Why Fiscal Stimulus Won't Happen This Time Around
[Editor’s Note: David Stockman has just released his third and most important book: Trumped! A Nation on the Brink of Ruin and How to Bring it Back. For a very limited time we’re sending Daily Reckoning readers free autographed copies when they respond right here.]
It’s a virtual certainty that another recession lies dead ahead.
But what is truly startling is that the market is giving no recognition whatsoever to the fact that the nation’s fiscal situation is very rapidly going to hell in a handbasket.
And that there is virtually no prospect of another massive shovel-ready stimulus like the Obama $800 billion plan this time around.
The warning signs of the impending fiscal paralysis are readily evident. The budget deficit in the year just ended soared by 37% — from $438 billion last year to just under $600 billion for FY 2016. But the outcome was actually worse due to various kinds of budget gimmickry addressed below.
In fact, the total public debt rose by $1.4 trillion during FY 2016, and will almost surely cross the $20 trillion mark soon after the next president is sworn to office.
Needless to say, there will be no budget headroom at all for fiscal stimulus or the kind of huge infrastructure packages that both Hillary and Trump have bloviated about.
This economic turn is at the very heart of my latest book, “Trumped! A Nation on the Brink… And How to Bring it Back” where I speak to why Flyover America has had enough of a rigged system.
Whichever candidate enters the White House — and it looks like Hillary — is going to be shocked by the news that its first full year budget (FY 2018) will exhibit a $1 trillion deficit based on current tax and spending laws. And that’s before even a single dime of stimulus can be lobbed at a recessionary economy.
This upcoming shock is not merely a matter of academic or even “political” interest. To the contrary, Wall Street is so confident of the latter that it has actually “priced-in” a fiscal rescue — a rinse and repeat version of the 2009 borrow-and-spend spree.
Au contraire! We are in a new ballgame, and there are no bailout fireman at the ready.
This time there will be no quick stock market rebound like in 2002 and 2009. And after a period of recessionary stasis and no massive stimulus from Washington, the remaining punters in the casino will really panic.
That will catalyze a second leg down unlike anything since the 1930s.
The Fed is completely out of dry powder and that there will be no post-crash reflation of financial assets owing to monetary stimulus. Indeed, even the mainstream commentariat is rapidly pivoting to the proposition that the central banks have shot their wad, and it now time for fiscal policy to pick-up the ball.
This is a will-o-wisp. Indeed, my level of confidence that fiscal stimulus is dead in the water is immensely bolstered by the sheer complacency that characterizes both ends of the Wall Street/Washington axis at the moment. Kicking-the-budget-can has been such a deceptively effective strategy that everyone expects the game to continue.
For instance, between December 2008 and the present, the public debt exploded from $10.7 trillion to the $19.6 trillion figure displayed in the graph above. That means that on Obama’s watch, and during a period in which the economy was rebounding from the worst recession in modern times, new public debt was issued equal to 83% of the total public debt created during the entire prior 220 years of the republic and the tenure of 43 presidents.
The point is that $9 trillion eruption of the public debt happened during the so-called “good times” of the business cycle. Yet the sleepwalking politicians of the Imperial City did not even notice it happening. The Democrats are actually crowing about their accomplishment in taming the deficits and the Trump campaign doesn’t give the soaring national debt nearly enough attention.
But now it is going to get much worse, and rapidly so. Even by the Congressional Budget Office’s (CBO’s) Keynesian scorekeepers, the budget deficit will hit $ 1.4 trillion and 5% of GDP by 2026 under current policy. This means that another $10 trillion is already baked into the fiscal cake and would be added to the public debt during the next decade as a whole.
Yet that assumes, no recession for 17 years and a rate of nominal GDP and wage growth 65% higher than during the last decade. Imagine what will happen in the real world when the Red Ponzi finally crumbles in China and the global economy plunges into a prolonged deflationary recession.
What will occur, in fact, is that the public debt will rise by at least $15 trillion in the decade ahead under even a halfway-decent economic scenario. Add that to the $20 trillion which the next president will inherit and you have a $24 trillion GDP lugging around a $35 trillion public debt.
Yet Trump says he is going to rebuilt the military, launch a $500 billion infrastructure program and not touch medicare or social security. Worse still, Hillary is now humping Bernie’s playbook, promising to lower the Medicare age to 50 years, provide free college tuition and a goodly amount of other free stuff.
The larger point is that the Fed’s massive repression of interest rates has spawned a fiscal culture of unspeakable deception, duplicity, lies and dysfunctionality on Capitol Hill.
On the one hand, it means that the current $19.6 trillion of national debt can be serviced on the cheap — currently at a weighted average yield of about 1.8%. Accordingly, debt service costs which would be upwards of $1 trillion under normalized interest rates (5%) are currently only about $350 billion.
So the politicians — even self-proclaimed fiscal hawks like Speaker Paul Ryan — have felt no financial pressure, and became accustomed to kicking the can. At the same time, Washington’s moveable fiscal scam has resulted in an utterly deceptive 10-year deficit forecasts — even after funding the national debt on the cheap.
The CBO’s so-called baseline projections show out-year spending far lower than what is actually built into the system. And not merely due to the deceptive rosy-scenario economic forecasts that assume the business cycle has been abolished and that the U.S. economy will dwell in the nirvana of Keynesian full employment without interruption and forever.
The long-term deficit outlook is further understated owing to the phony entitlement reforms that CBO is required by Congress to credit. That’s right. Congress has no intention of allowing these future-year fiscal curtailments to become effective, but still insists on counting them when summing up completely phony 10-year savings totals.
Yet when the “out-years” become the current year, they are simply suspended, deferred or covered up with new offsetting out-year savings gimmicks like those in last year’s omnibus appropriations bill.
By the same token, baseline revenues are projected to be far higher than will actually materialize under current policy. That’s due to the operation of the same kind of moveable scam on the income side of the budget ledger. There are literally hundreds of billions per year of tax incentives, subsidies and loopholes that have been in the IRS code for years or even decades that are made to artificially and abruptly expire a year or two down the road.
Accordingly, CBO scores a commensurate increase in the out-year revenue base, thereby contributing to the appearance that the long-term deficit is shrinking. But when we get to the statutory expiration dates, these provisions never happen and the huge revenue drains continue. The culprit is something called that annual “tax extender” bill, which mostly just rolls forward the expiration dates by a year or two so that the CBO can keep projecting sunny fiscal skies ahead.
This was evident in spades in the $680 billion worth of so-called tax-extenders also contained in last year’s omnibus budget bill.
One of the most egregious cases of this kind of double shuffle pertains to the three Obamacare taxes, which were “deferred” by several years at an alleged cost of $28 billion.
In truth it’s more like $260 billion. Here’s why. Recall that the true cost of Obamacare was in the trillions, but it was outrageously disguised as a deficit reducer through a series of huge gimmicks, such as changing the student loan program from an entitlement to a direct loan. And also through a series of stiff taxes on insurers, medical devices and so-called Cadillac medical plans.
However, these so-called “pay fors” were back-loaded into the middle of this decade in order to pacify the intense political opposition to them and to assemble the razor-thin partisan majority by which the program was enacted in 2010. In particular, core Democrat constituencies like the labor unions were violently opposed to the so-called “Cadillac tax” on expensive, gold-plated employer health plans.
That was even after the threshold plan value was raised to $27,000 per year for family coverage before the 40% tax kicks in. So the inception date was deferred into the distance future — to 2018.
Well, the distant future is now getting closer, and like with almost everything else in Obamacare that created intensive political opposition, such as the employer mandate, the time had come time to kick the can. So the same omnibus bill deferred the Cadillac tax two years until 2020.
That’s right. They had the audacity to say they “paused” the very thing that they never intend to become effective. In that same vein, the health-insurers tax that pays for part of the Obamacare subsidies to families up to 3X the median income was also paused for a year.
The plain fact of life is that none of these out-year Obamacare taxes will ever be collected.
If Trump wins, they will be repealed; if Clinton wins they will be deferred. Accordingly, the real hit to future deficits is in the order of one quarter trillion dollars over the next 10 years due to the Obamacare taxes alone.
There is an underlying moveable fiscal scam at work — a systematic process by which future spending growth is disguised and future revenue collections vastly exaggerated.
Accordingly, if you eliminate the phony out-year reductions that are still embedded in the CBO baseline, spending would be about $1 trillion higher after you factor in the carried interest. In short, an election-minded Congress produced a $2.5 trillion budget buster!
So here’s the truth. When you add back the trillions of phony spending cuts and revenue increase that are built into the current budget baseline and throw-in the next recession, I’ve estimated that the real world addition to the national debt will be at least $15 trillion during the next ten years.
And that will be piled on top of the $20 trillion of public debt that will be in place by the time of the 2017 inauguration.
Can this nation manage a $35 trillion public debt at the very time that the baby boom is retiring at a rate of 10,000 per day? That’s not likely under any circumstances — but one thing is quite certain.
When the Imperial City is faced with the next recession it will descend into unprecedented partisan acrimony and conflict over an exploding public debt that will scare the daylights out of even the spendthrift politicians of Capitol Hill.
They have been in a dreamlike trance ever since the 20098-09 financial scare was suddenly ended by the Fed’s printing presses. When the coming recession rudely awakens them, they will have no place to run and no basis for agreement on any kind of conventional fiscal stimulus whatsoever.
And when that scenario begins to unfold, the Wall Street punters will truly give-up the ghost.
Now is the time to get ready.
Regards,
David Stockman
for The Daily Reckoning
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