No matter where your political leanings lie, one thing that we can all agree upon is that President Donald Trump’s road to the White House was a controversial one.
While he offended many along the way and while many of his proposed social policies appear to be a bit crazy, I don’t think that his economic policies are necessarily off the wall.
President Trump entered office facing a very difficult economic climate with which he needs to contend.
There’s not much wiggle room regarding expansionary fiscal policy (fiscal policy refers to using government funds to achieve outcomes and monetary policy refers to the actions of the central bank), when you are facing a national debt of $20 trillion.
We know that Trump’s proposed plan, generally speaking, is to cut company taxes and increase spending on infrastructure. Normally, we would view this as good for stimulating the economy and helpful in raising it above the anemic 1-2% GDP growth recently experienced by the United States.
We have to keep in mind that in this case, if the government deficit increases, it needs to be financed by borrowing and that will add to the already owed $20 trillion.
The market’s reaction to the promise of this fiscal stimulus was to bid up commodities, buy stocks and sell bonds.
The reasoning behind this is that that higher inflation brought upon by an increase in government spending should be a good thing for stock and commodity prices, but bad for bonds.
My use of the word “should” is key here. The ironic part of this is that the decrease in bond prices or increase in yield, will make it even more challenging for Trump to enact his proposed plans.
Let’s take a look at why this is the case. If the government increases borrowing, then they would need to issue more bonds, thereby increasing their supply.
We know that the basic laws of economics dictate that an increase in supply will force prices downward and as a result, we see yields being forced upward.
If we have a $20 trillion debt and use the current 10-year bond yield of 2.22% (an approximation of average borrowing costs), our annual interest cost would be $440 billion. If we think that is exorbitant, what if it inched up by just 1% more to 3.22%? That would wind up at a cost of $640 billion.
Let’s put this into perspective. The entire revenue for the federal government is approximately $3.5 trillion.
If we use the higher interest rate of 3.22%, the interest would eat up more than 18% of the government’s total revenue and keep in mind, a 3.22% interest rate is extremely low! We can see that clearly, the government can only increase its budget deficit by so much before other problems start arising.
Right now, we just don’t know for sure what the Trump presidency will mean for the economy. It isn’t that his economic policies are bad, but implementing them given the current financial status of the United States Federal government is going to be extremely difficult.
We are not really going to know the effect Trump’s policies may have until we closely evaluate them and in order to do that, we will need to see the firm and detailed policies laid out before us.