It has been a few weeks since Trump won the US Presidential elections. A lot of people still seem to be shocked by his victory. I was unpleased but not surprised that he won. I even almost broke my no betting rule and placed a bet against Hilary’s election. But it did not seem like a situation meriting breaking a good principle. Well, sometimes it costs you to have principles.
While I was not surprised by his election, what really did surprise me was the reaction of the markets. In hindsight, of course, I should not have been surprised. Everyone predicted that the markets would crash with a Trump victory. Markets hate uncertainty and Trump is a loose cannon. So I, like most other people, expected a turbulent down reaction of stocks, bonds and the dollar on the one hand, and an up move for gold on the other. But it is an important rule of investing to do the opposite of what everyone else is doing, and it seems this time my contrarian radar was not switched on. Luckily, I am not a short term trader, but a value investor.
However, for a brief moment on election night, it looked like the negative predictions would become true. The stock market had a violent down move and gold shot up. However, it did not last long. The markets soon turned around, and at the end of the Wednesday after the election, the DJIA even finished positively. Since then, it is up several hundred point and has reached new highs. Gold on the other hand has experience one of the most violent down moves in recent years. After a very good year, it now is even testing its $1180 support level and it looks like it is heading all the way towards $1050 until the end of the year, we will see. The only thing that did happen as expected is a sell off in the very overpriced bond markets. The yield on the 10 year US Treasury went up from 1.74% on election Tuesday to currently 2.38%. That is a massive down move, on probably the biggest investment instrument in the world. I say down move, because bond prices go down with rising interest rates. At the same time, the dollar is reaching all time highs and is heading for parity with the euro.
So, how to make sense of all of this? The narrative turned on election night when billionaire Carl Icahn, a Trump supporter, aggressively started buying stocks in the middle of the free fall. According to him, that night he put about 1 billion dollars of his own money to work in the stock market, before he ran out of people selling to him. Simultaneously, Stanley Druckenmiller dumped his entire gold holdings on the market. We are talking about 1 billion dollars of gold. According to him, the reasons to own gold had disappeared with the election of Trump. These trades seemed to have been enough to change the narrative from panic to the glory days are hear again, as Trump apparently truly will make America great again.
But it is very questionable whether Trump really will be able to do that? In fact, if there is a way, I cannot see it. And Trump himself is certainly not showing it to us. He has been notoriously vague about the policies that he is planning to pursue. That is probably because he himself is actually clueless about the problems and their solutions in the US. So what we hear is the old recipe that has worked well for politicians in the past. That is, lower taxes and simultaneously increased spending to stimulate the economy.
In other words, Trump seems to plan to host a party for everyone paid for with new dept. And the markets are accepting that party invitation. Considering this, it makes perfect sense that stocks are rising and bonds are falling. An increase in spending, financed by dept, means more inflation. Stocks love an inflationary environment, while bonds become more risky in the latter. But why is gold falling, when all the other indicators point towards inflation? A falling gold price is an indicator of deflation not inflation. So the markets definitely got something wrong at the moment.
In my view, they seem to have started the party slightly too early. It will have to be cancelled the last minute. Since the US is probably already near the peak of the Laffer curve when it comes to taxation, dept is the only way to finance tax cuts and simultaneous spending increases. The reality is that the US is in pretty bad shape. She has a national dept of about 20 trillion dollars. That is way over 100% of GDP. Not a good position to start another massive round of borrowing.
At the same time, the economy has some severe structural problems and is doing very poorly. The official GDP numbers for the US this year have been 1.1%, 1.4% and 2.9% for the first three quarters. GDP, in my view, is not a good measure of economic improvements anyway. It simply measures the amount of money that is going around. It is also easy to manipulate, since it depends on accurate assessment of inflation, which is likely understated in the official statistics. Things like asset inflation and government spending also have a positive effect on GDP. But that is exactly my politicians like it as a tool. Considering that, it is even more remarkable that after all these years of no interests rates and money printing the numbers are so poor.
The 2.9% will almost certainly be heavily revised downwards. There are clear indications that this number is fantasy. The unemployment numbers show a strong trend away from full time employment to more and more low quality part time jobs. The labour participation rate is also very low. Is this what would happen in a strong economy? In this interview with CNN (around 21min) Warren Buffet, who is a professional optimist on the US, seriously questions that the US is growing at 2.9%. The famous investor of course runs Berkshire Hathaway, a company that incorporates more than 70 big companies from all areas of the economy. Buffet is a genius when it comes to numbers. He owes his remarkable success to this exceptional skill. He knows the balance sheet of all these companies in detail. And according to Buffet, those numbers show a much weaker picture. But we don’t need to look at Berkshire Hathaway. The pure fact that Trump, who is perceived to be the enemy of the establishment, won the election is a clear indication that the economy is not doing very well. At least not for large parts of the US.
The economic policy of the US government in the years after 2008 has been to flood the markets with cheap money. According to their economic models, this is supposed to help the economy as a whole. However, as the Austrian School of Economics predicts, this idea is false. Printing money does not improve wealth creation. Instead it is a form of wealth distribution that hurts the real economy by misallocating capital. The printed money is being spend by a small amount of elites, located in specific areas. These areas, like New York or large parts of California, have experienced an artificial boom. But this boom comes at the expense of the rest of the country, which is doing more and more poorly.
If we look at a map of the areas where Clinton has done well in the election, it is obvious that these are mostly the areas in which the establishment lives. These are the people on the recipient side of this wealth distribution. As a result, their perceived reality is that America is doing fine. This is precisely why they did not see Trump’s victory coming. It is difficult to have an accurate assessment of reality, living inside this bubble. That is why I was convinced that the bubble based polls were not portraying an accurate picture of the mood in the country.
This is a phenomenon we often see at the end of political systems, where there is a huge divide between the people running the country on the one hand and the rest of the people on the other. Since the people at the top have locked themselves into a huge echo chamber, they really cannot see what is going on, as all their data comes from within the bubble. A similar phenomenon happened with Brexit, where London, the place where all the cheap money flows, was the only real stronghold of remain in England. Brexit was less a vote against Brussels as a vote against the status quo.
No, the real economy is not improving in the US. Flyover America finds it more and more difficult to make a living. And they remember that this used to be different. The big problem with Trump is that he only talks about change. In reality, he is one of those ‘change through no change’ candidates. Real change usually requires a period of hardship in which the mess is cleaned up. That is a scary message and does not go down well with voters. But Trump promises a clean transition from the mess that America is in, to a new glorious future, without any hardship in between, at least not for the people who could vote for him. That is an attractive story that people like to vote for. But unfortunately, it is a fantasy.
It does not seem possible to go from a massively indebted nation, with huge misallocations of capital in the economy, to a healthy sustainable system without a crisis in between. Of course, if people were clever enough to choose liberty, this crises could be severe but very short. Markets tend to be more effective problem solvers then even the most optimistic people usually imagine. The problem is, for this solution, the whole political class would need to step down and admit that they have always been the problem. That is not going to happen. Especially not with someone like Trump who seems to be outright opposed to free trade and quite frankly is mostly clueless anyway.
That is why I assume that Trump is going to try everything he can to keep the fantasy alive. And the only tool left for him to do that is to print more money. The only alternative to that is to massively cut spending, which would make him hugely unpopular in no time. However vague he might be on his agenda, he has already declared very clearly that that is not going to happen. And so money printing it is going to be. But this time it won’t be a party. After so many years of zero interest rates and money printing it has become too obvious that the government is not in control. There are no real solutions and more and more investors will decide to leave the sinking ship.
30 years ago, Trump, just like Reagan, could have become a popular President on the back of a massive debt party. Today, this seems impossible. He does not even seem to be aware of what a disastrous state of affairs he will inherit shortly. His idea of massive new spending and tax cuts, while at the same time putting in barriers for free trade, seems doomed to fail from the beginning. The markets have not quite figured this out yet. But they will very soon. Now is a good opportunity to position oneself for that.