This money will, of course, need to be borrowed and as interest rates rise, including bond yields, there is a growing threat of a debt trap emerging for the US government and its economy – that is, borrowing money to pay the interest on the growing level of debt, but also to cover the higher interest rates. The level of US government debt had stabilised in the period 2014 to 2016 at around 78 per cent of GDP.
Trump’s tax cuts will see the level of government debt rise from US$16 billion in 2018 to $29 trillion or 96 per cent of GDP in 2028 with no signs of stabilisation at the end of the forecast. The concerning thing is that these forecasts are based on optimistic forecasts that there will be no severe economic downturn at any stage over the next decade. A growth moderate will add further pressure to government finances.
Either way, it is a simple truth that the US stock market has been a beneficiary of a simple cash transfer from the government to private sector corporations.
Which begs the obvious question – can these fundamentals be sustained?
The answer is quite clearly no.
At some stage, as the impact of the cash transfers from the government to the business sector fades, as the hikes in US interest rates impacts on the real economy (business investment and consumer borrowing) and as there is a realisation that funding the budget deficits and level of government debt is fraught with danger, policy changes will be needed.
There are only two ways to fix a budget deficit– tax increases or spending cuts. With government spending already low, the scope to correct the budget imbalance through cuts is low, and any impact on the budget bottom line from a few cuts in spending will be small. Rather, it appears that if the US government is to stabilise its level of debt, let alone reduce it, tax hikes are needed.
And this is where the irony comes. Tax hikes will reverse the sugar-hit to the economy and share prices which, almost by definition will pull the rug out from under the US stock market when it comes.
All of which suggests the recent run up in US stock prices is built on a foundation of sand. It cannot last – it is artificial and not much based on fundamentals of rising productivity and innovation, rather it is based on a simple cash transfer to business.
Enjoy it while it lasts, but be prepared for the unwinding of the stimulus in the not too distant future.