Romney decisively won the debate last week, and he is tied in many polls after being written off by most prior to the debate -- and the market has fallen almost every day since. Question: Is there a link between a potential Romney win and a falling market? My view is "there is". Even though I have fought vigorously for Romney, as an investor I would look to sell the news of a Romney victory. The reasons are two-fold.
First, Romney is a hawk when it comes to inflation. He believes in tight money. He very well may appoint a man like John Taylor to the head of the Federal Reserve as Bernanke's replacement. Taylor believes in a rule-based monetary policy. He is author of the Taylor Rule. This rule ties interest rates to inflation and growth. So if inflation goes from 2% to 3%, Taylor would increase rates by at least 1%.
I don't trust rule-based monetary policy. Even a 3 to 5% rule to increase the money supply as Milton Friedman suggested is now questionable. And I certainly don't think we should tighten monetary policy further in today's world. Leaning toward a more rigid monetary policy is to lean toward a European style economy. Keep in mind that Taylor is a top Romney advisor in this campaign, and as such is on the short list of possible Bernanke replacements.
Secondly, Romney will declare China a "currency manipulator" and clamp down on trade with the country. He intends to strong arm it and pressure it economically to stop cheating and stealing from us. We all want fair trade, but it's not the point. This is not the time for the world to move toward greater protectionism. The surest way to a world-wide depression is to engage in a trade war at the same time you tighten money and credit.
And we all know that a certain amount of austerity will be imposed under a Romney Administration. Austerity, tight money and credit, and protectionism are a prescription to the return of the recessionary/deflationary bias we just emerged from. This concern may explain this week's strange run into bonds and run out of stocks and gold. Is a deflation trade developing?
Don't get me wrong, I think Romney, if he becomes President will turn this economy around by the end of his first four years. I will vote for Romney because he would be a vast improvement from what we have today. I also think that Romney will move to correct his mistaken notions about monetary policy and trade quickly, if and when the adverse effects of his policies begin to become evident. Romney is a businessman, and as such he will move with the evidence of success and try to avoid failure. Unlike Obama, he is open to change. The problem is that all of this will take a great deal of time. In the time before growth takes effect, the market and commodities could move into a major bear market. And that I will not be willing to endure.
On the other hand, if Obama wins, he will probably appoint someone like Janet Yellen, the current Vice Chairman at the Fed. Yellen is a dove on inflation, and if appointed would most likely move toward a higher inflation rate than Bernanke would permit. So, the market will most likely begin to bake in a 4% inflation rate over time. This will move gold up and commodities with it. Growth will improve, but only in the short term, where under Romney it will be more lasting growth, yet take longer. Also, long-term interest rates will probably begin to move up along with inflation, and solvency fears will most likely accelerate under an Obama second term. Easy money and higher inflation, versus tight money, deflationary and recessionary fears. Which way do you think markets will move given those two scenarios?
So, things are not as simple as they seem. To fix the economy and preserve freedom and the American way of life probably means a bear market, where a go at inflation and socialism could mean great profits for gold bugs and stock investors -- at least for a while. What should an investor do? I'll follow the money.