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Trump And Reflation

US Government bond yields are up about 35 bps at the long end of the yield curve over and US equities are up about 3.6% off the pre-election lows. I suspect that once reality sets in the stock market will falter and bonds will rally. Many of Mr. Trump's policies are not pro-growth and the uncertainty surrounding implementation will dampen the effects of the fiscal stimulus proposed.

I have heard many people say something to the effect that Mr. Trump will change now that he has been elected. That solely reflects the hope of the speaker. His constituency elected him to do what he said he was going to do. I doubt he will abandon those plans.

The two components of the Trump agenda that are anti-growth are withdrawing from trade agreements and deporting illegal immigrants. Aside from the outright negative economic consequences of lower levels of international trade, withdrawing from trade agreements will introduce uncertainty and cause businesses to postpone investment decisions. Modern supply chains are complicated and often involve back and forth deliveries across national borders. Disrupting those supply chains by terminating trade agreements will disrupt manufacturing businesses. At a minimum they will face increased costs. At worst, the supply chain will break causing production outages and lost output. Instead of increasing GDP by bringing back jobs, the likely result is lower GDP.

Immigration policy if implemented is likely to have an even greater negative effect on GDP. If the estimates of the number of illegal immigrants is correct at 10 million, illegal workers represent roughly 4% of America labor force. Precision is not necessary to get a sense of the reduction in economic activity that would result. There are about 160 million people in the labor force and the participation rate is about 62%. Applying a higher participation rate to reflect that illegal workers are here to work, I estimate that there are roughly 7 million illegal workers. At $8 per hour, those workers earn and spend roughly $120 billion. For perspective US GDP is over $18 trillion, so the earnings of illegal workers represent about 0.5% of GDP. In an environment of 2% GDP growth, loss of their productive capacity would be a significant drag on growth. With low unemployment, there is not excess capacity in the labor market to replace their labor with American workers.

The negative impact of the immediate deportation would have a larger effect due to the multiplier effect. To start, apartment vacancy would skyrocket. Overall Trump's immigration policy would be a huge negative. Once the market considers the ramifications, the euphoria related to reflation will disappear.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.