strong dollar,” but Kudlow calls “King Dollar” (with the capitals)—is good for the economy.
.. That’s the essence of what I call economism, the subject of my new book: a worldview that assumes that society operates according to a small set of fundamental principles, and that public policy can be shaped on that assumption.
.. With Kudlow as chair of the CEA, Donald Trump is giving up even the pretense of trying to understand economic reality, instead doubling down on a handful of abstract slogans that have little to do with our current challenges. That’s hardly surprising, given that Trump is basically just an extreme caricature of contemporary conservatism