The Deflation Demon Lives!

Look, I guess “America first” doesn’t necessarily have to mean “world fucked”, but you’d be forgiven for thinking that’s the way it’s likely to turn out.

I mean, on immigration it’s not really even necessary to lampoon Trump’s recent trials and tribulations or even to point to the the travel ban if what you want to do is make a case that America’s doors are closed. All you have to do is go back and read the transcript of the President’s call with Australian PM Malcolm Turnbull when, in an effort to “explain” why America couldn’t honor an Obama-era deal to resettle more than 1,000 refugees currently held in Australia’s offshore detention centers, Trump said this:

I hate taking these people. I guarantee you they are bad. That is why they are in prison right now. They are not going to be wonderful people who go on to work for the local milk people. I am the world’s greatest person that does not want to let people into the country.

The only thing that isn’t crystal clear there is what he means by “local milk people”. The message on immigration is unequivocal.

As far as trade goes, it looks like he’s getting set to ratchet up the protectionism and last week, Steve Mnuchin fired what certainly looked like the opening shot in a “hot” currency war.

We spent all of last week discussing the ramifications of Mnuchin’s comments for the ECB and the BoJ (see here for the funniest version). Long story short, they did not need to be put into a situation where the dollar has another reason to remain weak just as their respective attempts to normalize policy risk catalyzing euro and yen appreciation. Mnuchin has made it more difficult for them to roll back stimulus without putting upward pressure on their currencies, pressure which could very well feed back into their economies, undercutting their progress on the growth and inflation fronts.

This is why Mario Draghi chided Mnuchin in the post-ECB presser last Thursday and on Monday, officials from the Ministry of Finance, Bank of Japan and Financial Services Agency met to discuss the impact of comments on currencies by U.S. and Japanese officials.

In essence, the U.S. risks pushing the world back towards deflation if it persists in moving down this path and Bloomberg’s Mark Cudmore was out this morning saying just that.

For one thing, policymakers will be reluctant to give up on their plans to normalize because at this juncture, persisting in NIRP and QE risks blowing egregious asset bubbles. That means they’ll probably move ahead even if their currencies strengthen raising the specter of still more currency strength which could very well undercut their inflation targeting effort.

“Anticipation of faster inflation is now driving the narrative of monetary policy normalization [and] this is a particular concern in the euro zone and Japan, where pressure for policy tightening is rising despite the fact that neither economy is set to get near target inflation rates on a sustainable basis even by next year,” Cudmore writes, adding that “U.S. tax cuts and a weakening dollar, along with prospective synchronous monetary-policy normalization, threaten to undermine the emergence of stable inflation rates.”

The tax cuts are also contributing to the selloff in Treasurys which, as Cudmore goes on to write, puts pressure on rates around the world, thus tightening monetary conditions.

Meanwhile, none of the structural factors suppressing inflation have gone away. Here’s Cudmore again:

The world has struggled for years against structural disinflationary pressures, in part thanks to technology and demographics. Neither of those trends has reversed.

The widespread belief now is that solid global growth will become the dominant driver of prices, with falling unemployment rates fueling expectations for the long-broken Phillips curve to kick back into gear.

That view overlooks the twin problems of low labor-force participation rates and the rise of automation.

Finally, it’s worth noting that if what you want to point to for evidence of rising inflation is commodities, well do keep in mind that, to quote Cudmore one last time, “the weakening dollar means the gains are less impressive in other currencies — the Bloomberg Commodity Index remains toward the bottom end of multi-year ranges when measured in almost any currency besides the dollar.”

So, could Trump end up resurrecting the deflation demon we thought we’d finally exorcised?

The answer is yes. Maybe the “local milk people” can help.

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One thought on “The Deflation Demon Lives!

  1. given current capacity utilization levels….these corps claiming to build more factories are either sowing their own seeds of destruction or just getting some free positive press. low rates and now lower taxes are serving only to lower hurdle rates, encouraging expansion that will ensure low prices and thinner margins later.

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