It appears as if we are entering a new era of ever expanding federal budget deficits, and this is causing interest rates to rise, which changes the whole economic scene.
Not only is this altering the domestic economic picture, but it also has implications for a much weaker value for the US dollar.
The higher interest rates and the weaker US dollar will inhibit any hoped-for improvements in factor productivity for human as well as physical capital and result in constrained growth.
The United States government is poised to enter a new era of ever expanding federal deficits, raising the ratio of US government debt to Gross Domestic Product to newer, never-before-seen peacetime highs.
Stanford economist John Cogan lays this picture out in his Wall Street Journal op-ed piece "Why America is Going Broke."
The culprit? Entitlement spending. Spending on Social Security, Medicare, Medicaid, disability insurance, food stamps, and a host of other welfare programs. As a share of Gross Domestic Product, the figure on these numbers just goes up and up and up.
"Since the late 1940s, entitlement claims on the nation's output of goods and services have risen from less than 4 percent to 14 percent."
He adds that:
"If left unchecked, these programs will push government spending to levels never seen during peacetime."
Meanwhile, the share of GDP going to national defense and other non-defense expenditures has remained constant in recent years and will stay constant going forward.
National defense and non-defense discretionary programs combined are no higher today than they were seven decades ago.
Overall:
"Financing this spending will require either record levels of taxation or debt."
Neither option is desirable for the longer run because the focus of the nation will have to be on even slower economic growth, as people have to pay taxes - or, inflation, as credit inflation accelerates; or both.
Neither of these will create faster growth of total factor productivity - either from labor or from capital - which is what is needed for the economy to achieve faster, sustainable economic growth.
And, in fact, there will even be a further drag on productivity, coming from the international sector.
A startling report has just been presented by the Financial Times. This report examines the relationship between US fiscal expansion - the tightness or looseness of US fiscal policy - and the value of the US dollar.
Since the late 1980s, there has been a strong positive correlation between the looseness of the government's fiscal position and the weakness of the US dollar.
As explained by Hans Redeker, a strategist at Morgan Stanley, in the current situation:
"The booming global economy and rising capital demand mean the US will face stiffer international competition for capital to finance the deficit, which means it will have to offer higher rates or a cheaper exchange rate, both of which we have seen this year."
Both outcomes will not be helpful to increasing the total factor productivity in the United States, and if the total factor productivity is stagnant, then economic growth in the United States will also be mediocre. Although the weaker dollar will help generate more exports from the US relative to imports, this will have a modest impact on economic growth but will not produce any incentive for corporations to improve the efficiency and productivity of either their human or physical capital.
The article also quotes Vasileios Gkionakis, head of currency research at UniCredit:
"Based on the 2018 projected federal deficit, US fiscal policy will see a loosening, the magnitude of which has not been seen over the past 30 years."
The consequences of this projection are captured in the chart at the bottom of this post.
All of this will put more and more pressure on the Federal Reserve. Whereas, at the current time, the Fed is working to allow short-term interest rates to rise, further pressures on market rates to increase may not be quite what the central bank wants.
Already, the Fed is facing increasing pressurefor longer-term interest rates to rise. And, then there is the concern over a possible stock market correction due to rising interest rates.
The feeling already exists in some circles that we are in - or are entering - a new era that will require us all to reassess our strategies for the stock market and other investments, for the thrust of financial engineering, and for the behavior of the economy.
If Mr. Trump wanted to shake things up, it certainly looks as if he is achieving his goal.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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