SEMI-MONTHLY FISCAL/MONETARY UPDATE – DEFICITS ARE NOT BEING DISCUSSED, THE NEW “THIRD RAIL”
There is not too much new, during just the last two weeks, in the way of fiscal/monetary developments. Governments, and their Central Bank (supposedly independent) agents have to adjust fiscal and monetary policy but between the US governmental dysfunction, the ongoing concerns over Brexit, and the French election there hasn’t been much time to get much actually accomplished.
In terms of fiscal and monetary affairs here at home, the political debate goes on as to whether the proposed tax cuts, which are now emerging as the centerpiece of the Trump agenda, will help or hurt our economy. Our conclusion on this front is that when the tax cuts finally take place they will be far less than has been discussed in the campaign and the early days of the Trump administration. The resulting impact on the economy will therefore be materially less than is hoped for.
A well established “Third Rail” of political discourse is the absolute necessity of adjusting non-discretionary spending, especially entitlements, if the budget is ever going to come close to balancing. Entitlements, interest on the debt, defense, and benefits including social security and disability payments, food stamps, medicare and medicaid make up 75% of the $4 trillion annual government budget. If only $1 trillion (25% roughly), is discretionary, it would obviously take an enormous cut in those services to seriously reduce the current “apparent” $587B annual deficit. We say “apparent” because what you see is not what you get, and we will discuss this later.
A new Third Rail, in addition to entitlement reform, has now emerged, and that is discussion of the Deficit itself, and the impotence of either party to seriously reduce it. When the Democrats were in charge, only the Republicans cared. Now the Republicans are in charge, and only the Democrats care. A point we must make in this regard, is that the Deficit that you see is not the Deficit you get. The Obama administration managed to bring the annual deficit down, to be sure, from over 9% of GDP, but the “under 3%” figure they trumpeted was seriously misleading. In the fiscal year ending 9/30/16, while the stated annual deficit was $587 Billion (up from the low of $470B the prior year), the actual cumulative debt went up by $1.25 Trillion, a difference of a cool $663 Billion. This is NOT a one year phenomenon, such as a result of “working capital” changes from one year to the next. We published back in October, 2016, year by year numbers over 9 years. In summary: For the nine years ending 9/30/16, the total of reported annual deficits was $7.755 Trillion, but the cumulative debt went up by $10.392 Trillion, higher by $ 2,637 Trillion. This difference is the result of “special” expenditures (“non-recurring”?) that do not run through the normal budgeting process. Be that as it may, the debt must be repaid at some point and, at the very least, interest on the debt must be paid. The interest rate is abnormally low at this point, but this is unlikely to be the case forever. There is relatively little discussion, by either party, of the deficit in the current year, and the potential increase in the total debt. When there is no discussion, you can count on the fact that there is a reason. Neither political party is willing to undergo the pain that reducing the deficit would entail. The Democrats will take the opportunity, at a time of their choosing, to cast blame for potential cuts (EPA, Planned Parenthood, The Wall, Entitlements, etc.etc.etc.) on the Republicans, but neither party is prepared to deal with the reality of the spending situation.
This debt buildup is important, especially since it continues to grow materially faster than the economy which it supports and supposedly stimulates. We harken back to the findings described in the highly respected (by most) 2010 economic treatise “This TIme is Different” by Reinhart and Rogoff. They studied the link between different levels of debt and countries’ economic growth over the last two hundred years. In summary, countries with a gross public debt exceeding 90% of annual economic output (GDP) tended to grow more slowly. Above the 90% threshhold (the US, at 85% in 2009, is now close to 110%), average annual growth was about two percentage points lower than countries with public debt less than 30% of GDP. There, of course, can be no absolute certainty that the Reinhart/Rogoff studies are currently relevant. However, the US economy has in fact struggled for almost ten years now, recovering from the financial crisis of 2008-2009 far slower than our federal administration and their economic advisors would have liked, or predicted. There is, at the very least, the possibility that Reinhoff and Rogart are directionally correct, and it will be increasingly difficult for our economy (or the worldwide economy by extension) to accelerate GDP growth, considering that the debt burden continues to grow on a relative basis.
Our conclusion: President Donald Trump has made it clear that he is not afraid of debt. He is less concerned about deficits than about defense, infrastructure spending, and protecting entitlements. The cumulative debt, and the Reinhoff/Rogart drag on the economy, will continue to grow, faster than GDP in the short term. Whether expenditures run through the normal “budget” or not, it remains to be seen whether it is well spent and will truly stimulate GDP growth. We’ve seen enough of the new administration to conclude that directional changes could be “business friendly” but not material enough to be game changing in the short run. The recently positive consumer and business sentiment readings will become more of a “show me” situation, since public economic stress will not be relieved in the short run. The 65-70% of the economy that is dependent on the US consumer will not kick into high gear quite yet. Amazon, Netflix, Google, and Apple can’t carry the economy by themselves. The rate of GDP growth will continue to be disappointing.
In terms of our interest in gold related securities: interest rates will remain relatively low, Central Banks worldwide will remain dovish to support still fragile economies. Assets such as stocks, bonds, real estate and art will remain at their elevated levels, perhaps move even higher as investors search for appreciating assets. Gold related securities, perhaps the most currently undervalued asset class , will narrow the valuation gap that has developed over the last several years.