Best of the Week
Most Popular
1. Will Gold Price Breakout? 3 Things to Watch… - Jordan_Roy_Byrne
2.China Invades Saudi Oil Realm: PetroDollar Kill - Jim_Willie_CB
3.Bitcoin Price Trend Forecast, Paypal FUD Fake Cryptocurrency Warning - Nadeem_Walayat
4.The Stock Market Trend is Your Friend ’til the Very End - Rambus_Chartology
5.This Isn’t Your Grandfather’s (1960s) Inflation Scare - F_F_Wiley
6.GDX Gold Mining Stocks Fundamentals - Zeal_LLC
7.US Housing Real Estate Market and Banking Pressures Are Building - Chris_Vermeulen
8.Return of Stock Market Volatility Amidst Political Chaos and Uncertain Economy - Buildadv
9.Can Bitcoin Price Rally Continue After Paypal Fake FUD Attack? - Nadeem_Walayat
10.Warning Economic Implosion on the Horizon - Chris_Vermeulen
Last 7 days
Is a Stock Market Crash Imminent or Does this Stock Market Bull Still Have Legs - 25th Apr 18
Gold Price Focusing on May Cycle Bottom - 25th Apr 18
Cash “Vanishes” From Bank Accounts In Ireland - 25th Apr 18
Is the Malaysian Economy a Potemkin Village - 25th Apr 18
Land Rover Discovery Sport Rattling / Knocking Sounds From Car Pillars - 25th Apr 18
China Takes the Long View on Gold-Silver... and So Should You - 25th Apr 18
Russia Buys 300,000 Ounces Of Gold In March – Nears 2,000 Tons In Gold Reserves - 24th Apr 18
Stock Market Study Shows Why You Shouldn’t “Sell in May and Go Away” - 24th Apr 18
UK Gambling Statistics - What the Numbers Say - 24th Apr 18
Chaos Capitalists Short Countries - How Chanos Got China Wrong - 24th Apr
Artificial Intelligence Defines the Political News Narrative - 24th Apr 18
Stock Market "Oops, They Did It Again" - 24th Apr 18
Fox in the Henhouse: Why Interest Rates Are Rising - 23rd Apr 18
Stocks and Bonds, This is Not a Market - 23rd Apr 18
Happy Anniversary Silver Investors! - 23rd Apr 18
The Hottest Commodity Play In 2018 - 23rd Apr 18
Stock Market Correction Turns Consolidation - 23rd Apr 18
Silver Squeeze, Gold Fails & GDX Breadth - 23rd Apr 18
US Economy Is Cooked, the Growth Cycle has Peaked - 23rd Apr 18
Inflation, With a Shelf Life - 23rd Apr 18 - Gary_Tanashian
Stock Market Predictive Modeling Is Calling For A Continued Rally - 22nd Apr 18
SWEATCOIN - Get PAID to WALK! Incentive to Burn Fat and Lose Weight - Review - 22nd Apr 18
Sheffield Local Elections 2018 Forecast Results - 22nd Apr 18
How Long Does it take for a 10%+ Stock Market Correction to Make New Highs - 21st Apr 18
Sheffield Ruling Labour Party Could Lose 10 Council Seats at May Local Elections - 21st Apr 18
Crude Oil Price Trend Forecast - Saudi Arabia $80 ARAMCO Stock IPO Target - 21st Apr 18
Gold Price Nearing Bull Market Breakout, Stocks to Follow - 20th Apr 18
What’s Bitcoin Really Worth? - 20th Apr 18
Stock Market May "Let Go" - 20th Apr 18
Overwhelming Evidence Against Near Stock Market Grand Supercycle Top - 20th Apr 18
Crude Oil Price Trend Forecast - Saudi's Want $100 for ARAMCO Stock IPO - 20th Apr 18
The Incredible Silver Trade – What You Need to Know - 20th Apr 18
Is War "Hell" for the Stock Market? - 19th Apr 18
Palladium Bullion Surges 17% In 9 Days On Russian Supply Concerns - 19th Apr 18
Breadth Study Suggests that Stock Market Bottom is Already In - 19th Apr 18
Allegory Regarding Investment Decisions Made On Basis Of Government’s Income Statement, Balance Sheet - 19th Apr 18
Gold – A Unique Repeat of the 2007 and How to Profit - 19th Apr 18
Abbeydale Park Rise Cherry Tree's in Blossom - Sheffield Street Tree Protests - 19th Apr 18
The Stock Market “Turn of the Month Effect” Exists in 11 of 11 Countries - 18th Apr 18
Winter is Coming - Coming Storms Will Bring Out the Best and Worst in Humanity - 18th Apr 18
What Does it Take to Create Living Wage Jobs? - 18th Apr 18
Gold and Silver Buy Signals - 18th Apr 18
WINTER IS COMING - The Ongoing Fourth Turning Crisis Part2 - 18th Apr 18
A Stock Market Rally on Low Volume is NOT Bearish - 17th Apr 18
Three Gold Charts, One Big Gold Stocks Opportunity - 17th Apr 18
Crude Oil Price As Bullish as it Seems? - 17th Apr 18
A Good Time to Buy Facebook? - 17th Apr 18
THE Financial Crisis Acronym of 2008 is Sounding Another Alarm - 16th Apr 18
Bombs, Missiles and War – What to Expect Next from the Stock Market - 16th Apr 18
Global Debt Bubble Hits New All Time High – One Quadrillion Reasons To Buy Gold - 16th Apr 18
Will Bitcoin Ever Recover? - 16th Apr 18
Stock Market Futures Bounce, But Stopped at Trendline - 16th Apr 18
How To Profit As Oil Prices Explode - 16th Apr 18
Junior Mining Stocks are Close to Breaking Downtrend - 16th Apr 18
Look Inside a Caravan at UK Holiday Park for Summer 2018 - Hoseasons Cayton Bay Sea Side - 16th Apr 18
Stock Market More Weakness? How Much? - 15th Apr 18
Time for the Gold Bulls to Show their Mettle - 15th Apr 18
Trading Markets Amid Sound of Wars - 15th Apr 18
Sugar Commodity Buying Levels Analysis - 14th Apr 18
The Oil Trade May Be Coming Alive - 14th Apr 18

Market Oracle FREE Newsletter

Trading Lessons

Donald Truimp the King of Debt Takes the Reins

ElectionOracle / US Debt Nov 17, 2016 - 12:51 PM GMT

By: Peter_Schiff


The election of Ronald Reagan in 1980 provides the best recent precedent for the unexpected triumph of Donald Trump (in my opinion, the other post-war Republican takeovers of the White House -- Ike in '52, Nixon '68, and W. in '00 - did not constitute a real break from the status quo.) As many people expect great changes from Trump, it is worthwhile to look at what the Reagan Revolution actually wrought.

Both Reagan and Trump were better known to many as entertainers rather than politicians, both came from outside the Republican mainstream, and both engineered hostile takeovers of the Party. During the 1970s, the Republican Party was dominated by "Rockefeller Republicans," the Ivy League-educated liberal Eastern elites. Reagan was the Western heir apparent to Barry Goldwater, the deeply conservative standard-bearer who went down in flames in 1964. In 1976, the brash Reagan had the nerve to challenge incumbent Republican President Gerry Ford in the primary, thereby weakening him in the general election, which he ultimately lost to Jimmy Carter. While Reagan was simply too conservative for the Rockefeller wing, Trump's various positions are similarly inconsistent with much of the mainstream neo-conservative orthodoxy. Both candidates also capitalized on a weak economy as a catalyst to encourage voters to cross traditional party lines. Many of the rust belt "Reagan Democrats" came home to Trump.

While books have been written about the cultural and political legacy of Reagan's presidency, harder facts can be found in his budgetary record. Despite the economic revival that his tax-cutting and deregulation tendencies delivered, the national debt ballooned as it never had for any other peacetime President. Although the fiscal imbalances have gotten significantly worse since Reagan left office, the Gipper gave plenty of cover for future Republican presidents to run up red ink. President Donald Trump, the self-proclaimed "King of Debt", now appears to be perfectly positioned to test the limit of how much debt the world's largest economy can issue.

Leading up to the election of 1980, Reagan and the conservative economists who supported him, warned that Federal debt, which had risen to approximately 26% of GDP, had grown too heavy to bear (data from Congressional Budget Office, July 2010) Reagan brought the spirit of Milton Friedman into the Oval Office, and his campaign was based on a clear intention to roll back the nearly 50 years of socialist government expansion that had occurred since Roosevelt's New Deal.

But when Reagan came to Washington he was confronted by a strong Democratic majority in the House of Representative led by House Speaker Tip O'Neill, a skillful and forceful defender of big government. Reagan soon discovered that the political price was always very high when government expenditures are being restricted. And so, Reagan decided to move on the tax cuts (a perennial political winner) but never really got around to the spending cuts. As a result, the 26% debt to GDP ratio that he inherited when he came into office expanded to 41% by the time he left. (data from Congressional Budget Office, July 2010) This was not the complete conservative victory for which his backers had hoped.

Trump comes to office with similar expectations for significant changes. The good news for him is that he will face far fewer restrictions than Reagan had to face. Most importantly, both houses of Congress are now Republican. The Supreme Court is currently split along ideological lines but is likely to swing conservative after Trump's appointment to the open Scalia seat.

On the taxation side, Trump has proposed cuts in personal and corporate tax rates that could likely sail through Congress. How much these moves will add to the deficit depends on how much growth they generate in the economy. Such predictions are very hard to make. But if the tax cuts are assured, the growth is not. However, there is no need to make algorithmic predictions on the budgetary implications of spending decisions. They are what they are, and their impact is immediate. Trump plans massive increases in Federal spending, initially in the form of a trillion dollar infrastructure spending over ten years, and billions to build his border wall and pay for his planned deportation force. On the spending side, Trump could likely get whatever he wants, and more. Had a smaller infrastructure spending plan been proposed by President Hillary Clinton, it would have likely been voted down by "fiscally hawkish" Congressional Republicans. Such scruples could fall by the wayside when the spending requests come from a Republican President.

Although the years of trillion dollar plus deficits we experienced during the first Obama term have been pared down to the $500 -$700 billion dollar range, the Congressional Budget Office's Summary of The Budget and Economic Outlook, 1/19/16, currently predicts that we will officially return to trillion dollar levels by 2022. (In truth we are already there. Over the last 10 years the actual expansion of the debt has averaged $1.1 trillion per year, about $300 billion more than the average deficit of $790 billion over that time). (TreasuryDirect; The CBO's projections are based on no unplanned spending increases between now and 2022, steady GDP growth in the 2% to 3% range, and no dip into a recession (even though the current expansion is already far longer than the typical postwar expansion). Given this very optimistic set of assumptions, and Trump's announced plans on taxing and spending, we should absolutely expect a massive expansion of the Federal debt over the next four years. The more difficult question is how it will be financed.

When making a comparison to Reagan, it is important to realize that he financed his debt expansion the old fashioned way: He sold long-term government debt to private investors. In the early 1980s, savings levels in the United States were much higher than they are today. The average American actually had money in the bank. And those with the means to invest were less inclined to dabble in stocks than they are today (there was no eTrade to make the process easy and transparent). The stock market had essentially made no gains between 1966 and 1980, (Dow Jones Industrial Average data) so investors could be forgiven for having given up faith. Bonds were a bigger part of the mix up and down the investment spectrum. And those investors who stepped up to the plate to buy those 30-year bonds in 1981 to finance the Reagan deficit ended up making some of the best portfolio decisions.

It seems impossible to believe in our current low interest world, but in 1982 the U.S government sold 30-year bonds with a 14% annual coupon. That's right, a guaranteed, principal-protected, 14% annual return for 30 years. Investors today could only dream of something so magical. Of course inflation was higher back then (partly because the government hadn't yet figured out how to recalibrate the Consumer Price Index), but even at its worst, inflation rose only to approximately eight percent. ( This means that buyers of those 30-year bonds were getting a real rate of six percent above inflation. But it just gets better from there.

Over the course of the Reagan presidency inflation and interest rates came down steadily. This meant that those investors who bought in 1982 would see their real rate of return increase every year. By 1988 inflation had come down to 4%, so those bonds offered a real yield of 10%. The falling inflation strengthened the value of the dollar itself. So in relative terms Americans holding those bonds were seeing a real increase in purchasing power of their principal relative to the falling prices of imported goods. Also, in an environment of falling interest rates investors holding 30-year 14% bonds could sell those bonds before maturity for more than they paid. That's because even at a price above par the bonds would still offer higher yields to maturity than newly issued bonds. But despite the premium, investors were better just to hold them till maturity. Purchasing Treasury bonds in 1982 was an investment in America's future, but it also happened to turn out to be the deal of the Century.

Think about how different it would be today for investors making a similar choice to finance the Trump deficits. 30-year bonds are currently being offered at a rate of just under 3%. If you believe the government inflation figures of just about 2%, this means that your effective yield is about 1% (pre-tax). If inflation is even slightly higher, the real yield could be negative. And in 30 years there is plenty of time for inflation to go, much, much higher. If it does, these bonds would be all but guaranteed to deliver less purchasing power than their original cost, even if held to maturity.

If interest rates were to rise from the current low levels, as almost every economist and investor assumes they must, the value of long-term bonds will surely fall. In another danger to bond prices, Bloomberg News reports that the new Trump economic team will likely put pressure on the Fed to reduce the amount of bonds on its balance sheet. To do so in any meaningful way will require that the Fed sell off portions of its $4.5 trillion bond stash of holdings into the open market. This could turn the biggest buyer of Treasuries into the biggest seller.

A sustained period of falling bond prices would mean that if current buyers wanted to cash out before maturity, they would likely have to sell for a loss, not the gain that their fathers would have seen with the 1982 bonds. If rates got as high as five or six percent (and I think they will go much higher) those losses could be substantial. As Jim Grant likes to say, today's long maturity bonds represent return-free risk. Or as Warren Buffet likes to say, it's like picking up pennies in front of a steamroller.

The risks become greater still when you consider how America's fiscal position is much worse today than it was in 1980. When Reagan took the oath of office America was the world's largest creditor nation. Today it's the largest debtor. Our debt was just 30% of GDP then, while today its 105% and projected to go much higher over the next generation...even without Trump's taxing and spending plans factored in.

But arguing the investment merits of long-term government bonds is a bit pointless in the current age. Real investors gave up on bonds long ago. What little savings Americans still have either stays in the bank, or gets directed to stocks or real estate. The bond market has almost become the exclusive playground of central banks. In Japan and Europe, central banks are sucking up the vast majority of government debt. We did the same during our four years of quantitative easing, and the Federal Reserve's balance sheet remains swollen.

If under President Trump annual deficits explode, whom should we expect to buy the trillions in debt we will have to issue to pay for it? In the recent past, the big buyers have been central banks in China, Japan and Saudi Arabia. Should we expect those customers to return? We may be in an allout trade war with China, Japan is already pushing its own QE program to the limit (its central bank is currently buying large portions of the Japanese stock market) and the Saudis are struggling with $50 oil. We may need to find new buyers.

But don't look to Mom and Pop USA. Those investors are tapped out. Don't look to the pension funds. They can't meet their numbers with 3% coupons. Don't look to the hedge funds. They are losing money fast due to bad performance, and their investors expect more nuanced thinking than U.S. Treasuries. What's more, (in contrast to 1982) the U.S. dollar is currently near generational highs. If the dollar should weaken, holders of dollar-denominated debt will be left holding the bag. When Reagan was elected, the dollar had been beaten down to all time record lows, having lost about 2/3 of its value against currencies like the Deutsche mark, Swiss franc, and Japanese yen. So high yielding, dollar-denominated Treasuries were attractive investments for foreign savers. But the dollar has already risen sharply over the last few years based on expectations the Fed would normalize interest rates. Investors should not be under any illusions that the dollar will experience another continued rally. With so many reasons arguing against buying long-term dollar Treasuries, the Fed may be the only game in town.

Given that, it's impossible to imagine that the Fed will ever allow interest rates to rise by any significant amount. (Doing so would devastate the value of their bond holdings and raise debt service costs past the point where the government, or most private borrowers, could pay). Already more than $4.5 Trillion of Treasury bonds sit on the Fed's balance sheet. Look for that number to balloon during the Trump years.

Debt monetization was the term that used to be used by economists to describe the undesirable outcome of a country's central bank becoming the exclusive financier of its national debt. Inflation and currency devaluation were expected to be the results of this brash approach to fiscal policy. But this will likely be our future under Trump. Investors would be wise to recognize this and to diversify appropriately.

In 2009, when the first Quantitative Easing program allowed the Fed to buy large quantities of Treasury bonds, then Fed Chairman Ben Bernanke pushed back against Congressional accusations of debt monetization by claiming that the purchases should be considered temporary, and that they would be unwound when the crisis passed. Since then the Fed has not sold a single Treasury and has used every penny of interest and principal repayments to buy more Treasuries. Should the Trump deficits force the Fed's balance sheet into the stratosphere, it will be obvious to all what the Fed is doing.

America was able to survive Ronald Reagan's debt experiments because we started borrowing from a position of relative strength. But the debt took its toll, and we are now a shadow of our former selves. Yet rather than reversing course before it's too late, Trump may just step on the gas, assuring we go over the cliff that much sooner.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Summer 2015 Global Investor Newsletter!

Read the original article at Euro Pacific Capital

Peter Schiff

Euro Pacific Capital

Peter Schiff Archive

© 2005-2018 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules