I grew up in a conservative political home.
My parents are members of an organization from the early sixties called Young Americans for Freedom. They went on to careers in politics and government service.
The climax of their political lives 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 day-to-day political activities, and our dinner table discussions, as I recall, was the federal government’s fiscal policy … above all, debt.
Given the behavior of Republicans in Congress in recent months, it’s clear that my parents’ kind of conservatism has worn off. The combination of unfunded tax cuts and the budget deal that destroyed last week’s deficit worries them a lot.
You should also be concerned … in fact, our irresponsible representatives in Washington are creating a perfect economic storm.
Just when things were looking 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 will last through 2019.
The nonpartisan Committee for a Responsible Federal Budget forecasts that the federal deficit could reach $ 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 7% to 8% in some estimates.
Long-term data suggest that a 1% increase in the debt-to-GDP ratio corresponds to a 3-5 basis point increase in the yield on 10-year Treasuries.
How can we be so sure of this? After all, the government has run deficits for the last decade and we haven’t seen any increase in bond yields, have we? What is different now?
The answer is something central bank mandarins cheerfully call “extraordinary monetary policy.”
Following the financial collapse of 2008, the world’s major central banks intervened 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 have more than $ 14 trillion in securities in their portfolios.
But the Fed has largely stopped buying those securities. At the end of last year, he initiated a so-called “orderly liquidation” of his position in the Treasury.
Therefore, unless another source of demand for Treasuries emerges, the influx of new supplies of Treasury bills to finance growing deficits will create a buyer’s market. That will lower Treasury prices and increase yields.
Projections suggest that the Treasury Department will sell more than $ 1 trillion of debt in 2018 alone.
That’s not all folks
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 buyers of Treasuries factor it into their future yields.
Those higher interest rates will force the government to funnel more funds toward ever higher interest payments. That will leave the economy with a smaller share of federal spending, depressing growth.
To complicate matters, the dollar is weakening. The dollar has weakened dramatically, losing about 10% of its value in 2017.
The combination of a weaker dollar and higher US deficits will attract foreign investors looking to increase their Treasury bond reserves. Those buyers will want higher returns to offset inflation and the risk of higher US debt. That will lower bond prices even further … further increasing US government interest payments.
Ultimately, rising bond yields and inflation will reduce the future value of anticipated corporate earnings and equity dividends. Lower future income streams mean lower prices for stocks. In that way, US government deficits will deflate the US stock market.
Give me that conservatism of yesteryear
Vice President Dick Cheney said the Reagan presidency demonstrated that “deficits don’t matter.”
But he was talking politics: voters at the time just weren’t punishing Republicans for running deficits.
The Reagan-era US government deficits were the largest since World War II, barring the immediate aftermath of the 2008 crisis.
But the current crop of Republicans claiming to revere Reagan is on track to create the biggest deficits this country has ever seen. In the eight years since they gained control of the House, the national debt has skyrocketed from $ 13.5 trillion to $ 20.4 trillion today.
This is the future they are creating: rising inflation. A declining stock market. Oh, and one other thing … your taxes will inevitably have to go up to pay them.
President Trump calls himself the “king of debt.” His intermediaries in Congress certainly seem to agree.