From Acting Man, by MN Gordon
Promises of Slop
“We have assembled a best-in-class team of policy advisors to drive President Trump’s bold plan for job creation and economic growth.”
– Gary Cohn, Chief Economic Advisor to President Trump
The art and science of spending other people’s money is not an occupation suited to just anyone. Rather, it’s a skill reserved for the professional world-improver. To be successful, one must act with a zealous devotion to uplifting the down and out, no matter the cost.
Donald Trump’s chief economic advisor Gary Cohn – as some observers have noted, he represents one of the factions in the wider circle of economic advisors (there are many advisors who are not members of an official body such as the Council of Economic Advisors, but reportedly have the president’s ear). This is considered problematic, or rather confusing, on the grounds that in some cases the views of these advisors appear to be diametrically opposed. The question is whose views will eventually prevail.
Photo credit: Kena Betancur / AFP / APA
Lawyers, bankers, economists, and government philosophers with fancy resumes, who attended fancy schools. These are the devoted fellows who comprise President Trump’s team of economic policy advisors. Moreover, these are the chosen associates who are charged with bringing Trump’s economic vision to fruition. Are they up to the task?
Only time will tell. But, already, it is quite evident that Trump’s economic policy advisors have their work cut out for them. During Trump’s speech to Congress on Tuesday night, he called for more jobs, more education, more military, and more affordable health insurance.
By all accounts the speech sounded delightful. Promises were made to spread the government’s slop far and wide. Trump pledged offerings that just about anyone and everyone – with the exception of grumpy face Bernie Sanders – could stand behind and applaud.
Indeed, articulating these plans is one thing. Using the force of government to execute them is another. This is where the advisors come in.
When government gets busy with infrastructure spending… this is without a doubt the best cartoon on the topic we have come across so far. We like its focus on the two essential problems of such spending: 1. the projects chosen by bureaucracies will often be unneeded and a self-evident waste of resources, and 2. bureaucracies are necessarily oblivious to the opportunity costs their spending incurs.
From Icarus to Humpty Dumpty
According to Wall Street, President Trump said all the right things. On Wednesday the Dow jumped up over 300 points to over 21,100. And despite Thursday’s pullback, the Dow ended the day above 21,000. What’s going on?
New York Fed President William Dudley says the market’s “animal spirits have been unleashed.” He also says “the case for monetary policy tightening has become a lot more compelling.” The case being, as noted by Dudley, “sturdy” jobs gains, inflation increases, and rising optimism for both consumers and business owners.
Hence, Dudley and the Fed may increase the price of credit at the next FOMC meeting later this month. In fact, as of yesterday, CME Group puts the odds of a pending Fed rate hike at over 75 percent. Bloomberg puts the odds at 90 percent.
This chart simply depicts the effective federal funds rate minus CPI. As such, it is not an ideal depiction of the “real FF rate”, since it shows the situation as is and doesn’t incorporate expectations. Inflation expectations have increased considerably in recent months though. Moreover, the chart demonstrates that the federal funds rate exceeded CPI from the early 1980s until 2000 (with the exception of a brief dip in the early 1990s) and has spent a lot of time below the zero line ever since. Currently is stands 189 basis points below CPI; if the Fed hikes by 25 bps in March, it will stand at minus 164 bps, ceteris paribus. If CPI continues to rise, this small change may soon be erased again, as has happened after the last two hikes – click to enlarge.
In other words, unless the stock market crashes before March 15, it is highly likely the Fed will raise the federal funds rate. Maybe the market will crash before March 15. Maybe it will crash after. Maybe it won’t crash at all. Who knows?
One analyst at Bank of America, with a creative metaphorical mind, has somehow penciled out a market path leading to a great fall in the second half of 2017. But first, says Michael Hartnett, investors must finish climbing the “wall of worry.” At that point, his “Icarus Trade” will turn into the “Humpty Dumpty Trade.” Thus, the great fall.
A Mess 30 Years in the Making
No doubt, Trump’s economic advisors are facing a tall order. Stocks are extremely overvalued. The Fed’s unwittingly jawboned itself into a March rate increase. Yet GDP, as reported for the fourth quarter 2016, slouches along at just 1.9 percent.
At the same time, it is projected the government will hit the debt ceiling on March 16. After that, Treasury Secretary Steve Mnuchin will have to take “extraordinary measures” – shuffle money around – to keep the lights on. By October, if Congress doesn’t raise the debt limit, the lights fade to black.
Discretionary spending in 2015 – in theory, this is the only part of government spending that can be cut. If you wonder about the “in theory” qualification, consider Greece. Of course a central bank printing press obviates the need to repudiate non-discretionary spending if push comes to shove – but only in nominal terms. Such a “solution” would still amount to a repudiation in real terms, and as such could hardly be considered to be in keeping with the “spirit of the contract”. Perhaps a stateless society would have different problems, but it wouldn’t have this problem – click to enlarge.
Somehow Trump’s advisors have to figure out how to boost the economy without boosting spending. So far their plan only accounts for half of the equation. That is, to boost the economy by pumping money into defense and infrastructure. But if spending isn’t going to also increase, where is the money going to come from?
Earlier this week it was reported that Trump wants to increase military spending by $54 billion without increasing the deficit. The $54 billion increase would be offset by cuts to other government departments and agencies. While this proposal doesn’t increase the $500 billion deficit, it doesn’t decrease it either. In short, half a trillion dollars will still be added to the debt.
A comparison of the world’s largest defense budgets. US defense spending is actually down by around $100 bn. since 2011 – but that is solely due to the wind-down of the Iraq and Afghanistan engagements. If one looks at the core defense budget exclusive of these war-related items, it turns out that it is only a smidgen below the all time high set in 2010 in real terms. It has essentially gone sideways since 2012 though. Increasing it by almost 9% will certainly make it difficult to cut total discretionary spending. Note that veteran’s benefits are not counted as part of the defense bill (and the plan seems to be to increase them as well). The two items together represent a 60% chunk of government’s discretionary spending. Given that trillions of dollars have “disappeared” without a trace at the Pentagon in recent years, it may be a good idea to focus on plugging the holes first. Just saying – click to enlarge.
In the meantime, in just under two weeks there will be an abundance of excitement emanating from Washington DC. Specifically, a rousing Congressional debt ceiling standoff will commence. Reagan era Budget Director, David Stockman is calling it a fiscal bloodbath:
“I think we are likely to have more of a fiscal bloodbath rather than fiscal stimulus. Unfortunately for Donald Trump, not only did the public vote the establishment out, they left on his doorstep the inheritance of 30 years of debt build-up and a fiscal policy that’s been really reckless in the extreme.
“People would like to think he’s the second coming of Ronald Reagan and we are going to have morning in America. Unfortunately, I don’t think it looks that promising because Trump is inheriting a mess that pales into insignificance what we had to deal with in January of 1981 when I joined the Reagan White House as Budget Director.”
Charts by: St. Louis Federal Reserve Research, National Priorities.org, SIPRI / Business Insider
Chart and image captions by PT
MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.