WHY THE US IS HEADING TOWARDS HIGHER INFLATION

Been away for a few days, but still keeping tap on the news in several fronts.

Let's talk about the Trump euphoria and the upward trend in the US indices.

The Dow made historic record high levels while the S&P and Nasdaq continue to trend higher. The argument is that Trump's policies will be good for US growth, and a strong US economy means a stronger US$ and rising interest rates.

Trump intends to have 15% corporate taxes and scale back payroll tax. Lower corporate tax will allow companies to repatriate their trillions of dollars back to the US from overseas and relocate their manufacturing back to the US.

Trump indicated he would implement strict immigration rules and deport illegal immigrants with criminal record, and according to some early estimates, as many as 2 -3 million people.

Also, Trump would slap 35% tariffs on a selected range of imports.

Besides the above mentioned, Trump's plans include spending US$1T to upgrade and build new infrastructure and continue to expand US military.

According to Ray Dalio, total US debt and unfunded liabilities is 1,100% of US GDP. Herein, lies the main challenge and why the US will face tremendous headwinds going forward.

And according to Zerohedge China has not bought any US Treasuries for quite some time and has been aggressively selling them since the election.

Here's my take based on the news:

1) Debt and unfunded liabilities remain the most thorny issue but Trump has not announced any plans how to combat these two which is why I think debt will continue to skyrocket under Trump due to spending on infrastructure and military in a reduced tax environment which in turn lowers government income. Sure, the growth in the economy could increase corporate tax and payroll tax revenue but according to the Congressional Budget Office, Trump's plans could likely increase US debt by another US$5T.

2) Trump may have the private sector funding part of the infrastructure development and allow the private sector to collect toll in return. So this would pass the burden to the consumer, possibly impacting on their consumption and create inflationary pressure due to price increase of goods as the tolls will increase the cost of delivery. In this case we have consumer with lower payroll tax but needing to pay for tolls and increase in price of goods. This may negate the impact of a lower payroll tax.

3) Deportation of illegal immigrants and a strict immigration policy could cause labour shortage. In a tight labour market, wages would have to increase and this could eat into companies profit. Company earnings could be pressured. The only way to offset this is to pass the labour cost to consumers. So inflation would rise.

4) As a result of rising inflation, the Fed would have to raise interest rates. As interest rates rise, so too will be the amount of interest the US government has to pay for its debt. The US deficit rose to more than more US$600B in 2016 with interest rate at 0.50%. With inflation expected to rise, the US deficit will continue rising going forward, and at a 5% normal rate, will push the US interest payment to US$1T a year based on a US$20T debt level! With mounting deficit and higher debt service, the US will have to resort to money printing. While the expectations of higher interest rates push up the US$, once the US government resorts to printing its way out of debt and to fund its liabilities, the US$ will tank.

Raising interest rates could impact upon the earnings of many companies as many have borrowed excessively to buy back shares in the last few years. So companies may have to cut spending or increase price to ensure earnings growth.

Not to forget any huge shift in interest rates could unravel the US$1.5Q derivatives market.

If the US is serious about reining in its debt, it would have to cut spending drastically, but which government will do that? Especially the US, which spends more in military and any country in the world?

5) A strong US$ will result in US multinationals being hit hard as their earnings in US$ will fall drastically. Export based companies will also be similarly impacted. Lower earnings could push the indices back to lower levels. The S&P now is valued at almost 60% higher than its historic average.

6) Slapping a 35% tariffs on goods will lead to higher inflation. So again this cost will be passed on to consumers. With costs such as toll, finance, labour and tariff being passed to the consumer, it could affect the consumer behaviour. In the event of higher interest rates, consumer will likely to spend less (due to inflation) and save more (saving against further inflation). So collectively, the impact on the economy could be worse and thought.

All the talk the inflation is bad for precious metals is unfounded. In the period of hyperinflation in the 1970 - 1980 gold rose 325%.

So in the end, we will come back to the vicious circle of more money printing, QE and loose monetary policies. It is by this rational that China is dumping US Treasuries. The world economy has gone past the point of no return with global debt now standing a record high. The only salvation is to rein in excessive government spending. But which government is ever willing to do that for fear of public discontent and revolt?