Washington Surrenders — the New Indifference Toward Deficits
Author: Greg Valliere
March 1, 2019
WHO CARES ABOUT DEFICITS? Virtually no one in Washington, as a remarkable pendulum shift is now clear: the new mantra is that deficits don’t matter, as insatiable demand for Treasury paper keeps interest rates low.
HOW CONVENIENT!! The new indifference toward deficits comes at a most opportune time for the Trump administration, which faces red ink of over $900 billion this fiscal year — with deficits above $1 trillion annually likely for years to come. Among Donald Trump’s economic advisers, Larry Kudlow never cared much about deficits, and Budget Director Mick Mulvaney — once a prominent deficit hawk — is a convert to the new thinking.
MOST DEMOCRATS HAVE THROWN IN THE TOWEL: A few favor spending cuts for the Pentagon but most cringe at the prospect of being portrayed as soft on defense. And while Democrats favor tax hikes on the wealthy, they would use the extra revenue for new spending, not deficit reduction. The next generation of Democrats has huge spending goals.
DEFICIT CUTTING SIMPLY ISN’T POPULAR ON CAPITOL HILL: Talk with members in each party and you’ll hear their off-the-record rationale — the markets don’t seem to care about deficits, so why should we? Besides, there’s a widespread fear of taking a meat-ax to spending; how can anyone get re-elected if they support cuts in entitlement spending?
TRUMP WANTS TO SLASH SPENDING for all of the Cabinet-level budgets by 5% across-the board, but that has very little support in Congress. The biggest battle is over defense outlays, which probably will surge again this year, to something close to $740 billion, as part of a deal that also raises domestic outlays well above spending caps, which are routinely ignored.
THE NEXT BIG FIGHT — RAISING THE DEBT CEILING: You thought the government shutdown fight in January was bitter? Wait until early fall. The debt ceiling was hit today but the Treasury Department can keep the government running for another six months. Three dozen Republican deficit hawks in the House will refuse to vote to raise the debt ceiling, which will force Trump to seek votes from Nancy Pelosi’s troops — and her price for cooperation will be more spending on domestic programs (and no money for a border wall).
BOTTOM LINE: This year’s deficit will approach 5% of GDP — in a full employment economy!! Yet there’s very little discipline to cut spending; the more likely path is for significant spending hikes. If there’s an infrastructure bill (maybe a 40% chance) we’d bet that it won’t be paid for.
THE BOND MARKET has seemingly ignored deficits, but as we enter a new decade there will be a rising concern about debt servicing costs, which could crowd out virtually all spending — education, infrastructure, etc. If this leads to Japan-style mediocre economic growth and low inflation, it ironically could be a plus for the bond market, keeping rates low.
THERE’S STILL TIME TO CURTAIL SPENDING AND RAISE SOME TAXES, but the Kudlow fantasy that we can grow our way out of deficits is ridiculous. At best, deficits could level off at a little less than $1 trillion per year — if there’s 3%-plus GDP growth, but that doesn’t seem sustainable. So the answer may be to simply sit back and learn to live with the red ink; fiscal policy will stay stimulative — the spending and tax cuts will keep the economy humming for a while longer.
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