The performance of gold in 2017 depends largely on whether the Trump’s presidency will lead to lasting shift in the markets. What changes do we mean? Some analysts mention the reflation, others point out the ‘risk on’ sentiment and the ‘great rotation’ out of bonds and into stocks. Ray Dalio, the founder and chairman of Bridgewater, claims that the Trump’s victory was a turning point ending the period characterized by increasing globalization, free trade, and global connectedness; relatively innocuous fiscal policies; sluggishGDP growth, low inflation, and falling bond yields. The new period is believed to be characterized more by decreasing globalization, free trade, and global connectedness; aggressively stimulative fiscal policies; increased economic growth, higher inflation, and rising bond yields.
Indeed, the U.S. Treasury yields, stock prices and inflation expectations have increased since the U.S. presidential election, which may really signal that we had already made the secular low in bond prices and inflation. We do not argue with that. The million-dollar question is whether these changes will be permanent, or, in other words, whether the expectations of Trump’s pro-growth policies are realistic.
You see, the whole reasoning is based on three premises. First, the new president will inaugurate a heavy schedule of fiscal spending. Second, this fiscal stimulus will significantly contribute to the economic growth and force the Fed to accelerate its tightening cycle to prevent the economy from overheating. Third, the tax cuts and boosted government spending will lead to higher inflation and, thus, higher long-term interest rates. Fourth, Trump will trigger a new ‘Reagan revolution’.
However, there are serious problems with these assumptions. First, Trump’s proposals would take a lot of time and political negotiation to be implemented and it would take even more time to influence the U.S. corporations’ profits. If they are introduced at all, because Republicans may actually not support higher fiscal deficits. Similarly, infrastructure projects have never been high on the Republican’s agenda. Actually, Trump did not say anything about more government spending. Instead, he proposed tax incentives for private companies to invest in infrastructure. Second, assuming that the U.S. economy is close to full employment (as the Fed argues), the increased government spending (if it happens and if it is funded by direct or indirect money printing) may only increase inflation instead of accelerating real economic growth (by the way, government projects are often ineffective). Third, it is not clear how the mere redistribution of funds from the private sector to the government or vice versa should increase inflation. However, assuming that it will, the widely expected higher inflation would increase nominal interest rates, but not real interest rates, which are crucial for the gold market. Fourth, the macroeconomic situation is now completely different than under Reagan when interest rates and inflation were much higher, while the public debt was relatively low. Therefore, Reagan had fiscal room to increase indebtedness and had a major tailwind in the form of potentially lower interest rates, in contrast to Trump who will face rising interest rates and an already high debt-to-GDP ratio, as one can see in the chart below.
Chart 1: The U.S. public debt-to-GDP ratio (green line, left axis, in %) and the 10-year Treasury yield (red line, right axis, in %) from 1980 to 2016.