(picture from Wix's library)
Hello everyone!
Given that my predictions for the last two years were very successful (you can find them here), let me go ahead and do some more for 2017! If I am successful again, you can all be convinced that I have absolute knowledge in all things of Economics (which would be very… very… very far from the truth) and if I’m wrong you can all convince yourselves that I don’t know a thing about Economics (which I would hope is also wrong).
Here we go!!!!
This year’s prediction is about Trump’s policies. Although a number of my colleagues are trying to argue that the new president of the USA is either a blessing or a curse for the American economy, I am not sure yet. He apparently pledged to double the USA’s GDP growth rate, which I think he could achieve if he implements the policies he claims he will put in place. However, is this good for the American economy? Not necessarily… at all.
SO! My prediction is about inflation. If President Trump implements most of the policies he committed to put in place, the USA could see inflation rates around 5% to 10% in the next two years.
Before I talk about his policies, let me put these figures into context. Although many countries have reached inflation rates of much more than 10% (Brazil had more than 30’000% of inflation in 1990 for example), this is very serious for what we call a rich country. Inflation rates in these countries tend to be around 2% or so. The central bank of most OECD countries (“Organisation for Economic Co-operation and Development”, the club of rich countries) actively aims at keeping inflation levels low and relatively stable in their own jurisdiction.
An inflation rate above 3% is seen as unusual and must be looked at seriously. Above 4% is usually a bit of a crisis and central banks tend to take action (mostly by increasing the interest rates of the country). Anything above 5% can lead to very strong reaction from different government organisations while 10% is the end of the world (not literally of course, we had that type of inflation in Canada at the beginning of the 70s and 80s).
One last thing before we go: the fun thing about this situation is that the central bank of the USA (called the Fed) will probably not be able to reduce inflation if it occurs. The type of inflation that President Trump may cause (if he does what he promised… and if I’m right) is called a 'supply-side shock inflation', which is immune to conventional policies from central banks. Unless the central bank crashes the American economy, the only way to get rid of that inflation would be to cancel the policies that produced inflation in the first place (which may be unlikely given Trump’s personality)
Ok then, let’s talk about some of the policies I think are going to be inflationary (produce inflation in the USA).
The new president has been talking about increasing tariffs on imported products from multiple countries, including Canada and Mexico (if NAFTA is scrapped or significantly modified). Import tariffs tend to have the same effect as taxes, except that they focus on imported products. Remember that many products made in the country use components from outside, which would also be taxed. These tariffs are very likely to lead to higher prices of products. In the USA, the value of imports was around 16.6% of total economic activity in 2014 (lower than other comparable countries), which means that prices are very likely to increase due to these tariffs. President Trump argues that these tariffs are going to reduce imports substantially. If this is true, their impact on inflation should be lower. Although imports may indeed decrease, it is unlikely that they decrease enough to cancel the increase in prices due to tariffs. Also, products that are not imported anymore must be replaced by local products, which is my next point.
President Trump has pledged to “buy American only”. This would mean that the government will purchase its goods and services from companies based in its country. The American government’s expenditure accounted for around 14.7% of GDP in 2014, which is significant. However, I doubt that American companies would be substantially more expensive than foreign companies for construction projects and the like. Inflation could be affected for products that are currently not produced in the USA (or not enough production capacity is in place). For those, local substitutes might be more expensive or not available at all… which means that the government will have to pay their own tariffs on imports (through higher prices of imported products). I see a much greater risk of inflation if the rest of the economy follows the same ideology. If a significant number of individuals and firms start buying “American” (perhaps inspired by the president’s rhetoric or by higher tariffs), then inflation can indeed be a problem. Foreign products are not imported just because they are foreign… they are chosen instead of local products because they are better in one way or another. In many cases, these products are preferred thanks to their lower prices. If a good proportion of foreign products are replaced by local ones (we call this ‘import substitution’), I expect inflation to increase.
Another promise the president of the USA has made is to start a wide infrastructure expansion. With much more demand for goods and services related to the construction and maintenance of such projects comes higher prices for them. That means that the price for materials, labour, energy, and other inputs of production are likely to increase for everyone… which means that the price of many products will be affected. This applies for both physical infrastructures (bridges, roads, hospitals, universities…) and virtual infrastructures (training centers, healthcare services, insurances….). If the government sticks with its import tariffs and “buy American” policies, these costs (and prices) will increase even more.
President Trump pledged to reduce immigration from Mexico and to deport all illegal immigrants from the USA. Although the discussion regarding illegal immigrants is often debated on moral grounds, there is also an important impact on the economy. Whether Americans like it or not, illegal immigrants have allowed for very low costs of production of a good number of local products. A quick search on the department of homeland security shows that illegal immigrants are plentiful in that country. Estimates seem to point to around 11 million illegal immigrants (close to 60% from Mexico), which is around 3% of the total population of the USA. We can easily imagine that they are over-represented in low-skill work, which is probably the only type of employment they have access to. As an example, Walmart seemed to routinely use illegal immigrants for cleaning services (the New-York Times reported that Walmart paid heavy fines in 2005 related to illegal worker employment). Deporting “all” illegal immigrants would probably result in an increase in costs for low-skilled employment in two ways: first, firms will not be able to pay salaries below the minimum wage as easily; and second, less competition for low-skill jobs leads to higher salaries for those that stay. Higher costs usually lead to higher prices… inflation!
Finally, President Trump seems to want a tight control on the policies of the central bank of the USA (the Fed). The Fed is supposed to be independent from the government to be able to focus on inflation targets. Janet L. Yellen, the current head of the Fed, should be able to take measures that may hurt the economy in the short-term. President Trump will probably put pressure on the Fed to keep interest rates very low for as long as he can. This can help economic growth by offering firms and individuals cheaper loans. However, it can also lead to an over production of low profitability projects which can fail more easily. It also tends to lead to less savings and more inflation, which is bad for the future of the country. It is not unlikely that the new president of the USA is already searching for a potential replacement for Ms. Yellen in the case she becomes ‘uncooperative’.
There we go guys! This prediction is relatively extreme… we did not see that level of inflation in the USA in a long time. I feel President Trump will just back down on most of these issues, which means that my prediction will probably not occur. However, he has already implemented a good amount of policies that many thought he would never put in place… so let’s see
I hope that the USA will not see inflation levels of around 10% ever again… but if it happens I’ll be there watching and keeping you guys informed and entertained!!!!!!
Take care and don’t forget to have fun!