Showing posts with label Fiscal Policy. Show all posts
Showing posts with label Fiscal Policy. Show all posts

Sunday, November 13, 2022

Shulmaven Quoted in Nick Sargen article in "The Hill" on the Midterms

 " 2022 midterm message: Voters want normal, not crazy"


"According to economist David Shulman, the Democrats remembered the lessons of 2009, when the $800 billion fiscal package enacted was woefully lacking in dealing with the Global Financial Crisis (GFC). However, they failed to recognize that the pandemic was a completely different type of shock: While the economy plummeted when businesses were shuttered, it rebounded quickly when businesses re-opened. Consequently, they wound up fighting the last fiscal war by enacting programs that were four times larger. Together with a highly expansionary monetary policy, the seeds for a resurgence of inflation were sown."

The 2022 midterm message: Voters want normal, not crazy | The Hill

Thursday, February 24, 2022

The Unravelling

 

The world as we have known it for the past 30 years is over. The era of low inflation, ever-falling interest rates, ever-rising stock prices, globalization, and geopolitical stability among the major powers is unravelling. Russia’s invasion of Ukraine has signaled that a new Cold War is upon us and making things worse was the Xi-Putin communique at the Beijing Olympics which marked the beginning of a renewed authoritarian alliance against the West. What this means is defense spending is going to ramp up bigtime with inflationary consequences.

 

The COVID pandemic has taught us that globalization and just-in-time inventory processes have made supply chains far more fragile than we had thought. As a result, higher buffer stocks and the moving of production closer to final demand will increase economy wide costs.  The inflationary process is being exacerbated by the rush to decarbonize the economy with its attendant underinvestment in oil and gas.  As they say, short term pain for long term gain. We are also relearning that reckless fiscal and monetary policies can bring about the high inflation we are now experiencing. It seems that Milton Friedman and his ideas about money are being resurrected from the dead.

 

Domestically there are too many eerie parallels to 1940 America where the Charles Lindberg America First group linked up with the Communist Party to oppose U.S. intervention in support of beleaguered England. Just the other day showboating lefties Alexandra Ocasio Cortez and Cori Bush linked up arm and arm with the right-wingers Paul Gosar and Matt Gaetz seeking Congressional preauthorization before sending troops in support to Ukraine, a move that President Biden said is off the table. And, of course, we have Tucker “Tokyo Rose” Carslon singing Putin’s praise every night on Fox.

 

This witch’s brew means inflation will remain higher for longer, a secular bear market for bonds, a very volatile stock market and as ugly as our politics are today, it will get worse.

 

Friday, September 27, 2019

"The Year of Living Dangerously," UCLA Anderson Forecast, September 2019


The Year of Living Dangerously[i]
David Shulman
Senior Economist, UCLA Anderson Forecast
September 2019

With his tweets of August President Trump escalated our trade war with China and attacked Federal Reserve Chairman Jerome Powell as an “enemy.” All of this occurring against a backdrop of near recessionary conditions in Europe with the potential for a Brexit disruption, Brazil and Mexico, a slowdown in China, rising geopolitical tensions in the Kashmir, the Middle-East, Hong Kong and the Korean Peninsula and a very real slowing in the U.S. economy. It seems that we are sleepwalking into a recession and perhaps quite a bit more geopolitically.

Although we are not calling for a recession over the forecast horizon, as we have noted for over a year it is very likely that economic growth will stall in the second half of 2020 as the effects of the 2017 tax cuts wane and as trade tensions exact their toll on corporate investment. On a fourth quarter to fourth quarter basis we are forecasting real GDP growth of 2.1% and 1.2% in 2019 and 2020, respectively. Indeed in the second half of 2020 growth is expected to decline to 0.4%, not quite a recession, but pretty close. (See Figure 1.) For 2021 we forecast growth to return to 2.1%.














Figure 1.Real GDP Growth, 2011Q1- 2021Q4, Percent Change, SAAR


Sources: U.S. Department of Commerce and UCLA Anderson Forecast

What are we Worried About?

We are worried about the following:
·        The escalating trade war with China.
·        The weakening of business investment in equipment and structures.
·        The negatively sloped yield curve.
·        The slowdown in employment growth.
·        The inability of housing activity to launch.
·        The stagnant stock market.

We will discuss each of these factors in turn.


Trade Shock

At the recent Federal Reserve conference in Jackson Hole, Wyoming Fed Chairman Jerome Powell noted:


   Moreover, while monetary policy is a powerful tool that works to support
     consumer spending, business investment, and public confidence,
      it cannot provide a settled rulebook for international trade.” (Emphasis
      added)

The reason why there is no rulebook is that we haven’t experienced a trade shock since the imposition of the Smoot-Hawley tariffs of 1930. We know how that turned out. Just after Powell made those remarks, President Trump weighed in with a substantial increase in the planned tariffs on Chinese goods (Increased to 10% and 25%, valued at about $80 billion/year) that are scheduled to go into effect on September 1st and December 15th.  As we have argued for two years tariffs are analogous to putting grains of sands into the gears of commerce which work to reduce output and increase prices.  Indeed a recent Fed study noted that trade uncertainty lowered real GDP growth about 1% in 2019 and projected another equivalent drop in 2020.[ii] And make no mistake American businesses and consumers will bear the brunt of the tariffs. And despite all of the Administration’s heightened rhetoric the real trade deficit will continue to rise as it approaches one trillion dollars this year. (See Figure 2)

Figure 2. Real Net Exports, 2011Q1 -2021Q4, Annual Data, $Billions

                                      
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Further the introduction of President Trump’s tariffs has greatly increased the uncertainty about the durability of existing supply chains thereby dampening business investment, more on that below. The Trump uncertainty is having pretty much the same effect of the uncertainties introduced by President Obama earlier in the decade with a multitude of regulatory changes coming from the Environmental Protection Administration, the Department of Labor and the Department of Energy.[iii]

Weaker Business Investment in Equipment and Structures

In response to the rise uncertainty the growth in business investment in equipment has stalled. After increasing at a solid 6.8% in 2018 real investment in equipment is forecast to grow at somewhat less than 2% from 2019-2021 and there will be several negative quarters along the way. (See Figure 3) The 11% increase in the first quarter of 2020 is based on our assumption that Boeing will resume shipments of the now-grounded 737-MAX in that quarter. Concomitantly real business investment in structures is already in declining at a 3% annual rate and that trend is forecast to continue through 2021. (See Figure 4)  Much of the decline is due to weakness in energy related investment especially related to oil and gas development in response to a 25% decline in oil prices.


















Figure 3. Real Business Investment in Equipment, 2011Q1-20121Q4F, Quarterly Data, Percent Change, SAAR

Sources: U.S. Department of Commerce and UCLA Anderson Forecast




















Figure 4. Real Business Investment in Structures, 2011Q1-2021Q4F, Quarterly Data, Percent Change, SAAR


Sources: U.S. Department of Commerce and UCLA Anderson Forecast

The Negatively Sloped Yield Curve

One of the most widely used and accurate signals of an oncoming recession is a negatively sloped yield curve where the return on short-term money is higher than the return on longer term money. Not only is a negatively sloped yield curve a signal of an oncoming recession it is also a cause because it eliminates the maturity transformation arbitrage profits of the financial system thereby reducing the willingness to lend. The indicator that the Fed uses is the difference between the yield on three month U.S. Treasury Bills versus the yield on 10-Year U.S. Treasury Bonds. (See Figure 5) Yes folks, we have been there since May. (See Figure 5). Aficionados on Wall Street prefer to use the difference between the 2-Year U.S Treasury Note versus the 10-Year U.S. Treasury Bond. That too turned negative in August.




Figure 5. Slope of the Yield Curve, 10-Year U.S. Treasuries minus Three Month Treasury Bills, Apr 1982 – Aug 2019, Daily Data, Percent



Sources: Federal Reserve Board via FRED

Although we have great respect for the signal coming from the bond market, we believe that the negatively sloped yield curve this time may sending us a false positive signal. Why? In the past then the yield curve was negatively sloped there was over-building in the housing market. This cycle, if anything, there has been under-building. As a result this time we might just skate by and avoid a recession.

Another cause of the negatively slope yield curve is the pressure coming from the global bond market. As of late-August there were about $17 trillion of negative yielding sovereign debt concentrated in Europe and Japan. (See Figure 6) With limited growth prospects, low inflation and aggressive buying from the European Central Bank European investors have little choice than to pay sovereigns a storage fee for their money. After all it hard to store a trillion euros under the mattress. As a result of the gravity coming from Europe the 10- Year U.S. Treasury yield has collapsed to 1.5%, about half of what it was last fall.







Figure 6. Selected Sovereign Yields, 30Aug19, Percent

Country
        
2- Year
10 Year
United States
1.990
1.50
France
-0.850
-0.40
Germany
-0.900
-0.71
Italy
-0.170
1.03
Japan
-0.310
-0.28
UK
0.400
0.49

Source: CNBC

Because the Fed is very knowledgeable about the yield curve and the contractionary forces coming from the trade war and European weakness, we believe that Fed has entered a significant easing cycle. Where the Fed Funds rate peaked at 2.625% last December, we now believe that the rate will be 1.625% by this December and a very low 1.125% by December 2020. The drop in the Fed Funds rate in 2020 will be the result of the economic weakness we forecast for later that year. (See Figure 7) Of course by then the yield curve will be positively sloped.















Figure 7. Federal Funds vs. 10-Year U.S. Treasury Bonds, 2011Q1 – 2021Q4F, Percent



Sources: Federal Reserve Board and UCLA Anderson Forecast

The Fed will be able to be aggressive in lowering rates because, although running somewhat above their target, overall inflation will remain benign. (See Figure 8) However we would point out that the imposition of tariffs means that there is upside risk to our 2%+ inflation forecast.










Figure 8. Consumer Price Index vs. Core CPI, 2011Q1- 2021Q4F, Percent Change a Year Ago




Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Employment Growth Softening

In August the Bureau of Labor Statistics announced that the estimate for March 2019 payroll employment was overstated by 500,000 jobs. We will not how this preliminary estimate will translate in actual monthly job growth until we get the January 2020 data, but as a first approximation recent employment growth has been overstated by about 40,000 jobs a month. Our forecast for job growth is based on current data and therefore it should be viewed as high. Nevertheless instead the recent normal of job gains of 200,000 a month, we envision job growth in 2020 to be a tepid 70,000 a month. (See Figure 9)This eventuality will be a shock to those business that have relied on the recent history of job growth. We would also note that our forecast includes the temporary government hiring associated with the census, especially in the second quarter of 2020. Given our GDP forecast the unemployment rate will remain stable at around 3.6% through early 2020 and then rise to about 4% at the end of that year. (See Figure 10)

Figure 9. Payroll Employment, 2011Q1-2021Q4, Quarter to Quarter Change, In Thousands, SAAR

                                   


Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast
















Figure 10. Unemployment Rate, 2011Q1-20121Q4F, Percent, SAAR


Sources: U.S. Bureau of Labor Statistic and UCLA Anderson Forecast

Housing Activity Remains Sluggish

As we have noted ad nausea, post the Great Recession housing activity has failed to recover to what historically has been a normalized level of housing starts of 1.4 million – 1.5 million units. Activity has stalled out in the 1.2 million – 1.3 million range and we forecast that it will remain sluggish throughout the forecast horizon. Specifically we are forecasting 1.25 million units for 2019 and for starts to average around 1.2 million units in 2020 and 2021. (See Figure 11) This sluggishness is especially noteworthy in light of the fact that mortgage interest rates have declined from 5% in late 2018 to around 3.75% today.   What this means is that unlike 2007 housing activity is really not in position to trigger a recession this time around.





Figure 11. Housing Starts, 2011Q1-2012Q4F, Thousands of Units, SAAR




Sources: U.S. Bureau of the Census and UCLA Anderson Forecast

Stock Market Has Gone Nowhere Since January 2018

Although the S&P 500 stock index remains very close to its all-time high, as a practical matter stock prices haven’t gone anywhere since January 2018. (See Figure 12) We would note that in January 2018 the Trump Administration got very serious about imposing tariffs and in March 2018 the first round of tariffs on steel and aluminum were put in place. As a result the wealth effect associated with rising stock prices is waning.









Figure 12. S&P 500 Stock Index, 1Sep2017 – 30Aug2019



Sources: Standard and Poor’s via BigCharts.com


What seems to be OK?

Although there is much to be worried about consumption, which accounts for about two thirds of GDP is chugging along, federal spending is advancing smartly in response to the recent budget deal and businesses continue to invest in intellectual property at a heady pace. Spurred on by low unemployment and higher wage income real consumer spending growth remains solid with gains of 2.5% this year and 2.1% in in 2020 and 2021, albeit with 1% growth in the second half of 2020. (See Figures 13 and 14) To be sure the pace is off from the 3% recorded in 2018, but still quite respectable for this stage of the business cycle.  As a result, if you are going to tell a story about a recession in 2020 you would have to have consumer spending far weaker than we now have it.



Figure 13. Employee Compensation, 2011Q1- 20121Q4F, Percent Change Year Ago



Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 14. Real Personal Consumption Expenditures, 2011Q1- 2021Q4F, Percent Change, SAAR

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Unlike earlier in the decade federal spending is now increasing at a 3% annual rate. (See Figure 15) As a result of the recently approved budget deal that increases both defense and domestic purchases the 3% growth rate established in 2018 will continue this year and into 2020 before stalling out in 2021. However we might be low for 2021 as a new Congress might aggressively respond to the weakness we expect to occur in late 2020.

Figure 15. Real Federal Purchases, 2011 – 2021F, Annual Data, Percent Change




Sources: Office of Management and Budget and UCLA Anderson Forecast

The flipside of higher government spending will be the prospect of trillion dollar deficits thorough 2021 and beyond. (See Figure 16) Although both the administration and the Congress do not appear to be interested in the deficit today the day will come when the deficit is interested in them.





Figure 16. Federal Deficit, FY 2011-FY2021F, Annual Data, In $Billions





Sources: Office of Management and Budget and UCLA Anderson Forecast

The one bright spot in business investment is the continuing growth in spending on intellectual property. That category includes, among other things, computer software, research and development expenditures and filmed entertainment. Unlike equipment and structures this sector is being driven by technological imperatives that extend well beyond the business cycle. Despite the slowdown we are forecasting real intellectual property spending will continue to grow robustly, albeit off the heady 8.4% forecast for this year. Specifically we are forecasting growth of 5.5% and 4.1% in 2020 and 2021, respectively. (See Figure 17)







Figure 17. Real Spending on Intellectual Property, 2011Q1-2021Q4, Percent Change, SAAR



Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Conclusion

Economic growth is dramatically slowing. The near 3% pace of over a year ago is now a memory with fourth quarter –fourth quarter real GDP growth for 2019 and 2020 now forecast to be 2.1% and 1.2% respectively. Further job growth will slow to below 70,000 a month, a far cry from the 200,000 plus we have been used to. The real risk is coming from the Administration’s high and erratic tariff policies and its potential impact on exports and business investment. As long has consumption remains firm we believe that the U.S. economy will avoid a recession next year, but nevertheless it will be “The Year of Living Dangerously.”

  


[i] With apologies to Peter Weir and MGM(Released in the U.S. in 1983)
[ii] See Caldera, Dario et.al, “Does Trade Policy Uncertainty Affect Global Economic Activity?” Board of Governors of the Federal Reserve System, Sept 4, 2019.
[iii] See Shulman, David, “The Uncertain Economy,” UCLA Anderson Forecast, September 2010

Thursday, December 8, 2016

First Pass at Trumponomics: From a Reckless Monetary Policy to a Reckless Fiscal Policy, UCLA Anderson Forecast, December 2016

First Pass at Trumponomics: From a Reckless Monetary to a Reckless Fiscal Policy
David Shulman
Senior Economist, Senior Economist UCLA Anderson Forecast
December 2016

Contrary to prior expectations, stocks soared and interest rates surged on the election of Donald Trump. (See Figures 1 and 2) It seems that both the stock and bond markets were pricing in the radical reversal in fiscal policy occasioned by his election while ignoring the negative impacts of his immigration and trade policies. Put bluntly the markets are now anticipating stronger real growth, at least for a while, higher inflation and higher interest rates. We believe that the markets have got it right with respect to direction.

Figure 1. S&P 500, Nov. 26, 2015 – Nov. 25, 2016, Daily Data




Source: Standard and Poor’s via Bigcharts.com





Figure 2. 10-Year U.S. Treasury Bond Yield, Nov. 26, 2015 – Nov. 25, 2016, Daily Data

Bigcharts.com

Our first pass at Trumponomics, which still remains quite vague, makes the following policy assumptions:
·        $300 billion/year annual mostly higher end personal tax cuts effective in Q3.
·        $200 billion/year corporate tax cut effective in Q3 with $50 billion of revenues associated with the repatriation of foreign earnings that quarter.
·        $20 billion/year infrastructure program effective in Q4.
·        $20 billion in higher defense spending in 2018.
·        $20 billion/year Medicaid/ACA cuts effective in Q4.
·        Relaxed energy, environmental and financial regulation.
·        Modest changes to immigration except for border wall/fence.
·        Modest changes to trade policy yielding net reductions in food and aircraft exports phasing in starting mid-2017.


The net result is a massive fiscal stimulus on an economy at or very close to full employment and is directionally what a host of liberal economists have been advocating for the past five years. To be sure the mix tax cuts and spending is far different from what they desired, but make no mistake this is real or even reckless fiscal stimulus. How so? The federal deficit will roughly double to over one trillion dollars by 2018.  (See Figure 3) Simply put an economy operating at full employment should not have a deficit equal to 5% of GDP; the budget should be in balance or in surplus. Thus in the next recession the federal deficit will make the deficits associated with the financial crisis look small. In a way policy going policy will be the mirror image of the past five years as the reckless zero interest rate/QE policy gives way to its fiscal equivalent. Further Europe will follow the U.S. with more aggressive fiscal policies to meet the growing populist challenge.

Figure 3. Federal Deficit, FY2007 -FY2018F

Sources: Office of Management and Budget and UCLA Annual Forecast

In response to higher inflation and the exploding federal deficit the long quiescent Fed will become more aggressive with respect to monetary policy. This month’s expected increase in the federal funds rate will be followed up with many more pushing the rate up to above 2% by the end of 2017 and above 3% by the end of 2018. (See Figure 4) Remember President Trump has two vacancies to fill right away and Chair Yellen’s term expires in January 2018. Trust me; we will have a much different Fed under President Trump. Similarly the yield on 10-year U.S. Treasury Bonds is forecast to exceed 3% by the end of 2017 and 4% by the end of 2018. We know this sounds aggressive but it looks like we are in for, what economists call, a regime change.







Figure 4. Federal Funds vs. 10-Year U.S. Treasury Bonds, 2007Q1 -2018Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast

With $500 billion in tax cuts arriving in the third quarter of 2017 we expect economic growth to accelerate from the recent 2% growth path to 3% for about four quarters. Thereafter growth will slip back to 2%. (See Figure 5) Why so little? First it is hard to stimulate an economy operating at about full employment and second the higher interest rates we foresee will begin to bite. In order to maintain 3% growth or higher the economy will need a productivity miracle. Whether that will come from as the Trump partisans expect the supposed supply side effects of the tax cuts and the proposed regulatory reforms remains to be seen. We would also note that our forecast is likely higher than what Trump’s Democratic opposition would expect.














Figure 5. Real GDP Growth, 2007Q1 -2018Q4F, Percent Change, SAAR
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

In this environment employment will continue to grow with job growth on the order of 140,000 a month in calendar 2017 and 120,000 a month in calendar 2018. (See Figure 6) To be sure if the new administration follows through with its campaign rhetoric to engage in mass deportations then job growth and the economic activity associated with it would be far slower than what we forecast. The unemployment rate is forecast to fall to around 4.5% by the end of 2017 and remain there through 2018. (See Figure 7)  Further as the labor market tightens wage growth will accelerate to 4% or more from the middle of 2017 on. (See Figure 8)











Figure 6. Payroll Employment, 2007Q1 – 2018Q4F
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 7. Unemployment Rate 2007Q1 – 2018Q4F
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 8. Compensation/Hour, 2007Q1 -2018Q4F
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

With year over year core inflation already rising above 2%, it should no surprise to anyone that this rate will accelerate to at least a 2.5% pace; a forecast we view as conservative. (See Figure 9) As oil prices rebound headline inflation will approach 3%. Therefore if we are roughly right about the economy operating at full employment with an unemployment rate of 4.5%, inflation exceeding 2.5% and the prospect of a one trillion dollar annual federal deficit, it should surprise no one that interest rates would be heading much higher.

Figure 9. Consumer Price Index, Headline vs. Core Inflation, 2007Q1 -2018Q4,

The Good, the Bad and the Ugly

The Good

The economic growth we envision will be powered by rising consumption, equipment and defense spending. Real consumption spending is forecast to increase at 3% and 3.7% in 2017 and 2018, respectively compared to 2.6% this year. (See Figure 10) Consumption growth will dampened by an increase in the saving rate as high end consumers stash some of their tax savings and benefit as well from the rise in interest rates. (See Figure 11) The saving rate rises from 5.7% in 2016 to 7.6% in 2018.


Figure 10. Real Consumption Spending, 2007 -2018F, Percent Change, Annual Data
Sources: U.S. Department of Commerce and UCLA Anderson Forecast




Figure 11. Saving Rate, 2007 – 2018F
Source: U.S. Department of Commerce and UCLA Anderson Forecast

Responding to lower corporate taxes and the likelihood of 100% expensing for tax purposes equipment spending is forecast to rebound from a 2.2% decline in 2016. Although we maybe on the conservative side here, we are forecasting increases of 4.5% and 6% in 2017 and 2018, respectively. (See Figure 12) Although the Trump plan includes 100% expensing for buildings along with the elimination of the business interest deduction, we are not sure this part of the plan will be enacted. This aspect of his plan raises a host of issues to geeky to discuss here.

See Figure 12. Real Equipment Spending, 2007 – 2018
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

We have been forecasting a turnaround in defense purchases over the past two years. With the election of President Trump it is upon us. After declining six years in a row real defense spending is forecast to increase by 0.8% and 3.2% in 2017 and 2018, respectively. (Figure 13) This is one spending priority that is expected to achieve broad support.

Figure 13. Real Defense Purchases, 2007 – 2018F, Percent Change, Annual Data
U.S. Department of Commerce and UCLA Anderson Forecast

The Bad

Housing activity will likely be a casualty of the economic environment we envision. The speed of the recent spike in long term interest rates and the prospect of further increases will dampen housing demand. Instead of the 1.4 million level of housing starts that we were previously looking for in 2017 and 2018, we are now looking for a far more modest level of starts in 1.2 million – 1.25 million range. (See Figure 14) To be sure this is an increase from this 2016’s estimated 1.17 million starts, but far below what we perceive to be underlying demographic demand of 1.5 million units per year.

Figure 14. Housing Starts, 2007Q1 -2018Q4F
Sources: U.S. Bureau of the Census and UCLA Anderson Forecast

The Ugly

Although President-elect Trump raged against imports and the trade deficit during the campaign, it looks like he will come up woefully short. Why? The consumer boom that his tax cuts will ignite will inevitably suck in imports. Further the change in policy mix from monetary policy to fiscal policy triggered a rally in the dollar making imports cheaper and exports more expensive. Recall where we started, we are not assuming a major trade war with our partners around the world.  If we are wrong here we are likely wrong everywhere. We are assuming that there will be minor tweaks to trade policy that would modestly reduce imports (mostly in the auto sector) and trigger modest retaliatory actions affecting aircraft and farm exports. As a result imports continue to rise and exports flat-line. (See Figure 15 and 16)







Figure 15. Real Imports, 2007 -2018F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 16. Real Exports, 2007 -2017F, Annual Data, Percent Change
Sources: U.S. Department of Commerce and UCLA Anderson Forecast 

The slowdown in trade that we envision is, unfortunately, only the beginning as the broad postwar consensus favoring open markets has broken down. The bi-partisan collapse of the Trans Pacific Partnership (TPP) and the Brexit vote signaled that we are moving to a more protectionist world and the age of ever increasing globalism is over, at least for now. The world will be a poorer place for it.

A Note on Infrastructure Spending

We do not believe that President-elect Trump’s tax credit based infrastructure plan will pass muster in Congress on the scale he is looking for.  Simply put he is proposing $137 billion in tax credits for private investors to fund major infrastructure projects. The problem is that in order for this to work it requires a revenue stream and there aren’t any revenue streams associated with highway, bridge and tunnel, wastewater and transit maintenance. Thus we anticipate a more traditional infrastructure program amounting to a more modest $20 billion dollars a year of direct taxpayer funding.  We could very well be low here, but it will take time for an expanded infrastructure program to ramp up.

Nowadays as President Obama discovered to his chagrin there are very few “shovel ready” infrastructure projects around awaiting funding. We live in a world of environmental impact studies and Davis-Bacon Act labor codes regarding prevailing wages. Thus if the President-elect wants quick action Congress would have to waive or fast-track the environmental requirements and waive provisions of the Davis-Bacon Act. This would be a tough sell for the Democrats, but the Republicans are in the majority.

A Note on the Deficit

Several my colleagues have cautioned me about the so-called “deficit hawks” in the Republican Party who would fight fiercely against the projected one trillion dollar deficit we are calling for in 2018. My response is that the Republicans want Trump to succeed and they won’t fight him. This is very similar to the evangelical wing of the Republican Party holding its nose and supporting Trump, whose life story certainly raised serious questions for that faction, in the general election against Hillary Clinton. Moreover the Trump Republican Party is not the party of Reagan; it is more a Jacksonian working class party that cares more about jobs than deficits.

Conclusion


The election of Donald Trump signaled a major regime change in economic policy. We are transitioning form a reckless monetary policy to a reckless fiscal policy. In the short run that will bring with it more real growth and inflation along with higher interest rates. However, because the economy is operating at or close to full employment, the growth spurt will be short-lived and we will return to the 2% growth economy of the past seven years. However we will be left with mega-deficits that will make it more difficult to fund the retirement and health programs that voters expect.  And the real risk is that a more aggressive Trump Administration trade policy would trigger a growth killing trade war. Thus we would caution that because there are so many ill-defined moving parts there is higher degree of uncertainty in this forecast compared to prior ones.