I was raised in a conservative political home.
My parents met as members of an early ’60s organization named Young Americans for Freedom. They went on to have careers in politics and government support.
The high point of the political lives was that the Reagan administration of the 1980s… the culmination of decades of effort to place a “true” conservative in the White House.
The core beliefs that defined their version of conservatism comprised anti-Communism, directly to life to the unborn and a limited role for government.
Those were long-term targets. The issue that dominated their day-to-day political actions – and our dinner-table talks, as I remember – was the national government’s financial policy… above debt.
Given the behaviour of congressional Republicans lately, it is apparent that my parents’ new conservatism has disappeared. The combination of unfunded tax cuts and last week’s deficit-busting budget deal worries them considerably.
It should stress you too… in actuality, our reckless representatives in Washington are developing a perfect financial storm.
Only When Things Were Looking Better
Over the past six weeks, Congress has additional trillions of dollars to future federal budget deficits.
Last week, Congress and President Donald Trump added another $300 billion to this figure with a funding deal lasting until 2019.
The Congressional Budget Office forecasts a doubling of federal deficits as a proportion of gross domestic product (GDP) in the next few years, reaching as large as 7% to 8% in certain quotes.
Long-term data suggests a 1 percent gain in the debt-to-GDP ratio corresponds to a 3 to 5 basis point increase in the 10-year Treasury yield.
How can we be so confident of this? After all, the government has run deficits during the last ten years, and we have not seen a rise in bond yields, right? What is different now?
The solution is something the central bank mandarins blithely call “outstanding monetary policy.”
In the aftermath of the 2008 financial meltdown, the world’s leading central banks stepped in to buy U.S. Treasurys 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 currently hold over $14 trillion of securities in their portfolios.
However, the Fed has mostly stopped buying those securities.
Therefore, unless another source of demand for Treasurys emerges, the influx of new supplies of Treasury bills to fund rising deficits will produce a buyer’s market. That will push the costs of Treasurys and push up yields.
Washington’s financial irresponsibility will work through the market in other ways, too.
The president reminds us that the U.S. market is in development mode.
In that circumstance, a enormous economic stimulus in the kind of deficit spending – bigger even than the crisis stimulus package of 2009 – will quickly turn expansion into inflation. Inflation will result in higher bond yields as buyers of Treasurys factor it into their future yields.
That will leave the market with a smaller share of national spending, depressing growth.
Complicating things is a weakening dollar. The dollar has weakened sharply, shedding about 10 percent of its value in 2017.
The combination of a weaker dollar and higher U.S. shortages will lure overseas investors seeking to add to their stockpile of Treasurys. Those buyers will want larger yields to compensate for inflation and the possibility of greater U.S. debt. That will drive down bond prices… increasing U.S. government interest payments much more.
Finally, rising bond yields and inflation will lower the future worth of expected corporate earnings and stock dividends. Lower future income flows mean lower prices for stocks. In that manner, U.S. government deficits will deflate the U.S. stock exchange.
Vice President Dick Cheney famously said that the Reagan presidency demonstrated that “deficits do not matter.”
But he was speaking about politics – voters of the day only did not punish the Republicans for running up deficits.
The U.S. government deficits of the Reagan era were the biggest since World War II, save to the immediate wake of the 2008 crisis.
But the current crop of Republicans who claim to venerate Reagan are on track to produce the biggest deficits this nation has ever seen. In the eight years since they won control of the House, the federal debt has dropped from $13.5 trillion to $20.4 trillion now.
Here’s the future they are generating: rising inflation. Oh, and one other thing… your taxes will necessarily have to go up to cover it.
His courtiers in Congress surely appear to agree.