Trump's fiscal policies are closer to Latin American debasement than anything seen before in US peace-time history
Donald Trump’s economic deal with the devil has failed even in its most immediate and cynical objective. It is downhill on every front from now on.
The President debased the US public accounts with a Peronist fiscal policy of staggering irresponsibility in order to keep control of Congress - or rather to buy Congress with $1.5 trillion of future public debt might be a better description.
He lost the House anyway, and with it his chances of avoiding a blizzard of subpoenas from the Oversight and Intelligence Committees. The Democrats won the popular vote by 7pc at the absolute apogee of a Republican fiscal boom.
The sugar rush of unwarranted stimulus so late in the economic cycle is already starting to fade. The slippage is what hedge funds call the ‘second derivative’. Over the course of 2019 the Faustian Pact will progressively close in on Mr Trump, and on the credit-rating of the US Treasury.
Morgan Stanley said the stimulus will turn ineluctably into “fiscal drag” as the months pass unless there are more handouts to feed the monster.
Perhaps Speaker Nancy Pelosi will give Trump a partial reprieve of sorts. Common ground exists on spending for roads, bridges, and infrastructure. But the Democrats will keep him on a tight leash before the next election. “They are not going to give him anything to run on, any victories,” said Steve Blitz from TS Lombard.
The first ominous signs are already evident in sectors most sensitive to higher borrowing costs. The Freddie Mac rate for a 30-year fixed mortgage has risen 100 basis points to 4.83pc over the last year. Home sales have dropped by 21pc. Average prices have slipped 3.5pc. The homebuilders’ equity index is on the cusp of a full-blown bear market.
This is remarkable given that the fiscal pedal is pushed to floor. The federal budget deficit is nearing 5pc of GDP, at a time when full employment and bulging tax revenues should restore balance. Bill Clinton had a surplus of 2.3pc at the end of the 1990s expansion, a model of rectitude.
The US has never run a late-cycle deficit of this scale in peacetime. The stimulus has washed over the economy like a deluge of rain on parched soil, a flash flood that leaves only damage. “They have had a terrible bang for the buck,” said Adam Posen, chairman of the Peterson Institute.
“They are racking up debt with a low fiscal multiplier. The tax cuts have not unleashed investment and have added almost nothing to GDP on a sustained basis,” he said. What remains is an overheated economy with early signs of stagflation.
Above all, there remains the future debt claims on American taxpayers. The International Monetary Fund says America’s gross public debt will be 106pc of GDP this year, 110pc in 2020, and 117pc in 2023, but without the huge pool of internal savings and external assets that have made it possible for Japan to defy gravity for two decades.
It was 61pc as recently as 2006. The task of taming America’s runaway entitlements will be that much harder by the time Trump has finished his handiwork, perhaps impossible. This is how to ruin a great country.
It one reason why former-Fed chief Alan Greenspan calls Trump “the closest thing that America has produced to a Latin American-style populist” - the Caudillo del Norte, millionaire voice of the descamisados.
The other reason is Trump’s clientelism: how he coddles incumbent interests - coal, steel, cars, the declining industries - that stand in the way of economic progress and creative destruction.
Trump’s policies flout the cardinal Keynesian rule - “the boom, not the slump is the right time for austerity” - without achieving its stated supply-side objectives. The President claimed a year ago that his ‘Tax Cuts and Jobs Act’ would lead to a Reaganesque investment boom and would be “rocket fuel for the US economy”.
It has done no such thing. Capex spending by business has been falling. Non-residential investment is the slowest in two years. The ‘happy hand-over’ from fiscal fizz to a durable surge in productivity is nowhere to be seen.
The cut in corporate tax rates from 35pc to 21pc has instead fed stock buybacks by US companies. Why would they invest a decade into an ageing boom, and in the midst of a global trade war?
This is not a replay of Reaganomics in the 1980s. The Reagan tax cuts came earlier in the cycle when there was still an output gap. Marginal tax rates where then much higher. There was at least some plausibility to Laffer Curve claims that tax cuts would pay for themselves with higher growth. And Reagan’s rearmament at least won the Cold War. His fifteen aircraft carrier battle groups had a high strategic return on investment.
The obvious problem with cranking up stimulus today when unemployment is at a half-century low and capacity constraints abound is that the Federal Reserve must fight back with monetary tightening or let the inflation genie out of the bottle. The equilibrium interest rate - R* in central bank argot - is jumping higher.
The loose fiscal/tight money mix has widened the differential in global interest rates and pushed up the Fed’s trade-weighted dollar index by 10pc since January to 128. It is just a whisker of shy of a 30-year high.
This is torment for a global financial system has never been so dependent on US dollar borrowing, with $26 trillion of offshore lending in bank loans, bonds, and equivalent derivatives (BIS estimates), and with a collective debt ratio some 40 percentage points higher than the pre-Lehman peak.
Much of the emerging market nexus is already in the grip of a credit crunch as a result. This may get worse until ‘blowback’ into the US economy finally causes the Fed to retreat.
The mechanical consequence of a US consumption boom and a soaring dollar is to suck in imports, painting the current account deficit in Gothic colours. The IMF forecasts a chasm of $652bn or 3pc of GDP next year. The non-oil component is already hitting the 4pc peak seen in the deficit scare twelve years ago.
Mr Posen’s fear is that the White House will hunt for scapegoats, lurching further into protectionism and tariff warfare. It is the culminating logic of Trumpism.
The Fed is now unwinding QE with bond sales of $50bn a month, both draining global dollar liquidity and adding to the supply of debt that US markets must digest. This is making life even harder for the US Treasury as it tries to cover Mr Trump’s $1 trillion deficits. Hence the jump in real 10-year Treasury yields (TIPS) to 1.23pc from 0.46pc in January.
Debt markets are tightening. The average borrowing cost for BBB-rated companies in the US has jumped 120 basis this year to 4.71pc. Michael Pearce from Capital Economics says US yields have already risen more for household and firms in this cycle than they did during the last four tightening cycles going back to the 1980s. This paves the way for trouble next year as fiscal largesse fades.
Trump faces the Red Queen syndrome. He must run ever faster to stay still. Such is the diminishing force of fiscal stimulus
Trump has sucked all the short-term advantage that exists by manipulating the macro-economic levers. Henceforth it will be harder. Lakshman Achuthan from the Economic Cycle Research Institute calls its the Red Queen effect from Alice in Wonderland. “It takes all the running you can do, to keep in the same place. If you want to go somewhere else, you must run twice as fast.”
If Trump is lucky, the Fed will calibrate its tightening perfectly - a feat rarely achieved - and pull back just in time to keep an ageing and by then enfeebled expansion going into 2020.
It is just as likely that the US will slip to stall speed and tip into recession in late 2019. Either way he will face his next election in far more hostile circumstances.