Trump Deficit Will Be Huge |
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weekly commentaries provide Euro Pacific Capital's latest thinking on
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the writer, and may or may not reflect those held by Euro Pacific
Capital.
There is much we don’t know about how the Trump presidency will
play out. Will the Wall get built? Who will pay for it? Will it have at
least some fencing? Will repeal and replace happen at exactly the same
time? Will Trump throw a ceremonial switch? Will there be a Trump
National Golf Course in Sochi? It’s anyone’s guess. But of one thing we
can be fairly certain. President Trump is very likely to preside over
the largest expansion of Federal budget deficits in our history. Trump
has built his companies with debt and I’m sure he thinks he can do the
same with the country. His annual budget deficits are likely going to be
huge. This development will make a greater impact on the investment
landscape than most on Wall Street can imagine.
In the past half-century, Republican presidents have been the going
away winners at the deficit derby, a fact that should make any true
conservative blush. The sad truth is that annual deficits exploded under
Ronald Reagan and George W. Bush, and generally contracted under Bill
Clinton and Barack Obama (despite the latter's distinction of having
added more total debt than all previous presidents combined.) Some of
the explanation is just luck of the draw, some walked into office in the
midst of recessions they didn’t create. But the better part of the
explanation is baked into the political dynamics.
Democrats want to raise spending and taxes. Republicans want to cut
spending and taxes. But whereas Democrats have generally succeeded on
both of their missions, Republicans have just succeeded in one. (Actual
spending cuts require politically difficult choices that are much harder
to vote for than perennially popular tax cuts). This puts a giant thumb
on the Republicans’ budgetary scale.
Like prior Republicans, Trump has promised to cut taxes, on both
corporations and individual taxpayers…even the wealthy. But unlike prior
Republicans, he has not paid a word of lip service to spending cuts. He
has promised to spend now, and spend big. Trump just doesn’t do the
austerity thing. It’s for losers.
In addition to fronting the cost of building the 2,000 mile Wall (accounts receivable has a reliable address in Mexico), Trump
plans big increases in military spending, both on active military and
on our veterans. His reboot of Obamacare has yet to be presented, but as
he has promised that no one will lose coverage, not even those with
pre-existing conditions, we can be sure that Trumpcare won’t be cheap.
But his big project will likely be his promised $1 trillion plus
infrastructure spending plan. Most importantly, he diverges from most
Republicans by promising no structural changes in Social Security and
Medicare, the entitlement leviathans that are the sources of the vast
majority of Federal red ink.
To aid him in these budget-busting efforts, Trump will have the
benefit of a compliant Congress in which his own party controls both
Houses. Most Republican senators and representatives now seem eager to
jump aboard the Trump train and will likely pass anything he sends to
the Hill. Those who resist should prepare for the kind of political
hardball that we have rarely seen in this country (I’m talking to you
Lindsay Graham). If Republicans couldn’t hold the line on Obama, how
will they do so with Trump and, politically, why would they even want
to? Grandstanding against Obama’s big deficits, even to the point of
forcing a government shutdown, did not play well politically. Standing
up against Trump will involve considerably more risk with Republican
primary voters.
Even if none of Trump’s taxing and spending plans come to fruition,
the United States would still be on the threshold of a sobering era of
debt expansion. The age of trillion dollar plus annual deficits began in
2009 when the financial crisis tripled a very large $458 billion
deficit in 2008 into a record smashing $1.4 trillion in 2009. Three more
trillion-dollar deficits followed. But since 2009, excluding a small
increase from 2010 to 2011, the deficits have declined steadily. By
2015, they had decreased to $438 billion, slightly below where they were
before the crisis began. (Of course these smaller deficits exclude
hundreds of billions of additional debt that is borrowed off
budget.) These developments have caused many to conclude that budgetary
issues are no longer at the top of the agenda.
But, as a result of the failure of Republicans and Democrats to
achieve any kind of agreement on long-term budgetary reform, the
six-year run of declining deficits has come to an end. The 2016 deficit
was more than $100 billion wider than 2015. This marks the first year
since 2009 that the deficit increased from the prior year (except for a
minimal .001% expansion in 2011 over 2010). This is just a down payment
on things to come.
The Congressional Budget Office (CBO) - the closest Washington
comes to actual objectivity - issues long-term budget assumptions.
Except for a relatively small dip from 2017 to 2018, the CBO sees
continuous deficit expansions every year through the end of the next
decade, culminating in continual $1 trillion deficits every year
starting in 2024. (8/23/16 CBO report) That’s the good news. The bad
news is that in making these projections, the CBO has to make some very
rosy assumptions. The most egregious of these is that the U.S. economy
will avoid recession for the entirety of the next decade.
Over the past century we have seen a recession, on average, every
60 months (based on data from National Bureau of Economic Research and
Bureau of Labor Statistics). According to current figures, the economy
has been in expansion for 92 consecutive months. This means that the
current expansion is already 50% longer than average. Expecting it to
last for nearly 18 years is completely without precedent. I believe it
will be sooner rather than later that we will have another
recession, which will greatly enlarge the deficits. History is clear on
that point. The Great Recession caused the deficit to triple. Even the
mild recession of 2001 turned a $236 billion surplus into a $157 billion deficit in
just two years. The next recession I expect to work similar magic. But,
in addition to being blind to recessions, the CBO was also blind to
Donald Trump.
In making its projections, the CBO simply assumed
that the taxing and spending laws currently on the books would remain
unchanged. The projections do not account for any tax cuts or spending
increases. As mentioned previously, Trump has virtually promised to do
both in the first year of his presidency. If he is successful, we could
return to trillion dollar deficits much sooner than the CBO thinks. A
recession could push the red ink well into record territory.
The graphs below chart the prices of gold and the dollar versus
annual budget deficits since 1990. The data shows clearly that after a
few months of lag time, the price of gold has followed
the long-term expansion and contraction of deficits, while the dollar
has moved in the opposite direction.
Of course, who on Wall Street has picked up on
these macro trends. In fact, one of the biggest issues currently being
discussed is how the U.S. economy will deal with a perennially
strengthening dollar. They are assuming that the Federal Reserve will be
raising rates and that the economy will be expanding under the Trump
stimulus thereby strengthening the dollar and attracting flows from
abroad. This type of “trees grow to the sky” thinking is similar to
Clinton-era assumptions that the national debt would be repaid by
perpetual budget surpluses, or the feeling earlier in this century that
real estate prices could never decline.
To make these assumptions, Wall Street must ignore
the obvious ramifications of big deficits, in particular the need for
the Federal Reserve to step up and buy all the new debt that the Trump
administration will have to issue. The last time the government had to
find buyers for more than a trillion dollars per year of debt, it relied
on foreign central banks. Eight years ago, the vast majority of
Treasury debt was purchased by China and Japan (and, to a lesser extent,
Saudi Arabia, Russia and other emerging nations in Asia and Latin
America). But as the debt surge persisted, the real heavy hitter became
the Federal Reserve itself which, through its Quantitative Easing (QE)
Program, bought more than half a trillion dollars of Treasury debt per
year from 2009 to 2014.
But there can be little expectation that the foreign buyers will be
returning for a repeat performance. Currently, both China and Japan are
looking to draw down foreign exchange and are engaged in active selling
of U.S. Treasuries in order to keep their currencies from declining
against the dollar (Scott Lanman, 10/18/16, Bloomberg). What’s more,
Donald Trump is likely to engage in aggressive trade wars that
may certainly discourage other foreign central banks from supporting our
debt issuance.
Also, bond analysts are now convinced that the 35-year plus bond
bull market, which began in 1980, finally topped out in July of 2016,
when European and Japanese yields sank deeply into negative territory
and yields on the 10-year Treasury hit 1.36% (Peter Boockvar, 9/19/16,
CNBC). Since then bond prices are down significantly across the
board. If this trend continues, it will discourage private buyers from
making the jump into Treasuries. In other words, the Fed may be the only
game in town when it comes to financing future deficits in a new bond
bear market.
This would mean that the QE programs that many had assumed to be a
thing of the past can return with a vengeance, becoming the signature
program of the Trump era. When this reality sinks in, you may
witness the dollar begin a long and steady decline from its current
decades-high strength. At the same time, gold, gold stocks, commodities
and foreign stocks could finally enter a turnaround.
Ultimately, I expect years of dollar decline to culminate in a
crisis, with the dollar plunging in value, as the world abandons it as
its primary reserve currency. The last time the dollar was on the brink
of collapse it was saved by the financial crisis of 2008. Next time we
will not be so lucky!
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