More Whack-a-Mole. President Trump, frustrated with the pace of trade talks with the EU, announced 50% tariffs by June 1 if insufficient progress wasn’t made. Within 48 hours that deadline was stretched to July 19th. And if it has to be modified again, it most likely will happen given that 50% tariffs will essentially halt most western-bound movement of goods, and the likelihood of retaliatory tariffs will halt most of our exports as well. Whereas equity markets fell 3% after Liberation Day announcements, last week’s 50% tariff news evoked a much more modest reaction. That appears to be reversed this morning after the weekend extension. It’s the world we have to live in today. More and more, investors are adjusting to Trump’s rhythm. The reality is that the center point for tariff discussions appears to be close to 10%. Tariffs alone are not the entire trade agenda. The EU’s persistent attacks on American tech companies won’t go unnoticed, for instance. There could be specific rules for specific industries varying country to country. Autos are a case in point. American imports come largely from Japan, South Korea, and Germany. The bottom line is that basic frameworks can be negotiated within a few months. Final details will take much longer.
But perhaps the biggest news last week that has serious long-term implications was the passage of the huge reconciliation bill that passed the House by one vote. As always, the devil is in the details and as is typical in Congress, the last-minute edits and additions designed to get the most reluctant on board at the last minute made the final result much messier than it should have been, and will be modified in the Senate. For the most part, Trump and fellow Republicans have talked about all the tax breaks included in the bill. But what is missing from the bill is any effort to lower the Federal deficit and regain fiscal responsibility. One can argue how much deficits will increase in the coming years or how to score the bill’s impact. But any way one does it, this bill will result in higher deficits annually over the next decade.
When Trump passed his big tax cut bill back in 2017, the national debt was about $20 trillion. Eight years later it is over $36 trillion. Do the math. $16 trillion more in 8 years. That’s $2 trillion per year. Debt service has more than doubled over the same period of time. In 2017, the Fed Funds rate was below 1%. Now it is over 4%. Rates all along the curve are over 4% today. Does that bother bond holders? Last week’s anemic 20-year auction and rate spikes in Japan suggest strongly that the answer is yes. We all know Trump wants a bill on his desk to sign by July 2. If Republicans in the Senate simply want to placate Trump and avoid stirring the pot, that will happen with some modifications. The SALT deduction is a case in point. No rational reason for it to be increased to $40,000. The only beneficiaries are the wealthy in high tax states. But these are also big donors. If the Senate cuts the $40,000 back to $20,000, House Republicans can tell constituents they tried and got something while others can claim fiscal responsibility. Trump-style art of the deal!
But back to the real message, adding $2 trillion or more every year to the debt would bring it to over $50 trillion in 8 years. Apply a 4% cost and you get an annual interest expense of over $2 trillion, about five times what it was in 2017. Today the government spends about $6.5 trillion per year. Debt-to-GDP is over 100% and could rise to 125% or more in 8 years, a level not even seen in World War II. Should there be an intervening recession, the numbers would likely be much worse.
No one knows when a crisis occurs requiring immediate austerity measures. There’s no need to find out. We can’t expect miracles out of the Senate. But some efforts to rein in deficits would be welcome news for financial markets.
With that said, any real effort to control deficits requires attacking the major parts of government spending that need to be reined in. So far, the only part of the budget being addressed is Medicaid and SNAP. Even there, early bold goals to reduce costs have been reduced meaningfully. There are three other 800-pound gorillas in the room to attack if one seriously wants to control spending. And make no bones about it, the problem is much more about out-of-control spending rather than a revenue shortfall. The gorillas are defense spending, Medicare and Social Security. Trump has declared the last two off limits but conceivably could address them later in his term. He wants more for defense. As Commander-in-Chief, any President’s first priority is to protect America. Trump’s Golden Dome proposal is certainly on target with that priority. But we don’t have infinite resources. Procurement is a mess. Look at the debacle over Air Force One. Why should it take Boeing 12 years to build two new planes? Boeing bears responsibility but so does the Pentagon which orders changes with each evolving technology. We are still building weapons to fight yesterday’s wars. The whole procurement system needs to be rebuilt from the ground up. DOGE made headlines firing people in what appears to be haphazard fashion but beneath the surface it was also trying to set the table to modernize infrastructure for today’s world. The poster child for this is air traffic control where parts of the infrastructure still even uses floppy disks. When was the last time you used one?
Getting any major infrastructure done takes many years. Much of the 2021 infrastructure bill passed by Congress is still unspent due to permitting delays. To his credit, Trump wants to strip away as much of the red tape as possible. But in Washington, things happen slowly. Bureaucracy gets in the way. So do courts.
The Senate could help by putting spending caps in place and by acts of recission. Recission means taking back, through legislation, monies previously allocated but unspent. In a world where more spending means more benefits to constituents who vote and fund campaigns, that’s a tough thing to do. But modest changes today will avoid significant austerity tomorrow. Does Wall Street care? Equity investors may not. After all, more spending and tax cuts are stimulative. But so is snorting cocaine. The highs might be brief but the aftermath painful. Bond investors do care. As we saw in last week’s auction of 20-year bonds, the lack of buyers means higher rates. One way Treasury has acted to keep 10-year bond yields in check is to issue fewer of them, selling more short-term bonds instead. The problem with front loading the big chunk of debt is that the subsequent turnover rate is higher. That means not only will Treasury have to issue $2 trillion of new debt (or more) annually, but it will also have to refinance an ever increasing amount of maturing debt at the same time. To be absurd but to make a point, if all Federal debt had a maturity of one-day, then Treasury would have to find buyers for over $36 trillion dollars of debt every day. Moreover, if inflation were to rise again setting off another inverted yield curve, debt service costs would skyrocket.
The bottom line is what the Senate will do with the House bill matters. It really matters. Lip service may make Trump happy. He wants to get everything on his agenda done as fast as possible. But fiscal responsibility matters as well. If Congress could get a constructive bill passed and incorporate an increase in the debt ceiling at the same time, Wall Street would react positively. The debt ceiling becomes part of this discussion because if raising it can be incorporated into the reconciliation bill, it would require only 50 votes in the Senate to pass. But if reaching agreement on the reconciliation package stretches out for too long, and the debt ceiling is reached before the reconciliation bill passes, then 60 votes would be needed allowing Democrats to dictate changes.
So, we will get a bill by early July. The issue is form. Simply put, a bill that shows little spending restraint will not be well received by the bond markets around the world. One that begins to address the level of deficit spending might contain fewer goodies, but would be more responsible. Trump can only lose four Republicans in the Senate. Rand Paul and Ron Johnson are taking the charge to cut the proposed deficit. They need just two more to stand ground and make constructive changes. Let’s hope they succeed.
Marjorie Taylor Greene turns 51 today.
James M. Meyer, CFA 610-260-2220