Peter Schiff
The optimism that has followed the election of Donald Trump has
pushed the Dow Jones Industrial Average to the threshold of 20,000, a
level that will be both a nominal record and a symbolic milestone.
Although this is not the way most observers had predicted that 2016
would play out, most on Wall Street have become extremely reluctant to
look a gift horse in the mouth…or to even look at him at all. The
impulse is to jump on and ride, and only ask questions if it pulls up
lame. But if this year has proven one thing, it is that predictions made
by the consensus should not be trusted.
Back in the earlier part of 2016 the mood was decidedly darker. At
that point most people believed that the Federal Reserve would be
raising rates throughout the course of the year. While such hikes had
been anticipated (and delayed) for years, most took comfort in the
belief that the economy would be expanding nicely by the time the Fed
actually pulled the trigger. But in late 2015, the already tepid GDP
growth seen in the prior two years seemed to be decelerating. Investors
also concluded that Hilary Clinton was a lock to win the election,
thereby assuring that the anti-growth policies of the Obama years would
continue. Many looked at these developments and concluded that the sins
of the past decade, in which the Government and the Federal Reserve had
used unprecedented levels of fiscal and monetary stimulus to prop up the
economy and the stock market, had finally caught up with us. As a
result, the Dow Jones shed more than seven per cent in the first two
weeks of the year, its worst start on record.
But the year comes to an end amid a cloud of Trump-fueled
bullishness. The markets fully embrace an unapologetic capitalist, and
his team of billionaires, who promises to cut taxes, rewrite trade deals
in America’s favor, take a machete to anti-growth regulations, repeal
Obamacare, and return America to its former industrial might. Many are
making parallels to the Reagan Revolution in which a maverick
anti-establishment Republican took charge in Washington and ignited an
economic boom, a stock market rally and a surge in the dollar. But to
make this comparison, boosters must jump over a more telling comparison
to the last Republican president elected, George W. Bush.
The parallels to W. are striking. Both lost the popular vote, and
will have taken office following the tenure of a two-term Democrat who
had presided over a furious stock market bubble and a surging dollar. In
the 4 years prior to Bush's election, the Dow Jones had surged
approximately 60% and the dollar index had risen approximately 19%
(1/2/97 to 12/29/2000). For Trump, the numbers are 48% and 24% (1/2/13
to 12/21/16). Then, as now, the U.S. was seen by investors as the only
game in town. Clinton's second term was rife with global crises that
both created safe-haven flows into the dollar and caused the Fed to
backstop U.S. financial markets with cheap money (at least cheap by the
standard that existed at the time). Both will have come into office
promising tax cuts and regulatory relief following eight years of
Democratic reign. As a result, the market gains of the Clinton and Obama
years were expected to continue under their Republican successors.
But the optimists did not anticipate that the big, fat, ugly bubble
that inflated during Clinton’s second term, would burst early in Bush’s
first term (although the air started coming out of that bubble while
Clinton was still in office). Given the ensuing recession of 2001, it
can be argued that the only reason Bush was reelected in 2004 was that
the Fed was able to inflate an even bigger, fatter, and uglier bubble in
housing that postponed the pain until the financial crisis of 2008.
That is where the similarities will likely end, as Trump will likely not
be that lucky.
One of the pillars of dollar strength under Clinton was eight
straight years of deficit reductions, culminating with a massive $236
billion budget surplus in 2000 (Congressional Budget Office). While the
surplus did require some accounting smoke and mirrors and a stock market
bubble to create, it nonetheless marked a significant achievement. At
that point, many economists had assumed that the U.S. debt problem had
largely been solved and that the country would ride a wave of permanent
surplus. The only problem most could envision was a shortage of Treasury
bonds once the national debt was fully repaid. No one is to worried
about that “problem” now.
Similarly, Trump is taking charge at a time when official budget
deficits have fallen consistently since 2009 (albeit from astronomically
high levels). But 2016 is projected to be the first year since 2009 in
which the deficit will have risen, significantly, from the prior year.
The Congressional Budget Office sees a return to perpetual $1 trillion
plus annual deficits in the early part of the next decade (The Budget
and Economic Outlook: 2016 to 2026 report, January 2016), even if we
have no tax cuts, spending increases or recessions over that entire
time. Under the Trump presidency, we are likely to get all three.
If a recession comes early in Trump’s presidency, it will be no
more his fault than the 2001 recession can be blamed on Bush. A sharp
pullback has been years in the making. Firstly, there is simply the
issue of timing. On average, the U.S. has experienced a recession every
60 months or so since WW II (based on data from National Bureau of
Economic Research and Bureau of Labor Statistics). The current expansion
is already 90 months old, or 50% longer than average. Sooner, rather
than later, it will have an end date. Recessions completely reshuffle
the budgetary deck, causing government outlays to rise and revenues to
fall simultaneously. The swings can be dramatic. The 1981-1982 recession
resulted in a 61% increase in Federal red ink. The recession of 2001
turned a $236 billion surplus in 2000 into a $377 billion deficit in
2003 (then a record). The Great Recession of 2008-2009 caused the $458
billion deficit in 2008 to more than triple to $1.4 trillion in 2009.
Rest assured, the next recession can cause a similar catastrophe to the
government’s finances.
Trump’s election was predicated on his intention to buck
traditional Republican policy of fiscal restraint. He has promised tax
cuts for people and corporations and massive $1 trillion plus spending
binges on infrastructure and the military. Of course the argument goes
that these moves will stimulate growth thereby raising tax revenue to
pay for both the cuts and the spending. The same arguments were made by
George W. Bush in 2001 when he cut taxes, increased spending, and pushed
through a temporary tax holiday to encourage corporations to repatriate
money held overseas. Deficits soared anyway. The only real question is
will the recession arrive before or after Trump’s fiscal policies kick
in. If the events happen simultaneously, the budgetary implications will
be hard to fathom.
Investors who are basking in the Trump victory should take a hard
look at what happened to the markets during the Bush presidency. In
mid-2008 (just a few months before the financial crisis sent stocks
plummeting), the S&P 500 was just 17% above the level when Bush was
elected nearly eight years earlier. The dollar, in particular, took a
beating under Bush. In August 2008 (right before the dollar rallied
temporarily as a result of the panic), the dollar index had fallen by
19% since his election. The opposite occurred in gold. In November of
2000, gold was at about $370 per ounce, close to a 20 plus year low. In
August 2008, it was more than $920, down significantly from it's high of
almost $1,100 hit earlier that year.
Also, for all the optimism about the U.S. stock market and
pessimism abroad, it was foreign markets that delivered for investors.
From Bush’s election to mid-2008, just before the global financial
crisis sent stocks reeling around the globe, developed foreign markets
were up 80% (priced in U.S. dollars) while emerging markets were up a
staggering 300% (priced in U.S. dollars). Even if you include the huge
losses in the back half of 2008, by the time Obama was sworn in,
developed markets were down less than 3% from the time of Bush’s
election, and emerging markets were still up about 80%. (In contrast,
the S&P 500 was down almost 27%).
The 2001 Recession, which was triggered by the bursting of the
dotcom bubble and the September 11 attacks, came very early in Bush’s
first term. Fortunately for W., the Federal Reserve was able to support
the economy by bringing rates down from more than 6% to just 1% (Federal
Reserve Bank of St. Louis) (which helps explain the swift collapse of
the dollar). As a result, the 2001 recession was the shortest and
mildest on record. In doing so, however, the Fed blew up an even bigger
bubble in real estate, the bursting of which created a far bigger
recession in 2008, propelling Obama into the White House.
But can the Fed ride to the rescue this time around? Given that
rates are practically zero and the Fed is choking on trillions of
dollars of assets that are permanently held on its balance sheet, the
answer is clearly no. All the Fed will be able to do is launch the
mother of all QE programs, perhaps in the form of a massive helicopter
drop. But the bad news for Trump fans is that the result will not be a
housing bubble like the one that bailed out Bush, but a wave of
stagflation that will make Trump a one-termer. The nightmare scenario is
that once again tax cuts and deregulation take the blame, allowing
Bernie Sanders or a socialist candidate to ride another populist wave,
only this one headed far left, into the White House of 2020.
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