As a class, investors have enjoyed the fruits of the Trump presidency. From the day of his election through this past January, the Dow Jones rose 48%, from 17,888 to 26,616. That is a rally of unheard of proportions for a large cap market index. After it hit that high in late January, the market corrected by 10%. Despite those who feared the worst, the pullback was a healthy – and needed – correction for a market that has been careening upward. Over the past week, the economic momentum encapsulated in the stock market's advance has been shaken by Donald Trump's apparent eager embrace of a trade war, and his willingness to threaten the myriad advantages that the United States has enjoyed as the architect of the post-World War II international order.
If you talk to investment advisors these days, they are an optimistic bunch. The world, they will tell you, is in a uniquely aligned period of economic expansion. Even Japan, which has been mired in economic stagnation and deflation for several decades now, is finally showing signs of growth. At home, the U.S. has rebounded from the 2007-08 global financial collapse more robustly than most areas of the industrialized world. Unemployment has continued a long, steady decline, domestic manufacturing is growing, and, as illustrated in the graph here, consumer confidence has steadily improved, to its highest level in nearly two decades.
Just as the stock markets had bounced back from the correction that began in late January, Trump threw a wrench in the works, announcing that he planned to institute a 25% tariff on steel imports. One might have thought that by now the world would have learned not to over-react to Trump's words, and instead waited a few days to see if there was any substance to his announcement or if it was just one more tactical diversion to draw attention away from what has been one of the most tumultuous weeks of his presidency, but markets are easily spooked by threats of tariffs and trade wars. However glowing the global economic context might look, these threats are a reminder of the risks that politics can pose, and harken back specifically to the Smoot-Hawley Tariff Act of 1930. That Act put in place protectionist tariffs and trade policies in the wake of the 1929 stock market crash. The retaliatory tariffs and trade war that ensued are widely credited with deepening the Great Depression. Trump's words proved to be hard to gloss over, and within the first hours following his announcement, $400 billion in market value evaporated. Within two days, the Dow dropped 1,000 points.
The threat posed by Trump's continuing flirtations with economic nationalism goes well beyond the tit-for-tat consequences that we might face should he go forward with imposing tariffs on one industry or another. It is easy to forget how dependent upon the rest of the world we have become, not just with respect to confronting global issues like the terrorism or climate change, but in the more mundane issue of how we pay our bills from one month to the next.
Talking about debt and deficits has gone out of fashion, and for good reason: after a decade of zero and near-zero interest rate policies by central bankers around the world, the annual interest cost on the federal debt has remained artificially low, assuring that the financial cost of federal deficits has been far lower than the political cost of doing anything about them (i.e. raising taxes or cutting spending). While total outstanding federal debt held by the public has grown ten-fold since Ronald Reagan was president – from $1.2 trillion in 1984 to $11.7 trillion in 2016 – the net interest cost in the federal budget has barely doubled, rising from $111 billion to $240 billion, as the average interest rate paid on the national debt plummeted from over 8% to under 2%.
In a world where borrowed money costs so little, Congress finally decided that yelling and screaming about deficits isn't worth it; a new consensus emerged: deficits don't matter. The moment of capitulation came when Republicans – including members of the formerly anti-debt Freedom Caucus – embraced tax cuts estimated to cost $2.2 trillion. After that, the budget deal costing $300 billion was a cakewalk.
The result of that capitulation is projected to be trillion-dollar deficits for years to come. That, in turn, means that the United States will be depending on the good will of the international community for years to come – a consideration that does not appear to factor into Trump's view of the international landscape.
Our ability to fund massive budget deficits year after year without feeling much pain has not been just because of zero interest rate policies that have been in effect since the 2008 collapse, but also because for the past half-century the U.S. dollar has been the reserve currency of the world. Both of these circumstances are now at risk, and both suggest that the future may not be as accommodating as the past.
Interest rates are already heading upward as the world economy is picking up steam, just as the Congress and the President have committed to a path of massive increases in annual borrowing. We are now dependent on the international community to assure adequate demand for our bonds, and minimize the interest costs we are forced to pay. Should rates rise to where they were in 2007 just before the global financial collapse – around 4.5% – the net interest costs in the federal budget would nearly triple from the current $220 billion to $650 billion per year. Should rates rise to where they were when Bill Clinton was president – 6.5% – interest costs would rise nearly four-fold to $850 billion. That would represent a cost increase of $630 billion, or more than the entire cost of the budget for the Department of Defense last year. And those numbers are based on the debt outstanding as of 2016, and therefore understate the risk posed by rising rates.
Donald Trump has carefully honed his disdain for the international order constructed by the United States over the past half century and is more than willing to lash out at the world in whatever manner he chooses when it serves his domestic political interests. We saw that this week, as he stirred up a hornet's nest by announcing import tariffs and endorsing the idea of a trade war. Casting aside the international order may be good domestic politics for the President, but there is a very real price to be paid if it goes too far. China has long-bristled at the exorbitant privileges the United States enjoys and has demonstrated that it is more than eager to step into any void created by the United States walking away from its historic leadership role – or by any actions of the American President that alienate the good will of the rest of the world. Already, China is pushing to shift the pricing of oil contracts from dollars to the Chinese renminbi, a critical step in unwinding a half-century of dollar hegemony in the global energy markets, and scaling back the privileges that we enjoy, including the incentives that foreign central banks have to purchase our debt.
In these circumstances, the last thing we need is the President antagonizing the rest of the world for his own momentary political advantage. Right now, those same countries he is antagonizing are the ones that he is assuming will buy the trillions of dollars of bonds that will fund his tax cuts. They don't have to do that if they don't want to. If they decide to turn their backs on him, we are going to learn very quickly that federal deficits do matter after all.
Follow David Paul on Twitter @dpaul. He is working on a book, with a working title of "FedExit: Why Federalism is Not Just For Racists Anymore."
Artwork by Jay Duret. Check out his political cartooning at www.jayduret.com. Follow him on Twitter @jayduret or Instagram at @joefaces.
Posts
No comments:
Post a Comment