Trump boosts US stocks with borrowed government money

Thu, 20 Sep 2018  |  

This article first appeared on the Yahoo 7 Finance website at this link: https://au.finance.yahoo.com/news/trump-boosts-us-stocks-borrowed-government-money-011637215.html 

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Trump boosts US stocks with BORROWED government money

US stock prices continue to trade at near record highs and a lot of the recent rise has a lot to do with the policies of President Donald Trump.

The surge in the Dow Jones Industrial Average has been phenomenal. Since the November 2016 Presidential election, the Dow Jones is up around 50 per cent despite a few hiccups at the start of 2018 as the US Federal Reserve hiked interest rates and the threats of a US trade war turned into a reality.

The rise in US stocks, whilst impressive, is built on all the wrong things. ‘Wrong’, that is, in terms of sustainability.

As President, Donald Trump has delivered a range of tax cuts that have a total cost to the budget of around US$1.5 trillion. This one-off, impossible to replicate policy like any other policy that dumps cash into the economy has underpinned stronger economic growth and a temporary lift company profits. The tax changes has seen US companies engage in a record level of stock buy-backs which by design, has been a powerful driver behind rising share prices.

The problem with the Trump tax cuts is that every cent of the US$1.5 trillion has been funded with money borrowed by the government.

Such is the destruction to the US budget, that the US Congressional Budget Office is now estimating the US budget deficit to average a staggering 4.8 per cent of GDP in every year in the decade from 2018 to 2028. When Trump became President, the budget deficit had narrowed to just 2.5 per cent of GDP.

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.

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