And the Winner Is… Donald Trump

November 17 2016

A careful thought experiment about the question what his presidency could mean for the gold price.

Donald Trump is the newly elected, 45th president of the United States. Trump obtained more than the 270 required electors to win the presidency and has beaten Hillary Clinton. This means that Trump can execute his policies starting in January next year – the moment he will be officially appointed as president. Those policies boil down to restructuring the US public debt by declaring bankruptcy (Trump wants to pay holders of US Treasuries only a fraction of their investments back), a considerable tax cut, restraining immigration, re-negotiate signed free trade agreements and a new strategy for free trade agreements that are still on the table (see, for instance, TTIP). Moreover, Trump has set his sights on Janet Yellen, president of the Federal Reserve. Only recently, he stated that she must be ashamed of herself, that her Fed-interest-policy resulted in a “false stock market” (in other words, she created a gigantic bubble) and that the Fed is all but politically independent. Regarding the low interest rates of the Fed, Trump argued that he as a businessman loved low interest rates but that when he thinks in the interest of the people “interest rates should be higher.”

Of course, it is to be seen what will remain of his proposed policies when it gets to implementing them. But let us assume for now that Trump will implement his plans exactly as we briefly summarized above, that these plans are not false promises; what would be the consequences for, for example, the gold price be?

If president Trump truly steers the US government toward a de facto default, then that would be good news for gold prices. Why? Because the US government has become addicted to structurally spending more than its income. If investors in US Treasuries only receive a fraction of their principal invested, then the probability is very low that these investors will be willing to lend money again in the future. However, with considerable tax cuts, the probability that the federal government must borrow more than ever will be high. In case this would not be possible on international capital markets or only against very high interest rates, it is likely that for instance the Fed has to provide some assistance.

Inflation

What also might be beneficial for gold prices in Trump’s plans, is his intention to re-negotiate and if necessary withdraw from free trade agreements if he considers them to be a bad deal for the U.S. One of the almost certain consequences of withdrawing from or re-negotiating free trade agreements, would be higher inflation in the U.S. On the one hand because imports would be more expensive due to import tariffs (on a side note, the U.S. imports much more than the country exports), and on the other hand because there is less competition on the U.S. market, which would mean that domestic U.S. companies could raise their prices. The outlook of increasing inflation generally creates the right conditions for higher gold prices.

If the U.S. dollar would weaken more, then that would be an additional factor that pushes up gold prices.

However, it would be negative for gold prices if Trump sticks to his word and indeed appoints a new Fed-president who, as Trump argues this is of utmost importance, will raise interest rates.

That would mean that the recent fears for inflation would quickly disappear. After all, a new Fed-president would be so much more anti-inflation than the current Fed-president Yellen (which is not very difficult in the first place).

On balance, the price of gold in our thought experiment would experience some upward pressure. But as I said before, this is a thought experiment; we assume as given anything that Trump said he would do and is practically able to do.

Look at his plan to move the U.S. into a de facto default. I can very well imagine that anyone who means something in economics, including his closest advisors, would point out the many, many negative consequences of such a decision. Moreover, the U.S. Congress should vote in favor of this plan. Yet many senators come from states where bankruptcies and reckless financial policies are met with little support. Since Trump will need the Congress to execute his plans, it is very likely that they would not approve of this part of his plans. Thus, a major factor that would contribute to higher gold prices would disappear from our thought experiment.

To a certain height, the same applies to withdrawing from various free trade agreements. While it may sound nice and helpful to discuss these free trade agreements, as soon as Senators would dive into the details, it would very soon become painfully clear that many U.S. states would suffer economically from such a reconsideration of free trade agreements. That would mean that the prospect of reaching the required majority in the Senate would be something that gets out of sight rather soon. The Republicans have a small majority (52 against 48 Senators); the 48 Democratic senators would almost certainly vote against withdrawing from any free trade agreement, if only because it is a proposal of Trump. That means that only a few Republican senators must vote against Trump’s plans in order to keep him from continuing his plans (do not forget in this regard that Trump does not enjoy wide support within his own party). This would mean the end of the second source that could cause an upward pressure on gold prices.

Reforms at the Fed

The plans of Trump which are the easiest to implement and move through Congress, are his appointments on the Fed-board and eventually expelling president Yellen. As I said before, it is likely that whoever will be the successor of Yellen, he or she will be more of an anti-inflation central banker than her. That means that the only source in this “what if”-exercise which would push gold prices down, will most likely not disappear.

Seen in this light, it should not surprise us if the gold price under president Trump would initially get under downward pressure. “Initially” because of at least two reasons. In the first place, because the Fed with a newly elected board might want to raise interest rates, but the more important question is whether the bank will actually be able to do so, given the high public debt and the fact that the U.S. economy and government are addicted to free or at least extremely cheap money, as I have discussed in the past in great detail.

In the second place, there is a possibility that the U.S. economy under president Trump will end up in a recession. Normally, the period between recessions in the U.S. equaled about 8 to 10 years. The last recession was already 8 years ago. According to the biological clock of the U.S. economy, the U.S. is on the brink of a recession. Because a recession would push the Fed to return to an expansionary monetary policy yet again, more expansionary than the past few years, and a recession would probably increase tensions between the U.S. and the rest of the world, gold is bound to profit from this unrest and the outlook of higher inflation down the road.

Briefly summarized: the economic plans of Trump would push gold prices down initially, but could push gold prices up at a later moment. Moreover, we have two additional factors that are beneficial for gold prices.

In the first place, I refer to the fact that Trump is very unpredictable. During his presidential campaign, he talked about any subject you might imagine in very different words, sometimes even completely changing his opinion. We could deduce from this that he is unpredictable, since even Trump himself frequently has no clue what he really stands for. Unpredictability of such a powerful man as the U.S. president translates per definition into uncertainty on markets. Precious metals tend to do well in times of great uncertainty.

In the second place, we are faced with the foreign policies of Trump. His ideas on foreign policy are the most pronounced of all his ideas, think of for instance keeping NATO intact but require higher contributions by the other members. One might say that Trump is moving toward a, relative, isolation of the U.S. on the world stage. The U.S. will no longer police the world, is what appears to be the motto of Trump. This implies among other things that there will be more room for other countries to execute their own plans. It would not surprise if down the line this would lead to increased geopolitical tensions in the world. Geopolitical tensions are as always good news for precious metal prices. By the way, do not forget a very important issue in this case: according to the U.S. Constitution, foreign policy is the domain of the president. Congress has little to say about foreign policy and therefore has little control over it. In other words, with regard to foreign policy, Trump can do whatever he wants.

Disclaimer

I will admit without any hesitation that the above analysis was made with many assumptions and a subjective appreciation of the consequences. But in this stage, we have no other choice. After all, we will have to wait and see which policies president Trump might want and is able to execute. Is such a thought experiment therefore of no use? I would answer with a firm “no.” A thought experiment helps us to mark the boundaries, stimulates us to consider possible consequences of the policies of the newly elected president, and gives us something to fall back on when we evaluate the policies that president Trump will implement in the coming year.

What the consequences of the election result will be for financial markets is something we have to evaluate constantly over the foreseeable future, something we will do in my blogs as well. For now it suffices to say that we should not forget a couple of things, namely:

  • Not everything Trump says he will do, he is actually capable of doing
  • Not everything Trump says he wants to do, is what he really wants to do
  • That his party have a majority in Congress as well as the White House, does not mean that Trump will find no resistance on whatever economic or financial policies he looks to implement
  • Politics is, with the U.S. being no exception, a matter of compromises; it is not a dictatorship. The same applies to Trump.
Having plans does not mean that reality will conform to your plans. I always point to the conviction of president Bill Clinton, who at the time argued that the U.S. public debt during his term would be paid back entirely. At the time, U.S. economists debated the question whether it would be a good thing, because financial markets might become uncontrollable. We all know where these plans ended up.

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