USA: Reflation = "trickle-out" economics

Monday, November 28, 2016 // Written by Enzio von Pfeil

Markets have been gyrating very much because of Trump's reflation plans. But they will trickle out overseas.

  1. Forthcoming policy mix

    Mr. Trump probably does not know that he is following the "Mundell-Fleming" theoretical model of the cyclical economy.  When you reflate fiscally by slashing taxes and re-building infrastructure, demand rises, so up go long  interest rates. And when you tighten monetarily,  up go short rates. Thus, the market is factoring in ever-higher interest rates. Step in the stronger dollar as a corollary to this feeling.
  2. Components of Keynesian reflation

    Let's stop the film at his proposed fiscal stimulus of one trillion dollars: what happens?  Here, we have to differentiate between two economic effects: a) the procurement of materials with which to re-vitalize America's infrastructure, and b) the actual re-building of her dilapidated infrastructure. 
  3. How Keynes works

    Ad 2.a), the procurement of materials like pipes, cement, tools and machinery will most definitely create employment; after all, someone has to make these materials, don't they?  We assume that the bulk of these input materials will be made domestically, i.e. in America herself.   So this creates domestic employment which generates incomes, 70% of which will be consumed. Hurray.  Now let's move on to less-sparkly 2.b), the re-building phase.  Do you honestly believe that American citizens themselves will don shovels and picks in order to build roads and bridges? Forget it.: Keynes does not work in post-industrialized economies!  Only foreign, i.e.  inbound migrant labour will stoop to this type of menial  work. So: an imported  Mexican worker builds roads and generates a wage. But instead of spending 70% of it in America herself, he elects to wire the bulk of his take-home pay to his destitute relatives in Mexico. Goodbye domestic consumption in America: instead of "trickle-down", we will witness "trickle-out" economics.
  4. "Trickle-out" economics

    Thus, that recent bond blowout has been overdone: rates cannot rise as strongly as anticipated, because growth won't rise as strongly as anticipated: "trickle-out" economics suggests that America's foreign labourers will export the bulk of their wage incomes back home. In a nutshell: Trump's rebuilding effort means that instead of being consumed in America herself, wage income trickles out of the country.
  5. Investment implications

    Load up on American suppliers to the infrastructure sector, e.g. of raw materials and tools.  But do NOT load up too much on consumer cyclicals, as the consumption effect of rebuilding itself trickles-out of the country. finally, as the growth effects must be weaker than the market anticipates, buy oversold long bonds. Once done, this implies that long bond yields will be lower than their current levels. That, along with rising Fed Funds rates, implies a flatter yield curve. And that flatter curve, in turn, suggests that you must not load-up blindly on financials. A rising tide will NOT lift all boats!
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