Trump Bulls in the White House, Red Flags on US Debt

By Hussein Sayed

Donald Trump’s administration is bullish right out of the gate. He’s chosen a cabinet made up of oil business tycoons like former Exxon chairman Rex Tillerson, so the agenda is clear; boost US big business and jobs. It’s less clear what Trump plans to do about the national debt, currently just shy of 20 trillion USD and 103% of GDP. The debt is a red flag challenge that has the bulls in the White House lowering their horns for battle.

In the 10 years since the real estate sub-prime and financial crises, US debt more than doubled. The 700 billion USD it cost to bail out the crippled financial sector in 2008 was just the beginning. A costly but necessary QE programme supported US Treasuries throughout the recession and recovery. QE combined with low interest rates helped to restore investment confidence. The Federal Reserve’s cautious monetary policy nursed the economy through the worst period. But government debt overheated dramatically, going from nine trillion in 2007 to nearly 20 trillion in 2017. 

It’s likely that the national debt will skyrocket under Trump’s presidency. Trump swears he will make America great again through aggressive fiscal policies. He has pledged to accelerate growth and create jobs and wasted no time rallying his network of mega business owners. During his pre-inauguration conference, Donald Trump said he was proud that Ford had decided to expand its factory in Michigan instead of building one in Mexico. Also, he is pressing General Motors to build its factories in the US instead of abroad. The president-elect promised that Big Pharma would be pressured into bidding for government contracts. He believes this would save billions of dollars over time. In short, Trump wants to run the federal government like a business, and make it more efficient. Trump wants to be the ‘greatest job creator’ ever seen.

The president-elect’s rhetoric is all very well. But common sense says that money – especially debt – talks louder. Even with savings on government contracts, at some point soon, taxes on business and households would have to be increased so the Treasury can service and even reduce US debt. This is unlikely to appeal to the Republican agenda of low taxes and less red tape, which is why Trump wants to raise import taxes instead.

The alternative to reducing the national debt is even less appealing. There is a risk of the US losing investor confidence in its bonds. This could lead to a huge rise in the cost of financing the massive debt, and the threat of default. The end result would be another prolonged recession. This scenario is highly likely if Trump goes ahead with high tariffs on imports from China. There are increasing risks linked to alienating China and other emerging countries which play a big role in lending to the US. 

As it stands, import tariffs slapped on top of a strong USD will have a cost of its own. The strong USD and higher interest rates will start pricing US products out of the export markets, meaning lower export revenues. Higher import costs due to increased taxes will heat up inflation. This would make goods less affordable for consumers, and reduce importers’ overall revenues. Higher import taxes might bring in money for the US Treasury. But at the same time, reduced demand for exports would mean lower tax revenues from domestic exporters. Nonetheless, it can’t be denied that there is an upside to protectionism for domestic energy companies. If there are increased taxes on imported commodities like crude oil, it would increase local demand and revenues for US suppliers. In that case, US companies like Exxon would theoretically be able to boost the number of jobs on their payroll.

On the markets side, Trump’s rhetoric has a motivating effect, as Wall Street picks up the bullish tone. Everyone wants to go back to a strong economy and away from the pain of the recent recession and struggle to recover. But a return to pre-2007 economic conditions may still be a long way off, especially if Trump’s gamble on protectionism backfires. 

The bottom line for investors is that the USD crosses, US share prices, and commodity prices still face a period of uncertainty.  Gold is likely to remain an attractive hedge, and a great deal depends on GDP performance in the US. The outlook isn’t earth-shakingly optimistic. The World Bank forecasts a modest US economic growth of 2.2 percent in 2017. Equally modest is its global growth forecast of 2.8 percent in 2017. This is accompanied by downside risks in emerging and mature economies. Clearly, local and global supply and demand are still not as bullish as Donald Trump’s rhetoric. 

The bulls in the White House are ready to do the kind of mega business that made America great, that much is clear. But calibrating an entire economy is a challenge on a much larger scale, especially one that’s only just back on the road to growth. Until Trump deals with the question of the national debt, investors will have to see it as a significant risk to their portfolios. 

–Hussein is Chief Market Strategist at FXTM