As I see it, the administration has two initiatives that will cause inflation:

–The easier to observe is the tariff program, under which foreign-sourced goods entering the country are taxed by Washington. Typically, this is done (in a vain attempt, in the case of US tariffs) to protect infant industries from foreign competition (in the dim past, though, McKinley tariffed away to prevent Southern plantations from buying the machinery needed to expand). In the current case, however, the ostensible objective is to offset tax breaks for the ultra-wealthy.

Economic theory, which I think is correct, says that the extra cost of the tax, or of any cost increase, will be distributed among all parties involved in the chain of buying and selling (e.g., foreign exporter, domestic importer, domestic buyer) according to their market power. One twist to this is that each seller will gauge what his customer is likely to tolerate right away and may decide to raise prices to recoup the tariff cost over a period of time–say, six months–rather than all at once.

–The harder to see is the ICE effort to shrink the workforce. The tools are intimidation, arrest, imprisonment and deportation. The apparent focus is workers of Hispanic heritage. And the effort appears to be working on all fronts.

According to a chart posted by Apollo chief economist Torsten Slok, so far this year the rise in the price of services (a strong function of labor costs) is far outpacing the increase in the price of goods. The former are up by 10%+ ytd, at the same time that, while starting to increase recently, goods prices are flattish.

An aside, sort of:

Paul Krugman has posted today about the 10% rise in electricity costs so far this year, making it seem unlikely that Mr. Trump will be able to keep his campaign promise to cut them in half during his first year in office. In the case of New Jersey, Trump cites the state’s reliance on offshore wind turbines as the cause of higher prices. The only trouble is that there are none in NJ.

This is only one in a whole series of reports that suggest a deepening cognitive decline. Very Biden-esque. This itself is troubling. But in the present case, the president has surrounded himself mostly with people chosen for their spokesmodel appearance–with a mean streak regarded as a lesser plus–rather than their knowledge or experience. My guess is that the administration will be yessed to death on social issues and ignored as much as possible on economic ones. If so, powerful donors will attack tariffs aggressively but ICE not so much.

Nothing to bet the farm on, but if I’m correct, shrinking in the labor force will be a continuing drag on domestic economic performance. At some point, it may even be cheaper to shift production out of the US and pay import duty–not a today issue, however.

mutual fund tax selling

According to the internet, about 20% of the capitalization of the US equity market is held in mutual funds. Another 15% of the US market cap is held in ETFs. The mutual fund number is about the same percentage as in 2000, when ETFs didn’t exist.

ETFs are by and large taxed to holders as if they were individual stocks. That is, the tax effect is on capital gains/losses from you and me selling. I really don’t know what happens in the case of an ETF complex like ARK, which as of the semi-annual report in January still had several billion dollars in unrealized losses on its balance sheet. My guess is that no one writing the rules anticipated that this could happen.

The mutual fund case is much clearer. Fund transactions aren’t taxable to the fund. But funds are required to distribute all realized gains to shareholders, who must pay income tax on them, at the end of the fiscal year–usually October. For some reason, holders actually like to get distributions, even though most automatically reinvest the distributions in the fund.

Fund managers typically spend a considerable amount of time tax planning in the six weeks or so between early September and mid-October. They sell stocks they have gains on to offset losses from things that haven’t worked out, and they sell to recognize gains for distribution to shareholders.

Last year, for example, the S&P fell by about 4% in the first couple of weeks of September before rebounding. In the overall scheme of things, not a big deal. Arguably, a chance to buy.

Also, in many years, the absence of selling pressure post-Halloween starts the “Santa Claus” rally, which typically continues through early December–when professionals tend to break for the holidays.

trumponomics

What stands out to me is that the dollar has stopped falling and the S&P, while still a world laggard at +9.6% ytd, has gained about 30% from its April lows (“laggard” is due to the 10%+ drop in the dollar since the inauguration). NASDAQ, although “only” up by 11.7% ytd, is 47% ahead of its April lows, as well. Gold, a traditional safe haven in bad times, is ahead by 30% ytd, but flat since early May.

Why the market strength?

Let’s take out the crayons and work in the simplest possible terms. Say that the typical US multinational has 50% of its revenues outside the US, that it has all its costs in USD (think: big tech) and that it has an operating margin of 30%. The dollar falls by 10%. This means total revenue in USD rises by 5%. Costs are unchanged, so the overall operating margin expands, like magic, to 35%. That’s a 16.7% gain in operating income, over what one might have projected at the beginning of the year.

On the other hand, if I have dollar revenues and non-dollar costs, I’m crushed.

This pattern reminds me of Japan in the 1980s, only in reverse. In that case, a strengthening yen crushed export earnings but increased the world value of importers and purely domestic firms a lot. In the current US case, the domestic economy gets hammered, but exporters do very well.

If we push the Japan analogy, though, the long-term results aren’t so rosy. The boom there in the 1980s was followed by decades of stagnation. What triggered the reversal? …as I see it, a series of policy decisions that resulted in the working population declining. Three aspects: overall population aging, failure to accept women in the workforce, and not permitting immigration.

That’s a quote from a New York Times article profiling E.J. Antoni, Trump’s pick to head the Bureau of Labor Statistics after he fired the former chief, Erika McEntarfer, a highly respected economist with decades of experience dealing with national economic data. McEntarfer’s “offense,” if that’s the right word, was apparently to ok the release of a monthly jobs report that shows that hiring is slowing.

Hard to believe that a hiring pause should come as a shock–and I can identify only one person who seems to have been shocked–given uncertainty about tariffs (the consensus is that they will clip about half a percentage point off economic growth, basically flatlining the economy) and efforts by ICE to shrink the labor force either through deportation or arrest or intimidation of potential workers.

What really strikes me is both the number of prominent economists who are speaking out against this move and the force they’re doing this. No mincing words, no subtle academic euphemisms …just flat out he doesn’t have the skills and there’s a good chance he’d doctor the figures, if asked. In almost a half-century of involvement in US financial markets, I can’t recall anything remotely like the bluntness of this disapproval.

In simple terms (the ones I like best), I think the worry being expressed is that shoot the messenger is a substantial step beyond the bounds of what’s acceptable. They put on the table the hitherto unthinkable possibility that one day a good chunk of the country’s economic books are being cooked (sort of like Greece in the early days of the euro), and the bond market, realizing this, will demand higher interest rates for taking this extra risk. That, of course, would make the economy’s fiscal problems a lot worse. Not great for the currency, either.

This isn’t necessarily a today issue, but the idea that this is now thinkable is, I think, why professional economists are speaking out forcefully against the administration’s apparent plans for the BLS.

Nvidia and AMD have just agreed to pay a tax of 15% of revenue on sales of advanced semiconductors to China. This is in return for Washington lifting a ban on such sales. Today, Treasury Secretary Bessent has suggested that this form of tax could reasonably be applied to other US-based industries.

In the here and now, this deal makes sense for all parties. The NVDA writedown of the production cost of the chips in question, once their sale to China was barred, was $4.5 billion. If we assume the average NVDA markup of 4x, the lost revenue was $22.5 billion and the lost operating profit was $17 billion.

Assume the chips, now a generation or more old, would sell for half that today– say, $12 billion. A 15% tax on revenues to Washington would be $1.8 billion. So, if they haven’t already been sold elsewhere, NVDA would gain around $10 billion, its production cost plus $5.5 billion in one-time profit. This isn’t $17 billion, but it’s not nothing. So it’s understandable in this particular case, where the chips are already made, paid for and in inventory, why NVDA would happily agree to this. (We can imagine other possible, but unlikely, I think, cases, where, say, NVDA has already sold the banned chips elsewhere and has to order fresh chips from TSMC, but let’s not worry about these.)

The main point I see for NVDA is that if it were to relocate to, say, Vancouver, it would retain China and its $100 billion+ annual revenue stream as a customer, without having to worry about future halts on sales or export tariffs of $15 billion.

At the very least, the actuality of export tariffs would diminish the attractiveness of the US as a manufacturing base for exports to the rest of the world. Couple that with the ICE efforts to shrink the domestic workforce, and it’s hard for me to see how we’re making the economy stronger. I still think the right portfolio posture is to have foreign sales and domestic costs, but it may now be that, until the economic policy picture becomes clearer, that companies with intangible assets will fare better than those with tangible.

I’m a big fan of Nobel Prize winner, economist Paul Krugman. Today he wrote about President Trump’s firing the (now former) head of the Bureau of Labor Statistics–for presenting the most recent monthly labor situation report.

The report itself was by no means a surprise. It showed that in a time of great uncertainty–on-again, off-again tariff declarations of sometimes high, sometimes higher, sometimes lower levies–employers were hesitating about hiring and employees were hesitating to take the risk of taking a new job. This shouldn’t have come as a shock to Mr. Trump, either. After all, he saw 48 of these during his first term. And, of course, he’s a graduate of the prestigious Wharton business school. It also appears to have surprised him that the long-standing procedure is for data to be collected over a three-month period, with two preliminary monthly reports followed by a final one. In any event, Trump shot the messenger.

This itself isn’t Mr. Krugman’s gripe. He seems to think that if the replacement will simply find a way to deliver the kind of numbers Trump wants, whether they’re reality-based or not.

If so, I think this would sooner or later be bad news for the Treasury bond market. Logically speaking, one might think that foreign holders of US government debt would be the first to be spooked by an administration effort to produce deeply flawed reports on the economy (and therefore on the country’s ability to repay government borrowings on time and in full). As I read history, though, it’s big US-based holders who are the first to abandon ship.

I’m not sure there’s a reading of this situation that’s good for Treasuries, since fudging the employment numbers seem to me to shift the burden of proof for all government reports from having to prove that a particular set of books are cooked to having to establish they’re not . For stocks, on the other hand, I think the winning formula is pretty much the same–foreign revenues and US costs. For down-and-out “value” stocks, though, one may have to hope for a foreign acquirer to step in, rather than a domestic rival.