Inflation: the election outcome Americans can count on

Millions of Americans awoke today knowing only what they knew before: that the nation is fractured down the middle, the 2020 election is the most contentious in their lifetimes, and the process is likely to drag on for days if not weeks before we see an outcome. Not since the 19th century, with the two sundering elections of Abraham Lincoln and the deeply flawed Compromise of 1877 elevating Rutherford B. Hayes to the presidency, have America’s politics been so horribly divisive and her society as ripe for wide-scale unrest and violence. As followed those elections, the volatile political environment of 2020 will eventually read across into the financial markets and real economy.

Capital markets have been volatile, perhaps a reflection of the country itself. Regardless of whether Biden or Trump is ultimately declared the victor, it is now nearly inevitable that inflation will emerge in the United States in the medium-term, albeit for different reasons in each case. Alongside this trend, we can expect to see a substantial devaluation of the U.S. dollar, exacerbating inflationary pressures as imported goods become more expensive in real terms for American companies and consumers.

The market has, for months, been signaling the risk of inflation. Reflationary asset trades have been among the best performers. The price of gold, the classic inflationary bellwether, is up by nearly a third from March lows. A leading ETF for timber and forestry, another reflationary bet, is up by two-thirds over the same period. The Federal Reserve’s five years forward inflation expectation rate has more than doubled. The S&P500 is itself up over 50 percent, largely due to the performance of the FANGs.

The p/e ratio for the S&P500 is now above 30 times, signaling inter alia that investors are willing to accept substantially lower yields for the partial hedge against inflation that equities offer. Real interest rates have gone below zero, rendering ineffective monetary stimulus from the Federal Reserve and making the U.S. dollar relatively unattractive to the foreign investors upon which America has come to rely.

With the expectation of a blue wave leading to a Democratic-controlled White House and Congress, the markets have been driving these reflationary trades to anticipate trillions of dollars of further stimulus. Under a Biden presidency, the persuasion of the more radical elements of the Democratic Party, many under the stupefying influence of Modern Monetary Theory, would be revealed in substantially looser fiscal policy and greater monetary stimulus in the form of further lockdown relief.

Beyond such spending to counteract the impact of further lockdowns, longer-term expectations for Green New Deal-like energy policies and expanded government social programs, combined with limited ability to increase taxes in a weak economic environment, would pressure the Biden administration towards greater monetary expansion (i.e., printing money).

The contributors to inflation under a Trump second term will be different but have a similar effect. To make good on the commitment to Make America Great Again, the Trump administration will press forward on a trade policy that includes the decoupling from China, the restoration of U.S. manufacturing, and new supply lines based on shifting alliances reflecting the emergence of a Cold War v. 2.0. Without fail, these policies will mean that prices will rise in the U.S., as import substitution and new supply chains will prove to be more expensive than existing sources, which have been optimized for cost at the expense of other considerations.

The Trump administration will consider that the benefit of growth in domestic employment and wages in a strong economy is worth the cost of rising producer and consumer prices. Over a certain range, this is indeed a worthwhile trade-off. The risk is that history has proven the inflation genie to be very difficult to re-contain once let out of its bottle.

The implications for U.S. investors and savers are clear. Bonds and cash are about the worst possible places to be right now. In an inflationary environment, the dollar’s purchasing power is likely to be diminished, and those on fixed incomes such as pensioners and retirees are at the greatest risk. Equities look tempting until suddenly they don’t. With the increase in volatility, individual investors are taking a great risk of playing in the markets right now. Even most professional traders are too young to have experienced an environment like this before and maybe walking into a disaster that they did not recognize.

As both citizens and investors, now is a good time to take care and take cover. While we should hope for the best, I suspect we haven’t seen the worst of it yet.

Michael Wilkerson is CEO of Fairfax Africa, a publicly-listed company with a mandate to invest in high-quality African businesses in food & agriculture, education, financial services, and renewable energy infrastructure. He is also the author of the new book Stormwall: Observations on America in Peril.

Originally published at on November 6, 2020.

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