Stimulus Gone Wild
Author: Greg Valliere
May 1, 2019
THE U.S. ECONOMY NEEDS NO FURTHER STIMULUS: Unemployment is near a 50-year low and GDP is growing by close to 3%, so the last thing this economy needs is more stimulus, but try telling that to the politicians. Led by President Trump, they want more and more stimulus — monetary and fiscal — and the inevitable result could be an economy that over-heats.
MONETARY STIMULUS: Trump doubled down on his criticism of of the Fed yesterday, contradicting Larry Kudlow’s reckless call for an immediate 50 basis point cut in the funds rate. The president wants a 100 basis point reduction, and a resumption of the Fed’s additions to its balance sheet. That most definitely will not happen, but Trump should be pleased that the central bankers are exploring novel approaches to stimulate inflation.
FISCAL STIMULUS: The desire for more spending has virtually no limits — Trump, Nancy Pelosi and Chuck Schumer apparently agreed yesterday to seek $2 trillion in infrastructure spending for bridges, highways, public transit, rural broadband, etc. There’s no agreement on how to pay for this (higher taxes are verboten). The beginnings of an infrastructure bill could pass in the next year — paid for by smoke and mirrors.
EVERYWHERE WE LOOK, spending appears to be headed higher — a huge hike in Pentagon outlays, more money for border security, and the abandonment of strict spending caps. A debt ceiling donnybrook this fall probably will result in more spending, as Pelosi provides the votes to raise the ceiling; her price for cooperating will be more domestic spending. And the budget deficit, which is approaching $1 trillion this year, almost certainly will exceed that amount in fiscal 2020. A $1 trillion deficit in a full-employment economy — that’s mind-boggling.
THE POLITICAL DYNAMICS: Trump obviously wants a roaring economy as he begins his re-election campaign. He won’t get significantly lower interest rates, but he can improve business psychology by signing a trade deal with China, and he can urge more spending. Democrats, not known for fiscal restraint, will generally go along, while congressional Republicans will complain about red ink but are likely to get steamrolled by the White House, as usual.
BUDGET DEFICITS? DON’T WORRY: The new mantra from former fiscal hawks like Kudlow and Mick Mulvaney is that deficits don’t matter much, thanks to the tremendous global demand for U.S. Treasury paper, which has kept interest rates low. Both Kudlow and Mulvaney would strenuously disagree that they’re proponents of the leftist Modern Monetary Theory, but it sure looks like they have embraced some of the MMT dogma on running high deficits to stimulate economies.
BOTTOM LINE: The Fed will keep rates unusually low until inflation perks up, and the politicians will spend and spend. This approach has been embraced by China, and even in stagnant Europe there’s a growing belief that more stimulus is necessary. The risk, of course, is that the Fed will get its wish on inflation — and then some — thanks to the exceptionally tight labor market.
AND THERE’S THE NAGGING ISSUE of debt servicing costs, which could explode early in the next decade and crowd out most discretionary government spending here and abroad; it already has in Japan. But in today’s ultra-low interest rate climate, the politicians aren’t focusing on debt servicing costs; most of them will be out of office when that crisis hits.
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THE MUELLER BOMBSHELL: Attorney General William Barr has a lot of explaining to do today in a Senate hearing that will focus on his disingenuous summary of Robert Mueller’s report. All the players will react predictably: Trump will tweet furiously this morning, blasting Mueller; Democrats will demand more hearings — and public testimony from Mueller; and most Republicans will remain silent, too timid to anger Trump or the GOP base.
THE BARR HEARING will have Washington in a fever pitch, buzzing about obstruction of justice, but it should have no impact on the financial markets, which will focus today on earnings, Jerome Powell’s press conference, and encouraging trade talks in Beijing.
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