Put it all together -- stronger dollar, higher deficits, wage and price inflation, tighter monetary policy -- and you have all the ingredients for an overheated economy quickly morphing into a weaker one. Trump's anti-immigration policies and trade restrictions, if adopted, would make things worse -- and could even trigger a recession.
The bond market is perhaps more telling than the stock market.
Trump's tax cuts and large-scale government-spending plans are likely to add to the deficit and raise borrowing costs, scaring bond investors: Yields on 10-year Treasuries have risen 37 per cent since the election.
Faster economic growth could result from the Trump stimulus. But with the economy at full employment, companies will have to pay higher wages to meet any new demand, and that will add to the inflationary spiral.
Factor in increases in state minimum wages and Trump's anti-immigration policies, which could result in worker shortages in some areas, and lobar costs might spike. The Fed, which doesn't like to get behind the curve, might have to tighten policy more aggressively than currently planned.
Trump's tax-cutting, deregulating and deficit-spending policies are tailor-made to boost corporate profits.
Trump could make inflation worse if, as promised, he imposes steep tariffs on the goods that US manufacturers produce overseas and import back into the country. Wall-Mart Stores and Apple products, many of which are made in China, would almost certainly be more expensive for American consumers.
The Fed's interest-rate increase of last week and the prospect of three more expected in 2017 already have investors shifting their capital to the US, where yields are better than in most countries. That, too, is adding inflationary pressure. Deregulation of the financial industry, which would make it easier for banks to lend, could make sectors like commercial real estate bubbly.
Mark Sandi, chief economist of Moody's Analytics, thinks inflation will breach 3 per cent on a sustained basis, "well above the Fed's inflation target" of 2 per cent.
A more muscular dollar could mute the Trump effect somewhat.
The Fed will respond, Sandi predicts, by increasing interest rates to nearly 4 per cent by early 2020. The bond vigilantes, in turn, will push 10-year Treasury yields as high as 4.5 per cent. "These are the classic symptoms of an overheating economy," Sandi writes, "which historically have ended in recession."
While he's not yet predicting a recession, Sandi sees the economy coming "unnervingly close by the end of Trump's term."
The more muscular dollar could mute the Trump effect somewhat. The stronger dollar makes US exports more expensive relative to European and Asian domestic goods. It also makes foreign goods less expensive for US consumers. A strong dollar, then, pushes down exports and pushes up imports, resulting in less inflation but higher trade deficits -- exactly the opposite of what Trump says he'll accomplish.
Of course, President Trump might not get all the changes he called for as a candidate. He's already pulled back from his pledge to deport 11 million undocumented people.
The cost of his original tax proposal has been cut in half. Congress may not want to spend $500 billion on infrastructure. If so, the economy would be better off.
It may not be readily apparent from the stock-market euphoria, but the more successful Trump is in getting Congress to adopt his ideas, the worse off the economy will be in the long run. Beware the sugar high.
