54: How Trump Did Something Yellen, Draghi Could Only Dream Of

a week. You could you could put it that way. There was something something about an election somewhere, right, Yeah, I remember that election. Uh quite. And not only was the election extraordinary for all kinds of sort of political and historical reasons. Uh, it's also been an extraordinary aftermath We've seen in financial markets, and it's uh, it's completely confounded. Basically everything anyone would have predicted going into the into

the vote, that's right. So we were told that if Donald Trump got elected, that was the ultimate, uh sort of political tail risk, and it happened, and we got an initial market sell off, like right when the results started coming in. But at the time of us recording this, we've seen markets rebound quite strongly, right right, I guess we should say, you know, just in the full transparency, we're recording this on a Thursday after the election. The podcast people won't be listening to it till a few

days from now. So if the entire market changes again and there's some huge crash or something before you hear this, just disregard. Disregard, you can stop listening. You can just disregard everything. Such is the world of podcast where we have to um where we have to do this in advantage, but one other thing. So we didn't get the crash

that people expected. In fact, markets have been surging. Perhaps more interestingly and far more importantly from a financial markets perspective, we've also seen a pretty big increase in a long term interest rates. Yield on the ten year US Treasury is above two percent for the first time since January. Other market based measures of future possible inflation have been

going up. Uh. This is also the people have been waiting for a rise in some of these measures for quite some time, and in the immediate aftermath of Trump's victory, we actually appear to be uh seeing some seeing some of these moves. Right, So all it took for inflation expectations to come back was the complete political upheaval of the United States of America. Right, Yeah, that's all. That's all.

It took, just a completely stunning political outcome. And where's Jenny Yellen and Ben Bernanke and Coroda have been trying so hard to get inflation expectations up. Donald Trump seems to have accomplished that in about a and he's not even in office yet. Amazing, And he's not even in office yet. So on that note, I think we have the perfect guest for h the Week. His name is David Beckworth. He's a research fellow at the Mercadis Center.

He writes a fantastic blog called Macro and Other Market Musings where he talks about monetary policy, uh, inflation, the macro economy and all that stuff. And I think he's a perfect guest to help us break down some of these moves in financial markets that we've seen and what traders might be anticipating under a Donald Trump presidency. Let's bring in David. David, thank you for joining us, Well,

thank you for having me on the show. Uh so, quite an extraordinary few days in financial margarets, wouldn't you say? Absolutely yes? As you mentioned in the intro, Donald Trump has done more to make treasury yelds great again that Yalen has has tried and be Bernankey tried and tears that couldn't accomplish. UM. It is quite shocking, but it also speaks to I think one of the things that plagued this this past seven eight year period has been kind of a swing and risk premiums to one extreme

of during the boom. I think we were maybe over optimistic and we've been stuck in a funk, and maybe Trump was the shock uh that we needed it maybe to change things around. So let's talk about this stuff, because you know, people like to talk about the FED having an inflation target, and the FED in the US, the central bank is supposed to target stable prices UH and full employment. They've aimed for this two percent inflation target UH for years and haven't really been able to

hit it, except very briefly. They've done all kinds of UH stuff. They've tried QUEI, they've tried forward guidance, they've uh, you know, hinted at other sort of extraordinary policies going forward. They have all these dots and press conferences, all these UH all these new innovations designed to uh keep prices stable and boost inflation. It's never worked. And we joke about Donald Trump having done more to accomplish this in uh forty eight hours after being elected than the central

bankers have done. But it's not really a joke. So what is it about, um, his win that seems to have jolted financial markets? And what does it say? Well, I think it speaks to understand that I've actually developed over these past years, and that is FED policies really constrained by what the body politic wants. So um, you know, if if it's the FED, think of the FED trying to to hit two percent inflation. I think there's some reasons inside the FED, maybe there's inertia, um that there's

a conservative nature to the institution. But I think a bigger issue is what if the set could have hit say two percent inflation with a button And maybe they couldn't, But what if they had tried the webpaid overshot their target as some people have advocated, I think it would

have been very politically controversial. Um Bernankee. If you recall in two thousand and ten, he had congressional hearings right around the time of the que two, he got railed for debasing the currency, and if you look at core inflation was one percent, then just the threat of it. So one thing I think that really we tend to overlook is the set is limited or is empowered, as

much as the public wants it to be. And if the public once a low inflation, you know, and they revers they expressed that through their uh Congress people, then I think that that's going to be um limited. And one way to look at what Trump is Trump is is a referendum by the public saying, Okay, we can try a little bit higher inflation, we can try a

little bit more rapid accurate demand growth. Now they're not saying that explicitly, but by bring him into office, some of his proposals for investment spending, um maybe he has more reckless nature. Speaks to maybe a change in attitude, And I think what that says is it says fiscal policy will be easier, it will be a tolerance for higher inflation. And that's something the FED couldn't do on its own. And that's again kind of one of the

points I've come to appreciated in theory. The FED can do whatever it wants, but in practice that can't because there's political constraints. But David, if that's the case, then what do you think has driven the change in the general attitude towards inflation, Like what's happened over the past four years or so to make people ready all of

a sudden for prices to go up. It's a tough story to tell, no doubt, but I think what has happened, um agatting, going back to the crisis up until Trump's election, is that, UM, there was this this desire for stability. The starts are for low inflation. It's partly um the result of fed down past success. If you look at

the history of inflation targeting, it hits the world around. UM, we really did need something to rain inflation, and simple banks have tried money supply targeting, they tried um in different attempts, and inflation targeting seemed to be the best solution. Over time. As they've done that, they've gotten better at it. I think they've built up the expectation among the body

politic that this is what we want. We go into the crisis, there's all this uncertainty, there's this disaster, and the last thing the public wants is to have a simple banks tinkering with three or four percent inflation overshooting their target. So I think the FED created an environment where a low inflation was expected. Warm then you have a crisis that people are concerned. They're fearful of big

institutions like the FED. But then after you know, seven eight years of slow, sluggish growth, that longer period of people becoming the falling behind economic angst, they want something different. So maybe people aren't aren't you know, explicitly articulate in their minds, we want higher inflation. But by voting for Trump, they want something new. They want something different, and that's going to include higher inflation. Um it's it's kind of

maybe an unconscious quote for higher inflation, higher aggres demand growth. Alright, So so I get that, and I you know, I get that politics changes, and you know, suddenly we have something new. But couldn't it also be as simple as fiscal policy really matters to inflation expectations? And and on Donald Trump, when he had his victory speech, he made a very point. He first of all, he said it

a lot during the campaign. He said tax cuts, he said, double infrastructure spending than Hillary Clinton, um, he said, repatriation of foreign cash. There's all this sort of raw money. And then in his victory speech he talked about rebuilding bridges and hospitals and America's cities and all this is a fiscal stimulus, and couldn't it suggest that maybe inflation is a h the fiscal side is a big determinant of inflation and inflation expectations. And then it's just not

really about the Fed as much as people thought. So. Absolutely, and I think it was neat about this is this is kind of a natural experiment to test that idea, right, um. If you recall, uh Trump actually said something that sounded very much like the m M T school spot um a while back during the campaign. He said, look, the government can never go broke. You know, he can preparent

its own money. If the government runs up depths that they can just eventually pay off the depth of pretty more money, very much of very you know, post Canesi and mm T type thinking. And and we're going to have a great now will experiment on that. And I guess what you can say is the early results, the early evidence seems to support that, at least the ford looking evidence. But absolutely, and again I'm going back to play mentioned earlier. I think it speaks to them then

the codependency of fiscal policy and monetary policy. Here's another way of thinking about this. Imagine the Federal Reserve had got a hole in it balance you so imagine, for example, some of its assets had lost value, some of those more effect securities for whatever reason, um, they suddenly lost value. So there was a big hole in the balance sheet. There were more liabilities, more monetary base outstanding than there

were assets. That would create a fear of inflation because now the FED couldn't pull all the monetary base in in the future. What would happen in that case, what would happen is the U. S. Treasury would bail out the FED. So should the Fed ever become insolvent in the sense that couldn't control inflation of the monetary base, the FED would be there. And the way we do it the FED would, you know, give bonds to the FED. The FED would then use as a pull the monetary

based out. What that speaks to though, is ultimately the FED being able to control inflation depends on the Treasury being solving itself. If the Treasury we're having problems with budget deficits, and there are concerns about the treasuries financial health, it would impair its ability to build a FED out. So no matter where we are in time, the Fed's ability to control inflation is implicitly backstopped by the Treasury,

which is fiscal policies. And I so it's going to your point if if treasury finances fall apart, if there's a change in approach to fiscal policy, it's ultimately going to shape expectations about inflation. So yes, Joe, Um, I do think it speaks to the important to fiscal policy port inflation A right. We have to take a quick break for a commercial, but then when we come back, I want to dive more into this question. But Knowledge to Working grow your business with s I T from

transportation to health, air to manufacturing. C i T offers commercial lending, leasing, and treasury management services for small and middle market businesses. Learn more at c I T dot com put Knowledge to Work. And we're back with David Beckworth. He's a researcher at the Mercadis Center, and we've been talking about UH the role of fiscal policy in driving inflation and inflation expectations. UH and I want to keep

hitting this question. I want to drill down further into this question because there has been a view out there that fiscal policy is essentially impotent on anything having to do with total demand and inflation. They talk about Riccardian equivalence and that if the government drives up deficits, then that'll make people think that there will be higher taxes in the future, and so they'll spend less, and ultimately that will counteract any stimulative effects of that UH spending.

And generally, I think it's sort of mainstream economic view that the fiscal side of the ledger of you know, economic management is not where UH inflation comes from, and that it's the you know, inflation is essentially controlled by the FED. But it at least seems like a possibility that if we do get you know, one of the things that's interesting about Trump spending plans is that they're not countercyclical in the sense that we're at four point

nine percent unemployment. UH, there is not obvious that there's a huge sort of output gap UH here. It does seem like, you know, as we've been talking about, there could be a real natural test here where maybe uh, the UH fiscal side is really the main driver, and the FED just isn't as important as we thought on this front. Do you think that's possible that some of these assumptions that we had about the significant of the FED in control your targeting inflation was overstated? I do.

I want to be careful and how we'd say this kind of what you're referring to. I think is is what we've called the Monterrey policy offset right in the past. So if fiscal policy, you know, had tried, and I think you could, you could argue this is actually would fit um Obama's fiscal stimulus, make this concrete large spending plan. But you know, we didn't see a huge spike in aggurate demand, a huge spike in inflation. You could have

argued to put a Florida the economy. But you know, the conventional view would say, well, the reason that didn't happen is because the FED wanted to maintain low inflation. So yes, there's a large fiscal stimulus, um, but the FED could only tolerate so much inflation. So in general, people who called for helicopter drops over the past year, um they would run up against the concern that the

FED might offset it. So the you know, the Treasury sends out checks, the household people spend, inflation goes, the FED gets nervous. But I think behind both of those, really maybe another way of sense behind fiscal policy and behind Monterrey policy is lurking. Maybe this again, this this this public um acceptance. What does the what will the public tolerate? And so maybe by electing Trump, the public has has stated clearly we're tired with with the norm.

We were tired with this tinkering on the margins by fiscal policy monetary policy. We want to open up the start the engine. Let's get going things going a little bit faster. Keep in mind, fiscal policy will affect spending and inflation by affecting the velocity. So it's you know, you think of you know, money times velocity that's total spending in the economy. Fiscal policy generally is gonna work

through velocity and and pss people to spend faster. Um. So it's still a monetary story ultimately, But fiscal policy and Montrey policy are interacting, and I think it's reflecting the public tolerance level for it. So on that interaction point, you suggested early on in the conversation that the FED may have been hamstrung a little bit by a general reluctance or political reluctance UM to do more in terms

of boosting inflation UM, and Trump potentially changes that. Um. How do you see that relationship between the Fed and Trump actually developing? Because there's also been the opposite suggestion, which is that if inflation runs too hot, then the FED might step in or even um, we saw city groups. Matt King suggests that maybe Janet Yellen just kind of wants to seek revenge on Trump in some way, and so maybe she'll be a reluctant partner in his um or an obstacle in his quest to boost inflation. So

how will that actually play out? Well, that'll be interesting to watch if she pulls a pole vulcer on Trump. But again I think it would play out um more through fiscal policy. It would be One way to look at this is, you know, he made tone down, he made you know, tighten what the Fed can do. He may appoint people there that will be because view that he's expressed. You all know, he was very critical to

said he said that cap rates too low. Um. Again, I think we can argue I thought that I definitely don't think it was the FEDS results rates were low. I think it was more following where the economy is going. But he yeah, he's very critical to said, he seems to be very supportive implicitly what he's saying about fiscal policy. So one way to look at it is he may rein in the stads aggressive unconventional policies, but he's gonna be you know, hitting the gas pedal on the fiscal

policy side. And and you know, so they they'll work in hand to to lead to this outcome. Um. You know someone who's probably be interesting to watch this follow over the next year is Judy Shelton. She has written some columns for the Watch for the Wall Street Journal of the Financial Times, and she's one of his advisors on monetary policy. And initially enough, she takes a very hard money view, um sympathetic to the gold standards. So it is a little bit puzzling how that would reconcile.

It's almost it's almost as if we don't totally know what Trump has got the planned. You could almost say it's a he's a bit of a mystery on some of these things. I'm being naively optimistic. I mean, we all, we all have very little, very few clues to go

on with this stuff. And that's why I think the financial mark, the decisive financial market reaction is so interesting because whereas you know, anyone could sort of pull together some Donald Trump quotes and try to come up with some theory about what he's gonna do economically, Uh, No one is totally sure, but there really is quite a

startling reaction financial markets. I want to ask another question about inflation and tell me if I'm just completely off base here and if this is nonsense or if there might be something to this. It seems to me that inflation is lower in really stable economies. So some of the some of the most stable countries, and I mean politically, uh, Singapore is in his negative cp I growth, Switzerland is

in has virtually no inflation. Japan, one of the most stable countries politically in a sense, hasn't had inflation in forever. And then if you look at the countries with a lot of inflation, you tend to see much more volatile emerging markets with weaker political stability South Africa, Brazil, Turkey,

the Zimbabwe being the most extraordinary one. Is there a connection in your view between um sort of political stability and inflation, and is there anything that we can derive from that given the appearance apparent decline in the US. I think there's two stories behind that. The first one, I think it's less important, but it's a part of the story, and I'll do that one first. That's demographics.

So often many of those countries you mentioned, their advanced economies, aging populations, they tend to rely more on fixed income as they get older. There's a paper of the i AM Ethic that when a cross country study and you know, the older the average age of the population UM, the more constraint again politically a simple bank will be in terms of inflation. So on it this speaks to actually, I think it's going on in Japan tabonomics. I mean,

they have an incredible queie. They pushed the limit at the what what's possible? Right over there? Their balance she's just blowing up like nothing else, and yet inflation remains really subdue. They've they've broken you know, the positive number, but it's still it's really low, much lower than they wanted. And in my view, I think one of the key stories in Japan is the politically they can't do this.

Their population shrinking, it's getting older, um, and that's the powerful voting block, and they won't tolerate high inflation that each the way they're fixed income. I think that's part of the story. There's a demographic issue, which also speaks to another reason rates might be low around the world in advanced economies. I think a second issue, though, is is the difference between you know, these advanced economies and

the emerging markets. Is the advanced economies again, and I mentioned earlier, have had inflation targeting for a longer time, and and and it just gets built into expectations. If you know, several decades of inflation targeting, everyone comes to expect well inflation and anything outside of that is considered devian. It's you know, how can you possibly go buck two percent inflation even if it's needed, even as the temporary,

you know, departure. I think we've gotten to the point where the body politic and a lot of advanced economies will not tolerate a deviation. So I've my writings, I've called this the inflation targeting straight jacket. Um. They've been so good that they've worked themselves into a corner and they can't get out. They don't have the flexibility they

need during deepercessions. So I think that's I think that's the probably the biggest part of the story and advanced economies is their own past successes have made them less able. And again, Donald Trump, what Donald Trump has done? If I continue my inflation straight jacket story, he he's unbuttoned that straight jacket. Given the central banks, given macro policy, fiscal policies, more degrees of freedom to work. Alright, Uh.

David Beckworth, research fellow at the Mercadis Center, I think this is a great conversation to uh sort of introduce people to what I think is going to be a really hot economic uh debate over the coming years and sort of a real time economic laboratory experiment, particularly on

the economy. Well, I really appreciate you coming on, David Beckworth. Um, you should check out his blog Macro and Other Market Musings, And David also has his own podcast Do you want to tell us about that real quickly where it's called Macro Museums and we look at um macro economists and writers, journalists and just look at the big macro issues of

the day. Well, I think everyone should check that out if they're interested in these topics, and I suspect again that as some of these debates unfold, that will continue to be a mud must lesson. So really appreciate you

coming on day. Thank you for having me on. Well, Tracy, I think that was like the perfectly time guest for what we've seen uh in uh in the market so far in the in the Trump era, and I am very interested in seeing, like you know, if a sort of economic regime change is sort of shocked to the system fiscally will actually change the trajectory of interest rates and inflation, which, as you know as well as anyone, has been a falling NonStop for years. Yeah, it's going

to be really interesting to watch. My only, um my only sort of one thought on this is I wonder if we're ascribing too much meaning to what we've seen in markets so far in terms of you know, these inflation expectations. No one you mentioned this, but no one really knows what Trump's exact policies are going to be on this front. And I just wonder if investors at this point are sort of projecting their hopes and their dreams onto Trump, right, they want they want inflation to

come back. They want infrastructure spending, they want tax cuts, they want business friendly environment, and who knows if that's

really going to happen. Now, I think that's obviously, Uh, this there's a lot of hopeful trading it looks like going on based on just sort of minimal evidence to piece together and the fact that we still don't really know how Republicans in Congress, who have been opposed to any sort of extra deficit spending under the Obama years, whether they're ready to turn on a dime the way I mean you could they could because politicians, you know,

politicians and politicians, So it's certainly you know, and anyone. We don't really know what anyone really believes on these things because everything is situational with this stuff. Um, but we don't really know how much they're willing to go back on everything that they've been saying. But definitely, I think we're gonna be talking about this for a while

to come, for sure. Yeah. And I think, you know, one of it's interesting looking at the financial market reaction because beyond stocks, beyond bonds, one of the things that we've been seeing is, uh, a really big surge in industrial metals prices uh copper iron ore again on this belief that we're gonna be building thousands of bridges and skyscrapers and new hospitals and schools, which is which is

going to need all this stuff? And if you know, if we actually get something like that, and I don't know if we will, but if we actually do, watching the economic ramifications of this is really going to be perhaps the one of the most important economic stories of the next few years. All Right, well, this has been another episode of the Odd Lots podcast. Thank you everyone for listening. I'm Joe Wisenthal. You can follow me on Twitter at the Stalwart and I'm Tracy Alloway. I'm on

Twitter at Tracy Alloway. And you can follow David Beckworth on Twitter at David Beckworth. Thanks for listening. Put knowledge to work and grow your business with c i T. From transportation to healthcare to manufacturing. C i T offers commercial lending, leasing, and treasury management services for small and middle market businesses. Learn more at c i T dot com. Put Knowledge to Work.