I grew up in a conservative political home.
My parents met as members of an organization in the early 1960s called Young Americans for Freedom. They went on to have careers in politics and government service.
The high point of his political life was the Reagan administration of the 1980s…the culmination of decades of efforts to put a “true” conservative in the White House.
The core beliefs that defined his version of conservatism included anti-communism, the right to life of the unborn, and a limited role for government.
Those were long-term goals. The subject that dominated his daily political activities – and our table discussions, as I recall – was the fiscal policy of the federal government… above all, the debt.
Given the behavior of Republicans in Congress in recent months, it is clear that the conservatism of my parents has disappeared. The combination of unfunded tax cuts and last week’s budget deal to end the deficit makes them very worried.
It should worry you too…in fact, our irresponsible representatives in Washington are creating a perfect economic storm.
Just when things looked better
Thanks to our representatives in Washington, we face a future of higher interest rates, a falling dollar, and falling stock prices.
Over the past six weeks, Congress has added trillions of dollars to future federal budget deficits.
The Tax Cuts and Jobs Act passed in late December added an estimated $1.5 trillion to the 10-year deficit projections. Last week, Congress and President Donald Trump added another $300 billion to that figure with a budget deal that lasts through 2019.
The nonpartisan Committee for a Responsible Federal Budget forecasts that the federal deficit could hit $1.2 trillion next year.
The Congressional Budget Office forecasts a doubling of federal deficits as a percentage of gross domestic product (GDP) in the coming years, reaching between 7% and 8% in some estimates.
Long-term data suggests that a 1% increase in the debt-to-GDP ratio corresponds to a 3-5 basis point increase in the 10-year Treasury yield.
How can we be sure of this? After all, the government has run deficits for the last decade and we haven’t seen a rise in bond yields, have we? What is different now?
The answer is something central bank mandarins blithely call “extraordinary monetary policy.”
Following the financial crash of 2008, the world’s major central banks stepped in to buy US Treasuries and other government debt as part of a deliberate strategy to keep interest rates low. The Federal Reserve, the Bank of Japan, and the European Central Bank now hold more than $14 trillion worth of securities in their portfolios.
But the Fed has largely stopped buying those securities. At the end of last year, he began the so-called “orderly liquidation” of his Treasury position.
Therefore, unless another source of demand for Treasuries emerges, the influx of new supplies of Treasury bills to finance rising deficits will create a buyer’s market. That will drive down Treasury prices and push up yields.
Projections suggest that the Treasury Department will sell more than $1 trillion of debt in 2018 alone.
E-That’s not all, friends
Washington’s fiscal irresponsibility will affect the economy in other ways as well.
The President continually reminds us that the American economy is in growth mode. Employment is increasing and so are wages.
In that context, a massive economic stimulus in the form of deficit spending, larger even than the 2009 emergency stimulus package, will quickly turn growth into inflation. Inflation will lead to higher bond yields as Treasury buyers factor it into their future yields.
Those higher interest rates will force the government to funnel more of its funds into ever-increasing interest payments. That will leave the economy with a smaller share of federal spending, which will depress growth.
Complicated things are a weakening dollar. The dollar has weakened drastically, losing around 10% of its value in 2017.
The combination of a weaker dollar and higher US deficits will attract foreign investors looking to add to their Treasury holdings. Those buyers will want higher yields to offset inflation and the risk of higher US debt. That will drive down bond prices even further… driving up US government interest payments even higher.
Ultimately, rising bond yields and inflation will reduce the future value of anticipated corporate earnings and stock dividends. Lower future income streams mean lower stock prices. In that way, US government deficits will deflate the US stock market.
Give me that conservatism of yesteryear
Vice President Dick Cheney famously said that the Reagan presidency proved that “deficits don’t matter.”
But he was talking politics: Voters of the day simply didn’t punish Republicans for running deficits.
Reagan-era US government deficits were the largest since World War II, barring the immediate aftermath of the 2008 crash.
But the current crop of Republicans who claim to worship Reagan are on their way to creating the biggest deficits this country has ever seen. In the eight years since they gained control of the House, the national debt has ballooned from $13.5 trillion to $20.4 trillion today.
This is the future they are creating: rising inflation. A stock market in decline. Oh, and another thing… your taxes will inevitably have to go up to pay for it.
President Trump calls himself the “king of debt.” His runners-up in Congress certainly seem to agree.
