When Budget Deficits Will Really Go Vertical

United States Secretary of Treasury Steven Mnuchin has a sweet gig.  He writes rubber checks to pay the nation’s bills.  Yet, somehow, the rubber checks don’t bounce.  Instead, like magic, they clear.

How this all works, considering the nation’s technically insolvent, we don’t quite understand.  But Mnuchin gets it.  He knows exactly how full faith and credit works – and he knows plenty more.

In fact, Mnuchin’s wife, Louise Linton, says she admires him because “he understands the economy.”  And Mnuchin, no doubt, admires Linton, a Scottish actress 18 years younger, because “she loves SoulCycle Snapchat filters that make people look like puppies and piglets.”  Naturally, Mnuchin gets the importance of puppy and piglet filters and how this bizarre fad fits into the big picture of the economy.

Unlike Mnuchin, we find the economy, and its infinite and dynamic relationships, to be beyond comprehension.  But that doesn’t deter us from attempting to make some sense of it each week.  When it comes to Snapchat filters we know nothing – and we could care less.  Still, who are we to question Snap Inc.’s $24 billion market capitalization?

What we do understand is simple arithmetic.  So, too, we care a great deal about the increasingly precarious predicament the 115th U.S. Congress is putting the American people in.  As far as we can tell, the approaching disaster is much closer than Mnuchin will publicly recognize.

Grim Particulars

The growth of federal debt has been out of control for decades.  The solution that’s commonly offered for reeling this back is for the economy to somehow grow its way out of the debt.  This has yet to transpire despite a variety of policies over the years that have generally involved borrowing money from the future and spending it today.

The simple fact is you can’t grow your way out of debt when the debt’s increasing faster than gross domestic product (GDP).  For example, in 2000 the federal debt was about $5.6 trillion and real U.S. GDP was about $12.5 trillion.  Today the federal debt is over $20.6 trillion and real U.S. GDP is about $17 trillion.

In just 18 years the federal debt has increased by over 265 percent while real U.S. GDP has increased just 36 percent.  This, by all practical means, is the opposite of an economy that’s growing its way out of debt.

But rather than adjusting spending to balance with the budget, or to at least structure debt growth to be more in line with GDP growth, the federal government is doubling down on its mistakes.  Steven Rattner, former counsel to the Treasury Secretary, and a man who soiled his hands orchestrating the 2009 U.S. auto industry bailout, offers the grim particulars:

“As recently as June 2017, the Congressional Budget Office projected that the federal budget deficit would total $689 billion next year — already higher than it should be at this stage of an economic recovery.  Now after passage of the tax cut and the new spending package, the anticipated deficit has shot up to $1.15 trillion.  That’s nearly as high as the deficit incurred by President Obama to fight the financial crisis and recession.

“Even worse than the 2019 forecast is the fact that the deficit is only likely to go up from there.  By 2027, according to projections by the Committee for a Responsible Federal Budget, the annual deficit will total $2.1 trillion.  These deficits will increase the nation’s total debt, which is now $20 trillion, and increase it to as much as $35 trillion.”

When Budget Deficits Will Really Go Vertical

When President Trump signed the GOP tax reform bill on December 22, the yield on the 10-Year Treasury note was 2.48 percent.  As of market close on Thursday, the 10-Year Treasury note yield had increased to 2.89 percent.  In less than two months the federal government’s borrowing costs have increased by over 16 percent.

Similarly, a 30-year fixed residential real estate mortgage rate has increased over this period from 4.14 percent to 4.51 percent – or roughly 9 percent.  Maybe this will finally take some of the gas out of the housing bubble.  At the least, it has likely contributed to the decline in weekly mortgage applications.

Several aspects that often coincide with the later stages of the business cycle include rising interest rates, rising price inflation, and rising trade imbalances.  Like interest rates, consumer prices, as measured by the consumer price index, are now rising at an annual clip of 2.1 percent.

Trade imbalances are also on the rise.  From our perch in Long Beach, overlooking the massive Port of Long Beach / Port of Los Angeles port complex, near the terminus of the Los Angeles River, we see plenty of action going on.

Last year the Port of Los Angeles moved 9.34 million twenty-foot equivalent units (TEUs), the most in its 110-year history.  Similarly, the Port of Long Beach moved 7.54 million TEUs in 2017, the most in its 107-year history.

So far, this year has picked up right where last year left off.  Traffic at the Port of Long Beach in January reached 657,830 TEUs, a near 13 percent increase from January 2017.  Indeed, the scope and magnitude of this trade is remarkable.

Container ships loaded with consumer goods from China, Hong Kong, Japan, South Korea, Taiwan, and Vietnam, among others, queue up in San Pedro Bay for berth entry.  Longshore workers offload the containers to rail and trucks with efficient competence.  The ships are then figuratively stuffed with paper dollars and sent back to the Far East.

The U.S. trade deficit in December widened to $53.1 billion.  The last time the trade deficit was this high was October 2008, one month after when Lehman Brothers vanished from the face of the earth.

Perhaps a decline in the U.S. trade deficit isn’t imminent just yet.  But as credit markets tighten in the face of rising consumer prices something will have to give.  The slowdown in economic activity will come soon enough.  Then we’ll see budget deficits really go vertical.

Happy Lunar New Year!

Sincerely,

MN Gordon
for Economic Prism

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