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IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
MARCH 8 , 2017
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This week in IntelDigest, we will have the first of several weekly discussions on the subjects of Legislation and Policy, as the Trump Administration goes to battle with Congress on issues of vital importance to the nation. The American economy is at stake in this conflict, and the actions of the White House and Congress will determine if we, as investors, finish the year on a sweet or sour note.
As we wrote in November, in the weeks following the election, the Dollar and stock markets were rallying ..
“… on the expectation that a Trump presidency will be good for business. The President-Elect has vowed to lower taxes (especially on corporations), commit Hundreds of Billions of Dollars to infrastructure spending, and reduce government regulation.”
The stock market has continued to advance since Donald Trump assumed the Presidency, on the same hope that these business-friendly policies will come to pass. However, the market strength will have to subsist on hope until the President and Congress prove that they can work together and move forward on two major issues: (1) the Debt Ceiling, and (2) Tax Reform. These are the topics for our discussions in IntelDigest during the remainder of March.
In our opinion, the new President has started with some counter-productive moves. In his zeal to overturn the Obama Legacy, he is making the same mistake that President Obama made in his first term: focusing too much on healthcare. As President Trump stated (without a hint of irony) in a speech to the nation’s governors on February 27, “nobody knew that healthcare could be so complicated.”
So, the hard work of governing begins …
The first draft of a Republican replacement for the Affordable Care Act has stoked criticism from both mainstream Republicans and right-wing Republicans (not to mention opposition from Democrats). Arguments over healthcare policy threaten to impede progress on more important matters affecting the economy.
In addition to Healthcare, the Trump Administration is seeking to vastly reduce federal government regulation, cut the budget for many government agencies and departments, and spend a whole lot more on the Military and Infrastructure. Tax Reform is a major issue, which we will discuss in detail over the next couple of weeks. But, the first major battle of vital importance to the nation comes up next week … the Debt Ceiling.
The First “Speed Bump” for the Trump Administration
It is likely that two events will occur next Wednesday which will directly impact the U.S. Economy. It is expected that The Federal Reserve will raise short-term interest rates by another 25 basis points (0.25%), as The Fed tries to put monetary policy back on an even keel (as we discussed last week). And, the President and Congress will begin to battle over raising the Debt Ceiling.
The U.S. Debt Ceiling is a legislative limit on the amount of federal debt which can be issued by the U.S. Treasury. As the federal government has been regularly spending more money than the Treasury takes in over the last few decades, the government must borrow to help fund operations. When borrowing pushes the national debt up to the Debt Ceiling, conflict arises.
The government must choose among cutting programs and spending, or defaulting on the Debt, or raising the Ceiling. Political conflicts have led to government shutdowns. In 2011, a crisis arose over a threatened default of government debt … leading to a downgrade in the credit rating of The United States … when political wrangling delayed an increase in the Debt Ceiling.
In October, 2015, President Obama and Speaker Boehner negotiated an agreement to suspend the Debt Ceiling until March 15, 2017, allowing the national debt to keep piling up. As of next week, the new President and the Republican-controlled Congress will have to come to terms on a new Debt Ceiling, or otherwise agree on federal spending limits.
History of the Expanding National Debt
We wrote, in the September 28 issue of IntelDigest, that:
“… the state of our official National Debt … stands at approximately $20 Trillion. Additional future unfunded government liabilities … Social Security, Medicare, Medicaid … would increase the true National Debt to hundreds of Trillions of Dollars over the coming decades.
The official Debt can only increase, as the federal government continues to spend much more than it brings in. Boston University professor Laurence Kottlikoff has written that over 90% of federal tax revenues go to cover entitlement programs plus interest on the Debt. ALL other federal government expenditures … including the cost of the largest military in the history of the world … has to be funded from the remaining 8-9% of revenues, PLUS more and more borrowing.”
Our national debt is close to $20 Trillion, while our national Gross Domestic Product (GDP) is approximately $19 Trillion, resulting in a debt-to-GDP ratio of 105%. How did things get this bad?
In the first 200 years of the Republic, such peaks in the debt-to-GDP ratio occurred during major wars … the Revolutionary War, Civil War, World War I, World War II. After the wars were finished, the country worked to re-establish sound financial footing, so that the debt-to-GDP ratio always came down to reasonable levels. As recently as the Nixon, Ford, and Carter administrations, the ratio stood at approximately 33%.
The Era of Expanding Debt began in the Reagan Administration in 1981, and has grown through Democratic- and Republican-controlled governments alike. After decades of strong economic growth and stable “real” interest rates, Reagan entered office in a time of high inflation, high interest rates, and a major recession. He had, in his favor, a low debt-to-GDP level and sound American credit.
After Fed Chairman Paul Volcker successfully brought inflation and interest rates under control, the recession ended and the Dollar was strong. President Reagan wielded American fiscal strength as a weapon to win the Cold War … using deficit spending and borrowing power for a huge military expansion, including the Strategic Defense Initiative anti-missile program (dubbed “Star Wars” by the press).
Reagan’s first-term tax cuts and second-term military spending ballooned the Debt and federal deficits; the debt-to-GDP ratio rose to 55%.
The fiscal conservatives in the Reagan Administration (some of whom now advise Donald Trump) expected that tax cuts would reduce government income, and the government would be forced to cut spending in order to reduce deficits. But, it didn’t work out that way. Higher and higher government spending became a way of life.
Under the administration of George H.W. Bush, the deficit grew, and the debt-to-GDP ratio rose to 60%. So, the Bush Administration negotiated a budget compromise, including some tax increases, with the Democratic-controlled Congress. This was contrary to his “No New Taxes” pledge, which damaged his re-election chances. Ross Perot entered the race as a third-party candidate, and Bill Clinton won the 1992 election.
The Clinton Administration was able to enjoy a period of relative peace in the world; through lower military spending, sound monetary policy by The Federal Reserve, and a small rise in income taxes (which are at roughly the same levels today), President Clinton presided over the longest peacetime expansion of the economy in American history, and produced a small budget surplus for the first time in 30 years.
At the time of the election of George W. Bush (and Dick Cheney) at the end of 2000, the federal budget was again in deficit and the debt-to-GDP ratio was at 58%. Although his predecessors had succeeded in holding the line on the debt level, it was still close to the highest level in history to that time.
Bush/Cheney pushed through major tax cuts in 2001 and 2003, and increased federal government spending across the board. They adopted additional increases in federal spending for military and intelligence in response to the 9/11 attacks, and prosecuted wars in Iraq and Afghanistan, as well as military actions in several other countries.
At the same time, The Federal Reserve continually lowered short-term interest rates, encouraging speculation in banking and real estate.
By the end of the Bush Administration, the debt-to-GDP ratio was up to 63%, the national debt had grown to $10 Trillion, and the world economy was in full-blown Financial Crisis.
Barack Obama entered office during the worst financial panic since The Great Depression … the economy was crashing and jobs were lost by the millions. The Administration’s attempts to stimulate the economy with government deficit spending succeeded, but at a slow rate of less than two percent per year. The 2009 American Recovery and Reinvestment Act provided little “shovel-ready” infrastructure spending, and went primarily to protecting jobs of municipal workers, teachers, healthcare workers. The Republican-controlled Congress blocked further stimulus programs.
The Way Forward
The Trump team believes that Growth is the answer to leading the American economy out of our Debt Crisis over the next decade. Although mathematically possible, it will be a long and difficult journey, even in the best of circumstances.
But, that long journey begins next week. In order to have the financial flexibility to pursue the Trump Agenda, the Administration will require the cooperation of the Republican-controlled Congress to increase the Debt Ceiling. There are factions within the Republican Party which are not likely to cooperate. So, we can expect a battle to be raging at this time next week.