Originally published by Rivkin Securities
President-elect Donald Trump had a highly contentious run to the presidency with many of his comments offending a large number of people. There is little doubt that some of the social policies he spoke about during the election campaign seem a ‘little crazy’ but the same can’t necessarily be said about his economic policies.
Unfortunately for Trump, he has inherited an extremely difficult situation. With a national debt of $20 trillion, there is little room to manoeuvre with regard to expansionary fiscal policy (fiscal policy is the use of government spending to achieve outcomes while monetary policy relates to the actions of the central bank).
Broadly speaking, Trump is proposing company tax cuts and increased infrastructure spending. Normally, these policies would be considered stimulatory and therefore good for helping to lift the economy above the sluggish 1-2% GDP growth that the US has been experiencing recently. In this case, however, any increase in government deficit will have to be financed by borrowing, thus adding to the $20 trillion already owed.
Since the election, markets reacted to the prospect of this fiscal stimulus by bidding up commodities, selling bonds and buying stocks. The logic is that higher inflation, caused by increased government spending, should be good for stock and commodity prices but bad for bonds. The irony here is that the fall in bond prices (increase in yield) makes it more difficult for Trump to actually implement his plans. Any increase in borrowing would take the form of issuing more government bonds, thus increasing their supply. As a fundamental law of economics, increased supply will put downward pressure on prices and therefore upward pressure on yields.
With a debt of $20 trillion, and using the current 10-year bond yield of 2.22% (as a rough estimate of the average borrowing cost), the yearly interest bill would be $440 bn. If yields rose by just 1% more, to 3.22%, the interest bill would be $640bn. To put this figure into perspective the total federal government revenue is around $3.5 trillion. Using the higher interest rate figure, the interest would consume over 18% of total government revenue and a 3.22% interest rate is still an extremely low rate! It is clear then that there is a limit to how much the US government can increase its budget deficits without causing other problems.
As it stands, we don’t really know what a Trump presidency will mean. His economic policies aren’t necessarily bad but may be difficult to implement considering the current financial position of the US Federal government. Only once firm policy proposals are put on the table can one evaluate the true effect of such a policy and therefore we will have to wait to discover what is put on the table in this regard.
