Why the Trump Trade is Flawed
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Posted 15/12/2016
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Last night the US Fed raised rates for only the second time in 10 years. Despite being a ‘sure thing’ the 0.25% rise saw the biggest sell-off in shares since the election and along with them, bonds and gold were beaten down also. The USD was the only (predictable) winner and that saw weakness in the AUD and buffered out all the gold losses for us. Silver ended up stronger. That stronger USD could start to play havoc with US business growth and Emerging Market debt stress. This, like last December, may be the first ‘reality check’ for the Trump Trade. The second may be near.
From the day the Trump based rally started we’ve warned of the realities of getting all that ‘promised’ stimulus and accompanying debt through Congress and the legacy thereafter. It’s where euphoria meets reality. Well, more than a month before he is even inaugurated Senate Majority Leader, Mitch McConnell, has signalled that stimulus is unlikely to get through if it is going to add to the already huge (around $600b) deficit and US debt pile.
From a Bloomberg article he “poured cold water on the idea of a massive stimulus package, effectively laying out markers on taxes and spending that that could cramp Trump’s ambitions." and that he "warned he considers current levels of U.S. debt “dangerous” and said he wants any tax overhaul to avoid adding to the deficit."
The US already has nearly $20 trillion in government debt (before including unfunded liabilities of around $100 trillion <see here>) and the Committee for a Responsible Federal Budget estimates Trump’s fiscal stimulus promises would add another $5.3 trillion in just a decade with deficits in the order of $1 trillion per year for the first 4 years. As we’ve reported previously too, Goldman Sachs calculate there would be no impact on the economy from all of this until 2018. For a sharemarket in its 8th year of expansion and the 3rd longest and 3rd most overvalued in history, that could well be a bridge too far.
There is the small issue too of the debt limit that needs to increase next year. In the past the Republicans have extracted an eye tooth from Obama each time. When McConnell says “I think this level of national debt is dangerous and unacceptable”, you’d have to think increasing it by another $5 trillion isn’t going to fly…
Finally, and more fundamentally on fiscal stimulus as is proposed, The Daily Reckoning’s Vern Gowdie penned a great article yesterday on the results. Here’s a couple of excerpts:
“In August 2014, the International Monetary Fund published a working paper titled ‘Public Investment as an Engine of Growth’ (emphasis is mine):
‘The general idea that public capital and infrastructure will boost economic growth is a prominent feature of government economic programs across the world.
‘The econometric evidence reveals small positive and instantaneous associations between public investment booms and economic growth, but little long run impact. Several aspects of the evidence cast doubt on the idea that past booms triggered or accelerated GDP growth. Most of the positive association occurs immediately; a spending boom tends to be immediately associated with a rise in GDP this year, but not subsequent years.
‘Overall it is difficult to find a clear-cut example that fits the oft-repeated narrative of a public investment boom followed by acceleration in GDP growth. If anything the cases of clear-cut booms illustrate the opposite – major drives in the past have been followed by slumps rather than booms.’
It’s no mystery as to why these economic programs fail to deliver the bang for the multibillion-dollar buck:
‘Case studies indicate that public investment drives tend eventually to be financed by borrowing and have been plagued by poor analytics at the time investment projects were chosen, incentive problems and interest-group-infested investment choices.’”, and
“If infrastructure spending actually worked, Japan would be the poster child in this regard. Instead, it’s a basket case.
According to Bloomberg:
‘[Japanese] Prime Minister Shinzo Abe’s “bold” plan to revive the economy with a $273 billion package leaves him traveling down a well-trod path: it marks the 26th dose of fiscal stimulus since the country’s epic markets crash in 1990, in a warning for its effectiveness.
‘The nation has had extra budgets every year since at least 1993, and even with that extra spending, it has still had six recessions, an entrenched period of deflation, soaring debt and a rapidly aging population that has left the world’s third-largest economy still struggling to get off the floor...
‘...if previous episodes are any guide, an initial sugar hit to markets and growth will quickly fade amid a realization that extra spending does little to cure the economy’s underlying problems. A Goldman Sachs Inc. study found that markets gave up their gains in the first month after the cabinet approved the stimulus in 18 of the 25 packages it studied since 1990.’”
So we have the double whammy of a sharemarket rallying on the hope of stimulus that may well be blocked, or at the very least watered down by Congress, and of which history tells us there is no lasting economic benefit regardless. Rather, we get an even bigger debt pile to overwhelm and collapse the economy instead of just letting markets be markets and, God forbid, have a recession every now and then, reset, and continue. Regular, natural recessions have happened for centuries and we’ve survived. This obsession to prevent the next one at all costs, could well be creating an economic, and indeed social, collapse of unprecedented proportions.