Faus­tian fail­ure

Trump’s deal with the devil failed ... now it’s time to pay Am­brose Evan­sPritchard

The Daily Telegraph - Business - - Front Page - Won­der­land. Alice in

Don­ald Trump’s eco­nomic deal with the devil has failed even in its most im­me­di­ate and cyn­i­cal ob­jec­tive. It is down­hill on ev­ery front from now on. The pres­i­dent de­based the US pub­lic ac­counts with a Pero­nist fis­cal pol­icy of stag­ger­ing ir­re­spon­si­bil­ity in or­der to keep con­trol of Congress – or rather to buy Congress with

$1.5 tril­lion of fu­ture pub­lic debt, might be a bet­ter de­scrip­tion.

He lost the House any­way, and with it his chances of avoid­ing a bliz­zard of sub­poe­nas from the over­sight and in­tel­li­gence com­mit­tees. The Democrats won the pop­u­lar vote by 7pc at the ab­so­lute apogee of a Repub­li­can fis­cal boom.

The sugar rush of stim­u­lus so late in the eco­nomic cy­cle is al­ready start­ing to fade. Over the course of 2019 the Faus­tian pact will pro­gres­sively close in on Mr Trump, and on the credit-rat­ing of the US Trea­sury. Mor­gan Stan­ley said it will turn in­eluctably into “fis­cal drag” as the months pass with­out more hand­outs to feed the mon­ster.

Per­haps Speaker Nancy Pelosi will give Trump a par­tial re­prieve. Com­mon ground ex­ists on in­fra­struc­ture spend­ing. But the Democrats will keep him on a tight leash be­fore the next elec­tion. “They are not go­ing to give him any­thing to run on, any vic­to­ries,” said Steve Blitz from TS Lom­bard.

Omi­nous signs are al­ready ev­i­dent in sec­tors most sen­si­tive to higher bor­row­ing costs. The Fred­die Mac rate for a 30-year fixed mort­gage has risen 100 ba­sis points to 4.83pc over the last year. Home sales have dropped by 21pc. Av­er­age prices have slipped 3.5pc.

This is re­mark­able given that the fis­cal pedal is pushed to floor. The fed­eral bud­get deficit is near­ing 5pc of GDP, at a time when full em­ploy­ment should re­store bal­ance. Bill Clin­ton had a sur­plus of 2.3pc at the end of the Nineties ex­pan­sion.

The US has never run a late-cy­cle deficit of this scale in peace­time yet the stim­u­lus has washed over the econ­omy like a del­uge of rain on parched soil, a flash flood that leaves only dam­age. “They have had a ter­ri­ble bang for the buck,” said Adam Posen, chair­man of the Peter­son In­sti­tute.

“They are rack­ing up debt with a low fis­cal mul­ti­plier. The tax cuts have not un­leashed in­vest­ment and have added al­most noth­ing to GDP on a sus­tained ba­sis,” he said. What re­mains is an over­heated econ­omy with early signs of stagfla­tion.

Above all, there re­mains the fu­ture debt claims on Amer­i­can tax­pay­ers. The In­ter­na­tional Mon­e­tary Fund says Amer­ica’s gross pub­lic debt will be 106pc of GDP this year, 110pc in 2020 and 117pc in 2023, but with­out the huge pool of in­ter­nal sav­ings and ex­ter­nal as­sets that have made it pos­si­ble for Ja­pan to defy grav­ity for two decades.

The task of taming Amer­ica’s run­away en­ti­tle­ments will be that much harder by the time Trump has fin­ished his hand­i­work, or im­pos­si­ble.

It is one rea­son why for­mer Fed chief Alan Greenspan calls Trump “the clos­est thing that Amer­ica has pro­duced to a Latin Amer­i­can-style pop­ulist”, the Caudillo del Norte. The other rea­son is Trump’s clien­telism: how he cod­dles in­cum­bent in­ter­ests – coal, steel, cars, de­clin­ing in­dus­tries – that stand in the way of cre­ative de­struc­tion.

Trump’s poli­cies flout the car­di­nal Key­ne­sian rule – “the boom, not the slump is the right time for aus­ter­ity” – with­out com­pen­sat­ing gains on the sup­ply-side front. Trump claimed a year ago that his “tax cuts and jobs act” would lead to a Rea­ganesque in­vest­ment boom and would be “rocket fuel for the US econ­omy”.

It has done no such thing. Capex spend­ing by busi­ness has been fall­ing. Non-res­i­den­tial in­vest­ment is the slow­est in two years. The “happy hand-over” from fis­cal fizz to a durable surge in pro­duc­tiv­ity is ab­sent.

The cut in cor­po­rate tax rates from 35pc to 21pc has in­stead fed stock buy­backs by US com­pa­nies. Why would they in­vest a decade into an age­ing boom, and in the midst of a global trade war?

The ob­vi­ous prob­lem with crank­ing up stim­u­lus to­day when un­em­ploy­ment is at a half-cen­tury low and there are ca­pac­ity con­straints ev­ery­where is that the Fed­eral Re­serve must fight back with mon­e­tary tight­en­ing or let the in­fla­tion ge­nie out of the bot­tle. The equi­lib­rium in­ter­est rate – R* in cen­tral bank ar­got – is jump­ing higher. The loose fis­cal/tight money mix has widened the dif­fer­en­tial in global in­ter­est rates and lifted the Fed’s trade-weighted dol­lar in­dex by 10pc since Jan­uary to 128. It is just a whisker shy of a 30-year high.

This is tor­ment for a global fi­nan­cial sys­tem that has never been so de­pen­dent on US dol­lar bor­row­ing, with $26 tril­lion (£18 tril­lion) of off­shore lend­ing in bank loans, bonds and equiv­a­lent de­riv­a­tives, and with a col­lec­tive debt ra­tio 40 per­cent­age points higher than a pre-Lehman peak.

Much of the emerg­ing mar­ket nexus is al­ready in the grip of a credit crunch. This may get worse un­til “blow­back” into the US econ­omy fi­nally causes the Fed to re­treat.

The me­chan­i­cal con­se­quence of a US con­sump­tion boom and a soar­ing dol­lar is to suck in im­ports, paint­ing the cur­rent ac­count deficit in Gothic colours. The IMF fore­casts a jump in the deficit to $652bn or 3pc of GDP next year. Mr Posen’s fear is that the White House will hunt for scape­goats, lurch­ing fur­ther into pro­tec­tion­ism and tar­iff war­fare. It is the cul­mi­nat­ing logic of Trump­ism.

The Fed is now un­wind­ing QE with bond sales of $50bn a month, both drain­ing global dol­lar liq­uid­ity and adding to the sup­ply of debt that US mar­kets must digest. This is mak­ing life even harder for the US Trea­sury as it tries to cover Mr Trump’s $1 tril­lion deficits.

Hence the jump in real 10-year Trea­sury yields (TIPS) to 1.23pc from 0.46pc in Jan­uary. Debt mar­kets are tight­en­ing. The av­er­age bor­row­ing cost for BBB-rated com­pa­nies in the US has jumped 120 ba­sis this year to 4.71pc.

Trump has sucked all the short-term ad­van­tage that ex­ists by ma­nip­u­lat­ing the macro-eco­nomic levers. Hence­forth it will be harder. Lak­sh­man Achuthan, from the Eco­nomic Cy­cle Re­search In­sti­tute, calls it the “Red Queen” ef­fect from

“It takes all the run­ning you can do to keep in the same place. If you want to go some­where else, you must run twice as fast.”

If Trump is lucky, the Fed will cal­i­brate its tight­en­ing per­fectly – a feat rarely achieved – and pull back in time to keep an age­ing and en­fee­bled ex­pan­sion go­ing into 2020.

It is just as likely that the US will tip into re­ces­sion in late 2019. Ei­ther way he will face his next elec­tion in far more hos­tile cir­cum­stances.

‘Over the course of 2019 the Faus­tian pact will pro­gres­sively close in on Mr Trump, and on the credit-rat­ing of the US Trea­sury’

A swim­mer shares the room with vot­ers for the US midterm elec­tions on Tues­day. Democrats won the pop­u­lar vote by 7pc


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