After missing expectations for Model 3 deliveries (by 50%), delaying production goals once again, it appears the bond market is starting to give up on Elon Musk’s dreams for Tesla’s future.
While stocks are rebounding, bonds are not…
In fact, Tesla’s 2025 bond – now dramatically below par – suffered its biggest drop yet today, heading back to lows on price…
And for those who see Tesla’s juicy 6.13% yield and feel like “reaching” for it… may we suggest Indonesia instead…
How long before Musk starts to discuss “Blockchain” implementations in Tesla’s product plan?
The United States spends almost twice as much on health care, as a percentage of its economy, as other advanced industrialized countries — totaling $3.3 trillion, or 17.9 percent of gross domestic product in 2016.
But a few decades ago American health care spending was much closer to that of peer nations.
A large part of the answer can be found in the title of a 2003 paper in Health Affairs by the Princeton University health economist Uwe Reinhardt: “It’s the prices, stupid.”
The study, also written by Gerard Anderson, Peter Hussey and Varduhi Petrosyan, found that people in the United States typically use about the same amount of health care as people in other wealthy countries do, but pay a lot more for it.
Ashish Jha, a physician with the Harvard T.H. Chan School of Public Health and the director of the Harvard Global Health Institute, studies how health systems from various countries compare in terms of prices and health care use. “What was true in 2003 remains so today,” he said. “The U.S. just isn’t that different from other developed countries in how much health care we use. It is very different in how much we pay for it.”
A recent study in JAMA by scholars from the Institute for Health Metrics and Evaluation in Seattle and the U.C.L.A. David Geffen School of Medicine also points to prices as a likely culprit. Their study spanned 1996 to 2013 and analyzed U.S. personal health spending by the size of the population; its age; and the amount of disease present in it.
They also examined how much health care we use in terms of such things as doctor visits, days in the hospital and prescriptions. They looked at what happens during those visits and hospital stays (called care intensity), combined with the price of that care.
The researchers looked at the breakdown for 155 different health conditions separately. Since their data included only personal health care spending, it did not account for spending in the health sector not directly attributed to care of patients, like hospital construction and administrative costs connected to running Medicaid and Medicaid.
Over all, the researchers found that American personal health spending grew by about $930 billion between 1996 and 2013, from $1.2 trillion to $2.1 trillion (amounts adjusted for inflation). This was a huge increase, far outpacing overall economic growth. The health sector grew at a 4 percent annual rate, while the overall economy grew at a 2.4 percent rate.
You’d expect some growth in health care spending over this span from the increase in population size and the aging of the population. But that explains less than half of the spending growth. After accounting for those kinds of demographic factors, which we can do very little about, health spending still grew by about $574 billion from 1996 to 2013.
Did the increasing sickness in the American population explain much of the rest of the growth in spending? Nope. Measured by how much we spend, we’ve actually gotten a bit healthier. Change in health status was associated with a decrease in health spending — 2.4 percent — not an increase. A great deal of this decrease can be attributed to factors related to cardiovascular diseases, which were associated with about a 20 percent reduction in spending.
This could be a result of greater use of statins for cholesterol or reduced smoking rates, though the study didn’t point to specific causes. On the other hand, increases in diabetes and low back and neck pain were associated with spending growth, but not enough to offset the decrease from cardiovascular and other diseases.
Did we spend more time in the hospital? No, though we did have more doctor visits and used more prescription drugs. These tend to be less costly than hospital stays, so, on balance, changes in health care use were associated with a minor reduction (2.5 percent) in health care spending.
That leaves what happens during health care visits and hospital stays (care intensity) and the price of those services and procedures.
Did we do more for patients in each health visit or inpatient stay? Did we charge more? The JAMA study found that, together, these accounted for 63 percent of the increase in spending from 1996 to 2013. In other words, most of the explanation for American health spending growth — and why it has pulled away from health spending in other countries — is that more is done for patients during hospital stays and doctor visits, they’re charged more per service or both.
Though the JAMA study could not separate care intensity and price, other research blames prices more. For example, one study found that the spending growth for treating patients between 2003 and 2007 is almost entirely because of a growth in prices, with little contribution from growth in the quantity of treatment services provided. Another study found that U.S. hospital prices are 60 percent higher than those in Europe. Other studies also point to prices as a major factor in American health care spending growth.
There are ways to combat high health care prices. One is an all-payer system, like that seen in Maryland. This regulates prices so that all insurers and public programs pay the same amount. A single-payer system could also regulate prices. If attempted nationally, or even in a state, either of these would be met with resistance from all those who directly benefit from high prices, including physicians, hospitals, pharmaceutical companies — and pretty much every other provider of health care in the United States.
Higher prices aren’t all bad for consumers. They probably lead to some increased innovation, which confers benefits to patients globally. Though it’s reasonable to push back on high health care prices, there may be a limit to how far we should.
The Financial Repression Authority interviewed Lacy Hunt, Chief Economist at Hoisington Management on Fed policies.
The interview below first appeared on the FRA website along with a video.
The emphasis in italics is mine.
FRA: Hi, welcome to FRA’s Roundtable Insight. Today, we have Dr. Lacy Hunt. He’s an internationally recognized economist and the Executive V.P. and Chief Economist of Hoisington Investment Management Company, a firm that manages over $4.5 billion USD and specializing in the management of fixed income accounts for large institutional clients. He also served in the past as Senior Economist for the Federal Reserve Bank of Dallas, where he was a member of the Federal Reserve System Committee on Financial Analysis. Welcome. Dr. Hunt.
Dr. Lacy Hunt: Nice to be with you, Richard.
FRA: Great. I thought we’d have a discussion on a variety of topics relating to the economy and the financial markets. You recently mentioned that you thought this was the worst economic expansion recovery in U.S. history since 1790. Wow. Can you elaborate?
Dr. Lacy Hunt: If you calculate the average growth rate in the expansions since 1790, this is a long-running expansion, but it’s the slowest and in the last 10 years the household sector lagged very, very badly. The rate of growth in real disposable household income per capita is only 0.9 percent per year. And in the last 12 months, we’re up only 0.6 percent per year. So it’s a long-running expansion, but it’s been a poor expansion. There are certainly problems with some of the earlier data, but this appears to be the slowest expansion since the turn of the 18th Century and our households are the main problem for the growth rate lag.
FRA: And do you point a finger for this cause as primarily on the Federal Reserve or do you see structural changes happening to the economy?
Dr. Lacy Hunt: I think that the main element suppressing growth is the heavily leveraged U.S. economy. We have too much public and private debt, and this debt does not generate an income stream for the aggregate economy. As a result of the prolonged indebtedness, which is on the verge of going much higher because of problems in the governmental sector, the economy is now experiencing very poor demographics. We have a baby bust, a household formation bust, and the lowest birth rate since 1937. These demographics are exacerbating the problems because we have too much of the wrong type of debt and thus the velocity of money has been falling since 1997. Velocity this year is only 1.43 percent, which is the lowest since 1949. Furthermore, the debt creates a situation where monetary policy capabilities are asymmetric. In other words, a lot of action is needed to provoke even a muted impact on the economy, whereas the slightest monetary tightening goes a long way in depressing economic activity. So the root cause of this underperformance is extreme indebtedness.
FRA: And what about the Federal Reserve? How has it undermined the economy’s ability to grow?
Dr. Lacy Hunt: The Fed’s most serious mistake was made in the 1990s up until 2006 during which they allowed the private sector to become extremely over-indebted with the wrong type of debt. And, in essence, I think that quantitative easing, through the push for higher stock prices, created more problems than it has solved for the economy. QE caused the corporate executives to switch funds from real capital investments into financial investments through the paying of higher dividends, buying shares of their own companies, and buying back their shares from others. While this type of action does produce a higher stock market; it doesn’t generate a higher standard of living. And so, Federal Reserve policy has not improved the economy, although it certainly has well served components of the economy.
FRA: And due to that do you think that there’s been too much financial investment versus real economy investment in terms of diverting the economic financial resources away from the real economy?
Dr. Lacy Hunt: I think that’s the principal problem. Business debt last year reached a record high relative to GDP. As I said earlier, Fed policies have created a higher stock market but have not generated an improved standard of living. When the Reserve undertook quantitative easing, it was a signal to the corporate executives that the Fed preferred and would protect financial investments. But that meant financial assets were preferred over real side investments. And so QT is intermingling with the growth-depressing effects of too much debt. And the debt levels are getting ready to move substantially higher in our governmental sector. Government debt is already approaching 106 percent of GDP, a record high with the exception of a brief period during World War II. And by 2030, federal debt will be approximately 125 percent of GDP. For a long time, we’ve known about the issues that would inflate the entitlements — such as the prior-mentioned demographic problems — but there is an increasing likelihood that new federal programs with expenditure increases will further accelerate the growth in federal debt. I think there is clear evidence that increases in federal debt at these high levels relative to GDP over any measurable length of time, reduces economic activity. Thus, the multiplier is not a positive but negative figure, or otherwise exactly what economist David Ricardo hypothesized in his 1821 work. I have looked at the relationship between per capita changes in real GDP and government debt per capita and the relationship is negative, not positive. And so, we’re trying to solve an indebtedness problem by taking on more debt. You can get intermittent spurts of economic activity and inflation, but ultimately the debt is a millstone around the economy’s neck.
FRA: So would you say that we have migrated to a sort of financial economy?
Dr. Lacy Hunt: Let me give you a couple of examples. There’s so much liquidity in the financial markets, particularly the stock market, that a lot of the economic news is constructively interpreted even when it’s unconstructive. Virtually the world believes that the United States is experiencing large job gains and the idea that such productivity may be incorrect is hardly considered. But the rate of growth in payroll employment on a 12-month basis peaked at 2.4 percent in early 2015 and for the last 12 months, has sunk to 1.4 percent. What is even more critical — if you look at just the expansions and don’t include the recessions since 1968 – is that the average growth in employment in an expansion year was 1.9 percent. And in the last 12 months, we are half a percentage point under that figure. Yet, given these numbers, there is an erroneous perception that the employment gains are strong. And this view undermines the improvement in the standard of living. And because of the liquidity and the need of some investors to fully participate in the rising stock market, investors tend to overlook other important developments. If we go back to the 12 months ending November of 2015, real average hourly earnings were up about 2.5 percent. And in the latest 12 months, real average hourly earnings gained a miniscule 0.2 percent. The liquidity tends to push the focus away from the more realistic interpretation of the economy for certain types of assets.
However, the weak performance overall and the deceleration in some of the indicators that I just referred to is not unnoticed by the bond market. So, we have a dichotomy in which the stock market is strongly up but the long-term bond yields are down. Now, the short-term yields are up because they are under the control or heavy influence of the Federal Reserve. The Federal Reserve is in the process of raising the short-term rates and winding down their portfolio. They sold 20 billion dollars of government agency securities in October and November, pushing up the short-term rates. Erstwhile, the long-term rates — which look at some of the more important economic fundamentals — are actually declining.
Another element not in the public understanding, since the Federal Reserve no longer produces this sort of monetary analysis, is a very sharp slowdown in the money supply’s rate of growth, bank loans, and within important credit aggregates. Last year, the M2 money supply was up 7 percent. In the latest 12 months, it decelerated to less than 4.5 percent. The rate of growth in bank loans and commercial paper, which topped out on a 12- month basis about 9 percent, is now under 4 percent. So the Fed is raising the short-term rates, reducing the monetary base, and causing a tightening in the financial side of the economy. Some investors understand what is happening and yet it’s not in the general psyche because such monetary analysis is increasingly rare.
However, another more public indicator is the very dramatic flattening of the yield curve. And when the yield curve flattens in such a way, first of all, it’s a symptom that monetary restraint is beginning to bite. Now, the slowdown in money supply growth and the bank credit flattening of the yield curve will occur well before there is any noticeable impact on a broad array of economic indicators or long lags in monetary policy. But when the yield curve starts flattening, that intensifies the effect of the monetary tightening because it takes away or, at the very least, greatly reduces the profitability of the banks and all those that act like banks. Banks make a profit by borrowing short and lending long. When those spreads recede, bank profitability is hurt, particularly for the higher, riskier types of bank loans since not enough spread exists to cover the risk premium. So the banks begin to pull back, further intensifying the restraint pressing on economic growth. To the vast majority of investors, we have an economy that is apparently doing well, but in fact there are elements right beneath the surface that strongly suggest to me that the outlook for 2018 is considerably more guarded than conventional wisdom implies.
FRA: And do you see the potential for an inverted yield curve in the near future?
Dr. Lacy Hunt: I’m not sure that we will have to invert because the economy is so heavily indebted and the velocity of money is its lowest since 1949. Now, a number of people have pointed out that we typically invert before a recession and historically such inversions have been the case most of the time — but not always if you go back far enough in time — and you should since this is not a normal economy. For example, money supply growth since 1900 has averaged about 7 percent per annum, whereas, currently, the rate of growth in M2 is about 36 percent below the long-term average, indicating a very weak growth rate. And the velocity of money is lower than all of the years since 1942 — with the exception of 7 years — and the economy has never been this heavily indebted. And so the yield curve could possibly approach inversion, but it may or may not occur or stay there very long because at that stage of the game, the flattening of the yield curve will greatly intensify all the other effects — the reduction in the reserve, monetary, and credit aggregates, as well as the weakness in velocity. And when this reduction becomes apparent, the Federal Reserve will not be able to reverse gears quickly enough to ameliorate the impact produced upon future economic growth.
FRA: So do you still see a secular low in bond yields on the long into the yield curve remaining in the future sometime?
Dr. Lacy Hunt: The lows have not been seen. The path there will remain extremely volatile. We will have episodes in which the long yields rise. My attitude is that the long yields can go up over the short run for any number of causes. While many elements work out of the system in the long end, yields cannot stay up. When yields go up — especially now that the yield curve is flattening — this intensifies monetary restraint, which puts downward pressure on commodities. This puts upward pressure on the value of the dollar and cuts back on the lending operations. Something I think has been somewhat overlooked in general euphoria over the strength of economic indicators, is the that commercial and industrial loans for all of the banks in the United States are now only up one-tenth of one percent in the last 12 months. There are forward-looking elements that have historically been very important for signaling that change is ahead. They don’t tell us the timing — timing is always difficult — but they are flashing signals that should be observed.
FRA: And as this plays out, do you see monetary policy and fiscal policy is changing, like will we get fiscal policy stimulus? Will there be a change in monetary policy and how will that look like?
Dr. Lacy Hunt: Here’s my attitude: the new federal initiatives, whether tax cuts or infrastructure or otherwise will not provide a boost to the economy if they are funded with increases in debt — that’s where we’re at. And by the way, it’s been that way for some time. If you go back to 2009, we had a one-trillion-dollar stimulus package that was said to be inflationary and was going to boost economic growth, but yet we still had this very poor expansion and little inflation except for intermittent bouts here and there, largely from highly-priced inelastic goods. All the while, the inflation rate has trended lower.
For example, when President Reagan cut taxes, government debt was 31 percent of GDP and now that’s 106 percent on its way to 120-125 percent. And so if you go back and if you read Ricardo’s great article in 1821, he was asked whether it made a difference as to whether the Napoleonic wars were financed by taxes or by borrowing. Ricardo said that, theoretically, either way private sector activity was going to be suppressed. Now we have a lot of evidence, including some that I produced, that the government multiplier is negative, not positive, over a three-year period. Thus, the tax cuts may work for a very short while, but not on balance. And if the tax cuts were revenue-neutral and financed by reductions in government expenditures that would be a positive since the evidence shows tax multipliers are more favorable than expenditure multipliers. Such a theoretical proposal would provide greater efficiency for private sector spending and government spending. There’s also evidence that you would lower the cost of capital, but that’s not what we’re talking about is it? We’re talking about a debt-financed tax cut and we’re not talking about a revenue-neutral infrastructure plan, just as we were not talking about a revenue-neutral stimulus package in 2009. We’re talking about the debt-financed variety of tax cuts and at this stage of the game, this will make us more vulnerable, except for a few fleeting instances.
I will say this: when you have a debt-financed infrastructure program or tax cut, there will be pockets within the economy that will benefit, but the aggregate economic performance will not benefit and so fiscal policy, as I see it, is not really going to be helpful. The risk is that the debt buildup will add to the problems. There is extensive academic research indicating that when government debt rises above 90 percent of GDP for more than five years, this trend will reduce the economy’s growth rate by a third. Remember, we’re at 106 percent debt to GDP and there’s evidence these higher levels of debt have a non-linear effect. In other words, we use up growth at a faster pace. And there’s a lot of evidence from the available data that we’re even losing a half of our growth rate from the trend. For example, GDP has risen at 2.1 percent per capita since 1790. The latest 10 years produced a reduction to 1.0 percent. And so we should have lost only seven-tenths or come down at 1.3 over 1 but we didn’t and this is a consequence that we have to deal with. We’re not in a position to ignore the debt levels. Fiscal policy can be talked about, we can debate about it, and we can proclaim its benefits, but I don’t see them in the current environment just as I didn’t see them in 2009. I would change my tune if they were revenue-neutral, but that’s not the issue here.
To me, inflation is a money-price-wage spiral not a wage-price spiral as with the Phillips curve. The way inflations begin is by money supply growth acceleration not being offset by weakness in velocity, which shifts the aggregate demand curve inward. Remember, the aggregate demand curve is equal to money times the velocity by algebraic substitution as evidenced in all the leading textbooks on macroeconomics. So you have declines in the money supply and velocity, which will make the aggregate demand curve shift inward over time. This shift gives you a lower price level and a lower level of real GDP. It doesn’t happen every quarter or even every year, but it’s the basic trend. Thus, monetary policy is in the process not of decelerating money supply growth and by a significant amount. If the Fed adheres to their schedule of quantitative tightening, I calculate M2 will grow by the end of the first quarter – it’s currently running around four and a half percent – and the year over year growth rate will be down to less than 3 percent. And so monetary policy is taking steps to lower the reserve monetary and credit aggregates, and these actions will further flatten the curve because they can press the short rates upward. But I think the long-term investors will understand that the inflationary prospects on a fundamental basis are weakening not strengthening.
FRA: And do you see these trends as being exacerbated on the emerging government pension fund crisis? Could there be more debt used to solve that like for bailouts? Do you see that potentially happening?
Dr. Lacy Hunt: Well the main problem with government debt is that we’re going to have approximately one million folks a year reach age 70 in the next 14 to 15 years and we’ve known that this was coming, but we didn’t prepare for it. We’ve made a lot of promises under Social Security Medicare and the Affordable Care Act and government debt will have to be used to fund the entitlement benefits — I don’t see any other way around it. Another overlooked problem is that the actual federal fiscal situation is much worse than these surface numbers. For example, in the last three years, the budget deficit worsened each year. If you sum the budget deficits for 2015, 2016 and 2017, the sum is 1.2 trillion, but a lot of what was previously called “outlays” have been moved off budget — we call them investments (such as student loans) and there are other examples. The actual increase in federal debt in the last three years is 3.2 trillion. So the budget deficit is actually greatly understating what is happening to the level of federal debt which wasn’t always the case. Furthermore, the deficit was made worse by a 2015 bipartisan deal between Congress and the White House. And while neither party is blameless — they both agreed on the deal — yet it doesn’t change the fact that the federal situation is deteriorating and at a much worse rate than the deficit numbers themselves indicate.
FRA: And what about for state and local jurisdiction locales, in terms of their government pension funds? Could there be federal level bailouts at that level?
Dr. Lacy Hunt: Again, what are they going to bail them out with? You’re going to have to sell Federal Securities. And one of the multipliers on new sales of Federal debt is negative, not positive. Forget what was taught you in your macroeconomic class 30, 20, or even 15 years ago. When I was in graduate school, I was taught that the government multiplier was somewhere between four and five percent. Now, it looks like the multiplier is at best zero and even possibly slightly negative.
FRA: Great insight as always. How can our listeners learn more about your work, Dr. Hunt?
Dr. Lacy Hunt: We put out a quarterly letter as a public service. Write to us at hoisingtonmgt.com and we’ll put your name on the subscription list. We don’t spam you with marketing so please go ahead and subscribe.
FRA: Okay, great. Thank you very much for being on the Program, Dr. Hunt. Thank you.
Dr. Lacy Hunt: My pleasure Richard. Nice to be with you
Economics as Taught
Note Lacy’s comments on what he learned in graduate school. Lacy once told me that he had to “unlearn” nearly everything he was taught in school about economic.
Multiple generations of economists have been trained to believe inflation is a good thing, saving is bad, that there are no consequences for piling up debt.
The GOP tax bill is not “at least something”. It’s not “better than nothing”. And, no, we are not letting the perfect become the enemy of the good.
In truth, this thing is a fiscal, economic and political monster. It is hands down the worst tax bill enacted in the last half-century—-maybe even since FDR’s 1937 soak-the-rich scheme, which re-ignited the Great Depression.
True, rather than soak them, the GOP’s bill will pleasure America’s wealthy with a bountiful harvest of tax relief. Owners of public equities, for example, will garner a trillion dollar shower of extra dividends and stock buybacks from the corporate rate cut.
Likewise, 4 million top bracket ATM (alternative minimum tax) payers will be relieved of about $80 billion per year of Uncle Sam’s extractions; around 5,000 dead people per year with estates above $20 million will get to leave more behind; owners of real estate will be able to deduct another 20% of property income that isn’t already sheltered by depreciation and interest deductions; and tax accountants and lawyers will become stinking rich helping America’s proprietorships (24 million), S-corporations (4 million), partnerships (3.5 million) and farms (1.8 million) convert their “ordinary income” into newly deductible “qualified business income”.
Notwithstanding these facts, the commonality between the FDR’s tax bill disaster and this one is that both represent exactly the wrong policy at a time which could not be worse.
In the New Deal case, business and investor confidence had finally begun to recover after the trauma of the Crash and subsequent withering depression, but FDR’s excess profits tax and punitive marginal rates on high incomes sent the economy tumbling until it was rescued by war mobilization after 1940.
In the current situation, the absolute worse thing you could do is draw on Uncle Sam’s credit card to fund temporary cuts for the middle class and a permanent windfall to the top 10 percent of households which own 80% of the stock. And the reason, of course, is that America is marching straight into a 20-year fiscal and demographic trap that has the potential spiral out of control and smoother any semblance of economic prosperity as we have known it.
Indeed, the signal event of 2017 is not the gimmick-ridden dog’s breakfast of K-street favors being enacted today, but the GOP’s utter failure to repeal and reform ObamaCare.
As we have long insisted, America’s health care system consists of the worst of both worlds. It amounts to socialism for the beneficiaries, which generates uncontainable demand via third-party paid, cost-averaged pricing; and crony capitalism for the providers, where delivery system cartels of doctors, hospitals, nursing homes, pharma suppliers, medical device makers etc. have implanted themselves deep on K-street and have thereby rigged reimbursement systems for maximum private revenue gain (and minimum system efficiency and competitive discipline).
That’s why the US spends 18% of GDP on health care compared to 10-12% in the rest of the (socialistic) developed world, on the one hand; and why the GOP couldn’t lay a glove on ObamaCare, which embodies in spades this “worst of both worlds” paradigm.
Indeed, there is no hope to slowdown the health care monster without restoration of consumer sovereignty and responsibility, risk-based pricing and free market supplier arrangements. Yet only Rand Paul got close to presenting a mild semblance of these necessary cures from the far stage-right periphery of the debate, where he was completely ignored by his GOP colleagues.
Not surprisingly, there is now no prospect of stopping the relentless rise of current law health care spending. Over the next two decades, Uncle Sam’s cost burden will double as a share of GDP.
Toss two other factors on top of the above chart—-the Washington War Party and the aging out of the Baby Boom—and you have an impossible fiscal equation. That is, a tax system under current law that is impaled on the 18% of GDP marker in terms of revenue collections versus a spending machine that is inexorably climbing toward 30% of GDP.
That’s right. The Donald has already succumbed fully to the neocons and the insatiable fiscal demands of the War Party. Thus, the enacted defense budget now stands at $700 billion and on top of that comes the $250 billion annual tab for past unnecessary wars (Veterans and debt service) and $50 billion more for Imperial Washington’s walking around money to fund military assistance, foreign aid and political skullduggery all around the planet.
In short, the Warfare State alone consumes $1.0 trillion per year or 5% of GDP and there is not a corporal’s guard in the Imperial City of a mind to challenge it.
And especially not now after the so-called “progressive left” has gone full bore McCarthyite on the Russkies and their purported threat to national security. That is, the danger posed by a midget $60 billion military and a pipsqueak economy, which sports a GDP ($1.3 trillion) roughly equal to that of the NYC metro area. (For our money, the latter is actually more the threat to national well-being)
Then you have 60 million social security recipients at $1.1 trillion in FY 2019 that will balloon to 80 million enrollees by the end of the 2020s, and eventually to 95 million recipients after the full measure of the Baby Boom demographic bubble cashes in its social insurance chips.
Finally, there is the compounding feedback loop of net interest: $350 billion today at a drastically suppressed weighted average yield of less than 2.o%; $820 billion by 2027 under more normalized yields and the CBO debt “baseline” before you count the massive interim deficit add-ons of the Trumpian-GOP borrowers; and into the trillions per year and rising in the following decade as spending escalates toward 30% of GDP. And even that’s assuming interest rates don’t get unruly but remain “normal “(weighted average of 3.4%) as far as the eye can see.
In a pattern which is discernible and inexorable, therefore, the nation’s fiscal accounts are being drawn-and-quartered by the embedded policies and gross financial irresponsibility of today’s Imperial City politicians.
As it stands, the Federal revenue baseline currently weighs in at 17.7% of GDP, which is as low as it’s been aside from recession years since 1980; and about exactly where the great tax-cutter, Ronald Reagan, left it to his successor in 1989 (17.5% of GDP). So the fact that real final sales ( GDP without the inventory fluctuations) growth of 3.5% per year during the 1980s has dwindled to a pathetically low 1.2% per annum over 2007-2016 is not due to some nefarious tax grab.
Stated differently, Imperial Washington loves to borrow, not tax. It’s operative fiscal model is Big Government and Small Taxes—–notwithstanding 10,000 Lincoln Day dinner speeches per year in which GOP orators tilt at the windmill of high taxes.
To be sure, lower taxes earned by first effecting a drastic shrinkage of government is always a worthy aspiration, and not entirely unrealistic. After all, President Dwight Eisenhower did just that—shrank the Pentagon side of the swamp by 40% in real terms in order to balance the budget and pave the way, ironically, for the ballyhooed “Kennedy Tax Cut” a few years later.
But this week Ike’s Republican heirs and assigns have surely caused the great man to rollover in his grave. Without lifting a finger to cut spending, and actually adding upwards of $200 billion in FY 2019 alone, as we documented yesterday, the Trumpian GOP is crowing loudly about what amounts to a sheer fiscal folly.
As we also previously explained, the tax bill is drastically front-loaded in order to scam the 10-year reconciliation rules (more below). Accordingly, the “static” revenue loss in FY 2019 is $280 billion, according to the Joint Committee on Taxation.
That not amounts to borrowed goodness equal to 1.4% of GDP. Yet, apparently, there is not even a single supply-sider—outside of an institutionalized domicile—-who would argue that just 10 months hence there will be a tsunami of jobs and growth and therefore revenue reflows owing to this giant hole in Uncle Sam’s cash box.
In fact, what is actually happening here is that the American public is being lied to by the GOP Pinocchio Brigade in a manner that is egregious even by Washington standards.
That is, it is being offered a giant (but disappearing) election-year tax cut which brings Federal receipts down to 16.4% of GDP in what would be the 10th year of a business expansion and the longest in recorded US history; and which would also be well below the 17.3% of GDP revenue average during the Gipper’s celebrated anti-tax tenure in office.
But being on the very low side of history is no virtue for a K-street and PAC-owned political party that has no plan or stomach whatsoever for taking on the spending machine that is cranking inexorably toward 30% of GDP. And, also, a party which should spare us the cant about next year’s aspiration to reform welfare.
The fact is 75% of the Federal government’s $600 billion per year for means-tested welfare is accounted for by Medicaid, and the GOP has already punted big time on that one during the “repeal and replace” debacle. So perhaps they can find $5 billion to extract from maligners on the $100 billion food stamp and family assistance program. Of course, that would amount to 0.02% of GDP for all the trouble.
In short, the GOP pols have paddled around the fetid waters of the Imperial Swamp so long that they apparently think the American public does spend its time riding around on a hay wagon. There is surely no other way to explain how they plan to sell to the American public a dopey theory that you can have spending policies which rise toward 30% of GDP and a tax burden at 16%.
When all is said and done, the picture below dramatizes the giant fiscal trap that is now built-in, and which the GOP’s tax folly would only make far worse because, at best, the now enacted tax bill boils down to the mother-of-all-riverboat gambles.
We are speaking, of course, of the growth dividend fantasy, and the risible idea that driving next year’s deficit to $1.275 trillion (see Part 1)won’t compound the debt problem in the long run because the outyear revenue loss will all be made up for with incremental growth, jobs, incomes and tax revenues.
Not a chance. Doubling the child credit and lowering the marginal rate schedule by a few points with borrowed funds, for example, will put money in the pockets of the household sector and extract it from capital spending—now that the Fed is out of the debt monetization business.
Likewise, the GOP revilers have gifted ATM payers with a $637 billion tax break over the next eight years, and for that, the “donor class” will surely be grateful. But thankful as they may be, we are also quite sure that the 4 million beneficiaries of this tax cut will not any hours to their work schedules or invest any more productively than they have been doing in the US economy—even if the do bid up charter rates on luxury yachts and net jets.
When all the sunsets and temporary middle-class breaks are set aside, the heart of the bill is a $1.76 trillion revenue loss over 10 years for the 21% corporate rate and the 20% pass-thru deduction for “qualified business income”. Yet as we will demonstrate in Part 2, there is every reason to believe that upwards of 90% of that massive increase to the Federal debt will be recirculated back to Wall Street and the top 1% and 10% of households in the form of increased stock-buybacks, dividends and other forms of capital return.
Just consider the case of Microsoft which employed upwards of 130,000 worldwide—including about 200 in Puerto Rico, 700 in Singapore and1100 in Ireland. So if headcounts in a high tech firm are a reasonable proxy for output, Mr. Softie’s production in these three tax havens amounts to just 1.5% of its worldwide total.
By contrast, its books upwards of two-thirds of its taxable income in these jurisdictions thanks to state of the art tax planning and the off-shoring of billions of “intangible assets” to havens where the tax rates are 2.0%, 7.3%, and 7.2%, respectively.
What we mean is that Microsoft off-shored its tax books, not its production and jobs. The rate reduction to 20%, therefore, will not bring back jobs and investment but only rearrange its tax books—even as it deploys the higher after-tax cash flows to shareholder returns.
At the end of the day, the GOP has set up a scheme of massive borrowing and tax sunsets and deferrals that will knock the stuffing out of what remains of Washington’s capacity to manage the nation’s fiscal disaster in the years ahead. Heading for the scenario below, it chose to embrace K-street
In the aftermath of the ‘great recession,’ private equity firms placed massive bets on subprime auto finance companies with the typical “thesis” going something like this: “well, people have to get to work don’t they?”…genius, if we understand it correctly.
Of course, the “thesis” seemed to be confirmed when auto securitizations performed relatively well throughout the financial crisis, amid a sea of mortgage bonds getting wiped out, and private equity titans were off to the races with wall street titans from Perella Weinberg to Blackstone and KKR scooping stakes in small niche lenders.
Unfortunately, as Bloomberg points out today, the $3 billion bet on subprime auto lenders hasn’t played out precisely to plan as the “well, people have to get to work” thesis has proved to be somewhat less than full proof.
A Perella Weinberg Partners fund has been sitting on an IPO of Flagship Credit Acceptance for two years as bad loan write-offs push it into the red. Blackstone Group LP has struggled to make Exeter Finance profitable, despite sinking almost a half-billion dollars into the lender since 2011 and shaking up the C-suite multiple times. And Wall Street bankers in private say others would love to cash out too, but there’s currently no market for such exits.
Since the turn of the decade, buyout firms, hedge funds and other private investors have staked at least $3 billion on non-bank auto lenders, according to Colonnade. Among PE firms, everyone from Blackstone and KKR & Co. to Lee Equity Partners, Altamont Capital and CIVC Partners waded in.
Many targeted smaller finance companies that often catered to the least creditworthy borrowers with nowhere else to turn. Overall, subprime car loans — those extended to people with credit scores of 620 or lower — have increased 72 percent since 2011. Last year, about 20 percent of all new car loans went to subprime borrowers.
“The PE guys sailed into this thing with stars in their eyes. Some of the businesses have done fine and some haven’t,” said Chris Gillock, managing director at Colonnade Advisors, a boutique investment bank. But right now, “it’s about as out-of-favor a sector as I can think of.”
Of course, the turnaround strategy was ‘simple.’ Given that subprime auto collateral held up well during the great recession, private equity investors figured they were sitting on rock-solid collateral that would holdup under even the most egregious loosening of underwriting standards. Therefore, given that there was ‘no downside’, lenders wholeheartedly embraced deteriorating underwriting standards, like stretching out terms so borrowers could ‘afford’ cars they couldn’t really afford, as a way to grow their loans books.
Alas, it didn’t work out as planned as subprime delinquencies are suddenly soaring and used car prices are tanking…making profits somewhat elusive.
Take Exeter. The company, which is licensed in all 50 states and works with roughly 10,000 dealerships, hasn’t been profitable since 2011, when Blackstone took a majority stake, an S&P Global Ratings report in September showed. That’s after the PE firm invested $472 million to help Exeter expand and cycled through three CEOs at the lender.
On a pretax basis, Exeter turned a profit in 2016 and 2017, according to Matthew Anderson, a spokesman at Blackstone. He added the New York-based firm hasn’t tried to sell the lender.
Blackstone may look to unload Exeter later next year, said a person familiar with the matter, who asked not to be identified because it’s private.
Bad loans remain an issue. This year, a rash of delinquencies in two bonds stuffed with loans that Exeter made in 2015 caused the securities to dip into their extra collateral to keep investors whole.
Another example is Flagship, which Perella Weinberg bought in 2010. (Innovatus Capital Partners, which manages the lender on behalf of Perella Weinberg, was formed by former Perella Weinberg managers last year after they split from the firm.)
As it turns out, the “well, people have to get to work” thesis only works to the extent that auto manufacturers maintain some level of discipline and refrain from exploiting their captive finance companies to flood the market with new supply…a move which will eventually lead to crashing used car prices and massive subprime securitization losses.
Unfortunately, as we pointed out last month, a review of the latest Fed data on auto loans underwritten by “Banks and Credit Unions” compared to those loans provided by “Auto Finance” companies prove that the nightmare scenario is playing out for subprime lenders…
First, taking a look at auto loans provided by traditional banks and credit unions, one can see some marginal deterioration in subprime auto loans. That said, the deterioration is certainly nothing substantial with 90-day delinquencies pretty much in line with 2004/2005 levels and no where near the rates experienced in 2008/2009.
But, a drastically different picture emerges when looking at just the auto loans originated by America’s auto finance captives. To our great ‘shock’, auto OEMs in the U.S. seem to have been much more “flexible” on underwriting standards over the past couple of years resulting in delinquency rates that nearly rival those last experienced at the height of the great recession.
Of course, we’re sure that GM Financial and Ford Motor Credit just got unlucky with their deteriorating credit portfolios…certainly, they would never knowingly attempt to game their own short-term financial success by putting millions of Americans into cars they can’t possibly afford, right?
Luke Rosiak of the Daily Caller is out with a follow-up to a report on the Awan Pakistani IT family who had access to highly sensitive Congressional networks, both on-site and from Pakistan, where they are suspected of a variety of crimes -including brokering classified information to hostile foreign governments. Of note, they had access to the House Permanent Select Committee on Intelligence – whose members have top secret clearance and are looking into Russian election interference.
Debbie Wasserman-Schultz and Imran Awan
Note Rep. Louie Gohmert‘s reaction when he learns of the Awan’s remote access from Rosiak:
Clip of the year? @replouiegohmert learns from @lukerosiak that Debbie Wasserman Schultzindicted staffer teleworking and providing House Dem IT “support” from Pakistan! Full @JudicialWatch discussion here….https://t.co/4HwY3Jgvd2 pic.twitter.com/VVjkiujJqo
— Tom Fitton (@TomFitton) December 17, 2017
The Awans also operated a used car dealership known as “CIA” in court filings, which has all the markings of a money laundering operation:
On its Facebook page, CIA’s “staff” were fake personalities such as “James Falls O’Brien,” whose photo was taken from a hairstyle model catalog, and “Jade Julia,” whose image came from a web page called “Beautiful Girls Wallpaper.”
If a customer showed up looking to buy a car from Cars International A, often referred to as CIA, Abid Awan — who was managing partner of the dealership while also earning $160,000 handling IT for House Democrats — would frequently simply go across the street to longstanding dealership called AAA Motors and get one.
While Imran and Abid Awan ran their car dealership in Falls Church, Va. in the early part of the decade, Drug Enforcement Agency officials a few miles away in Chantilly were learning that the Iranian-linked terrorist group frequently deployed used car dealerships in the US to launder money and fund terrorism, according to an explosive new Politico expose. –Daily Caller
“Based on the modest way Awan was living, it is my opinion that he was sending most of his money to a group or criminal organization that could very well be connected with the Pakistani government,” said Wayne Black – a private investigator who worked in Janet Reno’s Miami public corruption unit, adding “My instincts tell me Awan was probably operating a foreign intelligence gathering operation on US soil.”
Philip Giraldi, a former CIA officer, wrote that Attar “was observed in Beirut, Lebanon conversing with a Hezbollah official” in 2012–shortly after the loan was made. –DC
Dr. Ali al-Attar
Al-Attar’s license to practice medicine was revoked by the Maryland State Board of Physicians and he had to pay a $50,000 fine for unprofessional conduct, healthcare fraud, and failure to cooperate with an investigation.
The money which the Awans borrowed was moved from Ali Al-Attar through accounts intended for Fairfax County real estate. Both Imran Awan and Khattak — who also put up $200,000 in cash as an investor in CIA — had realtors licenses.
Per the Daily Caller:
It’s not clear where the dealership’s money was going, because it was sued by at least five different people on all ends of a typical car business who said they were stiffed. CIA didn’t pay the security deposit, rent or taxes for its building, it didn’t pay wholesalers who provided cars, and it sold broken cars to people and then refused to honor the warranties, the lawsuits say.
Adding to the list of interesting connections, when the Awans stopped paying vendors of their ‘CIA’ dealership, a U.S. Congressman from Florida began paying a monthly salary to a man who had threatened to sue the Awans.
Rep Theo Deutch (D-FL), Awan Benefactor
The brothers had numerous additional sources of income, all of which seemed to disappear. While they were supposedly working for the House, the brothers were running a car dealership full-time that didn’t pay its vendors, and after one — Rao Abbas — threatened to sue them, he began receiving a paycheck from Rep. Theodore Deutch (D-FL), who like Wasserman Schultz represents Florida. –Daily Caller
The Awans were also accused of stealing “huge amounts” of computer equipment from the House. As the Daily Caller reports:
Shortly before the 2016 election, investigators found huge amounts of House equipment unaccounted for under the Awans’ stewardship, and when they looked into the family further, they found that they had logged in to members’ computers for whom they did not work. There were signs that the House Democratic Caucus’ server “is being used for nefarious purposes and elevated the risk that individuals could be reading and/or removing information,” according to a House investigation. They were also moving files online, “a classic method for insiders to exfiltrate data from an organization,” the report found, and “steps are being taken to conceal their activity.”
In July, Imran Awan was was arrested by the FBI at Dulles Airpirt attempting to leave the country, and was indicted by a grand jury on four counts along with his wife Hina Alvi, on allegations that the pair made false statements on loan applications before wiring nearly $300,000 to Pakistan. ““Defendants AWAN and ALVI did unlawfully, willfully, and knowingly conspire, combine, confederate, and agree with each other to commit offenses against the United States,” including bank fraud, false statements, and unlawful monetary transactions, the indictment said.”
Awan’s arrest came days after a Daily Caller report that the FBI has seized more equipment from the garage of a house owned by Imran Awan and his wife Alvi after a tenant called investigators.
FBI agents seized smashed computer hard drives from the home of Florida Democratic Rep. Debbie Wasserman Schultz’s information technology (IT) administrator, according to an individual who was interviewed by Bureau investigators in the case and a high level congressional source.
The congressional source, speaking on condition of anonymity because of the sensitivity of the probe, confirmed that the FBI has joined what Politico previously described as a Capitol Police criminal probe into “serious, potentially illegal, violations on the House IT network” by Imran and three of his relatives, who had access to the emails and files of the more than two dozen House Democrats who employed them on a part-time basis.
Fellow IT staffers interviewed by TheDCNF said the Awans were often absent from weekly meetings and email exchanges. One of the fellow staffers said some of the computers the Awans managed were being used to transfer data to an off-site server.
Shortly after the criminal probe was revealed in February, Imran abruptly moved out of his longtime home on Hawkshead Drive in Lorton, Va., and listed it for rent on a website that connects landlords with military families.
The new tenants were none other than a retired Marine and his active duty Navy wife. In the garage, they found “wireless routers, hard drives that look like they tried to destroy, laptops, [and] a lot of brand new expensive toner.”
After hearing about the House investigation into the Awans on the radio, the tenants called the Navy Criminal Investigative Service (NCIS), and shortly thereafter the FBI and Capitol Police became involved.
Speaking on the condition of anonymity over concerns for his wife’s naval career, the former Marine told the Daily Caller:
“It was in the garage. They recycled cabinets and lined them along the walls. They left in a huge hurry,” the Marine said. “It looks like government-issued equipment. We turned that stuff over.”
The Awans also kept their Imprisoned their stepmother to bilk inheritance money
THREE DAYS before U.S. Capitol Police told House members about the Awans, their stempmother called Fairfax County, Virginia police report she was imprisoned in their house – kept from her husband’s deathbed. Oh, and they were bugging her with listening devices.
A relative described the woman’s life as being completely controlled by the brothers for months while they schemed to take their father’s life insurance. –Daily Caller
After their father died, the Awans carted their stepmother to Pakistan to collect her inheritance – which they promptly extorted from her.
So – the Awans, who were in a trusted position – handling some our nation’s most sensitive information, ran a shady car dealership, remotely accessed House networks from Pakistan, imprisoned their stepmother and stole her inheritance, took $100K from a Hezbollah-linked doctor, let Rep. Theo Deutch pay their bills, stole and smashed computer equipment, and helped Debbie Wasserman Schultz make a call using a voice changer to a law firm suing the DNC.
The only thing I can conclude from this is that Debbie Wasserman-Schultz had Hezbollah spies working for her.
Is Wasserman-Schultz a foreign agent? https://t.co/0NawkbCLd8
— Based Monitored???????????? (@BasedMonitored) December 19, 2017
The new Tax Policy Center analysis of the bill tells the story. It finds that in 2027, 53 percent of taxpayers will see a tax hike, relative to current law. That’s because the plan makes the individual rate cuts and the preferences that will benefit lower earners temporary, while establishing an inflation index that nudges people into higher income brackets over time, to limit the impact on the long-term deficit. Meanwhile, the bill makes the corporate tax cuts (which overwhelmingly go to shareholders and capital, and thus mainly to the rich) permanent.
The key to understanding the plan’s regressiveness is in the distribution of the tax cuts and tax hikes that will hit in 2027. I’ve created a chart, using the TPC’s data, that tells this story:
As you can see, the groups who see a tax hike in 2027 are heavily concentrated in the lower-income quintiles. By contrast, more than three-quarters of the top 1 percent get a tax cut — an average tax cut of nearly $40,000. And more than 90 percent of the top 0.1 percent get a tax cut — an average tax cut of more than $200,000.
Republicans have said that passing this plan is key to staving off a disaster in the midterms. They are hoping to sell it to voters by claiming that at its core, it is a middle-class tax cut, and they are hoping that the tax cuts that working- and middle-class Americans see in the short term will make this claim credible.
It is true that in the short term, the vast majority of taxpayers will see a tax cut. But even in the short term, the plan is very regressive. Here’s another chart that demonstrates this, using the TPC data:
Next year, the bottom three quintiles get an average tax cut of less than $1,000, while the top 1 percent gets an average tax cut of more than $50,000, and the top 0.1 percent gets an average tax cut of nearly $200,000. By 2025, the lower quintiles get approximately the same-sized tax cut, while the average tax cut for the top 1 percent jumps to higher than $60,000, and the average tax cut for the top 0.1 percent jumps to more than a quarter of a million dollars.
And over time, as the first chart shows, more and more in the lower quintiles end up paying higher taxes, even as the very wealthiest Americans continue to enjoy huge benefits. Indeed, the TPC data show that by 2027, more than 80 percent of the plan’s benefits go to the top 1 percent. As Dylan Matthews points out, this is even worse than a previous iteration of the bill.
The plan gets increasingly regressive over time. But this feature of it is essential to maintaining the GOP priorities at the core of the bill and to the GOP’s hopes of passing something that embodies those priorities. Republicans must pass the plan with only GOP votes because Democrats will not accept a plan that lavishes such an enormous share of its benefits on the rich, and Republicans will not accept a plan that does not do that. So Republicans must pass it through the Senate by simple majority, which requires keeping it from raising the deficit over the long term. Managing that — while also keeping the tax cuts that overwhelmingly benefit the rich permanent — required them to make the tax cuts that benefit everyone else temporary. Thus, the plan’s increasingly regressive nature is essential on multiple levels.
Republicans will try to get around the awful politics of this by arguing that in the short term, the middle class gets both a tax cut and will also benefit from the explosion of growth and wages that cutting taxes on corporations will supposedly produce. But very few economists believe that the latter will come to pass. And given the size of the tax cuts for less fortunate Americans relative to those that top earners will enjoy, it is far more likely that voters will continue to see the plan as a giveaway to the rich. Which is exactly what it is.
Since last November 8th the Russell 2000 has risen by 30% and the net Federal debt has expanded by an astounding $1.0 trillion dollars.
In a rational world operating with honest financial markets those two results would not be found in even remotely the same zip code; and especially not in month #102 of a tired economic expansion and at the inception of an epochal pivot by the Fed to QT (quantitative tightening) on a scale never before imagined.
And we do mean exactly those words. By next April the Fed will be shrinking its balance sheet at $360 billion annual rate and by $600 billion per year as of next October.
Altogether, the Fed’s balance is scheduled to contract by upwards $2 trillion by the end of 2020. And it’s apparently on a path that is so locked-in—-barring a recession—that Janet Yellen affirmed in her swan song that the Fed’s giant bond dumping program (euphemistically called “portfolio runoff”) would no longer even be mentioned in its post-meeting statements.
So the net of it is this: The Fed will sell more bonds in the next 3-4 years than had been accumulated by all of the central banks of the world in all of recorded history as of 1995!
That prospect alone might give a rational stock market at least some cause to pause. After all, the Fed’s $2 trillion bond selling campaign (likely to be joined by the ECB in 2019 when a German replaces wild-man Draghi) is on automatic pilot unless there is a recession.
So stock prices are either going to be battered by slumping profits if the business cycle hasn’t actually been abolished; or, in the alternative, rising bond yields will sharply inflate the carry cost of $12.5 trillion of US non-financial business debt (e.g. a 200 basis point increase in rates would lower pre-tax business profits by $250 billion or 15%) even as PE multiples shrink and stock buybacks are sharply curtailed.
And that’s not all, as the late-night TV man says. There is literally a fiscal red ink eruption heading straight at the Fed’s balance sheet shrinkage campaign that will rattle the rafters in the casino.
As detailed below, Uncle Sam’s borrowing requirements are likely to hit $1.25 trillion or more than 6% of GDP in FY 2019 owing to the fact that the tax bill is so heavily front-loaded and the GOP’s wild spending spree for defense, disasters and much else.
Needless to say, this impending bond market collision has not fazed the dip-buyers in the slightest. Financial markets are in the blow-off stage of the third great central bank bubble of the present era and are therefore entirely in the grip of momentum chasing robo-machines and day traders. The latter are processing price action alone—-to the complete exclusion of a swelling tide of facts and threats which sharply contradict the bullish mania of the moment.
For instance, the now booming Russell 2000 (RUT) wasn’t exactly a laggard when the Trump Trade incepted in the wee hours of election night. At that point it traded at 1190 and was already up by 230%from the March 2009 bottom.
But at yesterday’s record 1549 close, these small and mid-cap domestic companies had a combined market cap of $4.45 trillion. That represented not only 440% of the RUT’s $1.0 trillion market cap at the March 2009 bottom, but also reflected utterly absurd multiples of the current earnings and dividends attributable to its constituent companies.
To wit, the RUT companies generated just $60 billion of dividend payments during the LTM period ending in September. In what sane world does a GDP-hugging basket of main street companies trade at 74X their dividend?
Worse still, the RUT companies are apparently borrowing money to pay even that miserly 1.35% dividend.
That’s right. Net income during the LTM period was slightly under $42 billion or just two-thirds of the RUT’s dividend payout. So this also means that America’s main street businesses are being valued at a preposterous 107X earnings.
These absurd valuations would be troublesome enough if the fiscal and monetary context were stable rather than heading for a thundering dislocation. But there is no other word for a fiscal equation which is unraveling at lightening speed as we head for the onset of FY 2019 next October 1.
Under the CBO’s baseline projection of last June, the picture was already bad enough. Federal outlays were projected to rise from $4.0 trillion in the year just ended (FY2017) to $4.38 trillion in FY 2019. Notwithstanding revenue growth of 11% under current law over the two year period, the resulting baseline deficit still computed to nearly $700 billion.
But Trump has already signed into law a defense authorization bill which will raise baseline outlays from $625 billion to $700 billion. And on top of that, the House yesterday approved an $81 billion disaster aid supplemental for the hurricanes and wildfires, which will bring total spending for this year’s disasters to a staggering $133 billion.
That’s vastly more than the $51 billion spent for Hurricane Sandy or the Katrina outlays of $60 billion. More importantly, the Congressional Republicans are not contemplating any off-setting cuts elsewhere in the Federal budget—-a sharp reversal from their traditional insistence to that effect.
Indeed, the disaster fix is already in and will be attached to the next two-week installment of the FY 2018 continuing resolution (CR).
The fact that the Federal deficit is soaring and was already up by 75% in the year just ended compared to FY 2015 has apparently not registered with the Republican leadership. And that’s to say nothing of horrific timing: Upwards of half of the $133 billion of disaster aid will hit in FY 2019 at the exact time that the GOP’s front-loaded tax cut ($280 billion) will also arrive with full force.
As Bloomberg noted with respect to the disaster aid bills, fiscal rectitude is not the GOP’s flavor of the month. For instance, the “ask” of $61 billion for disaster aid from conservative Texas governor Gregg Abbott is more than has ever been spent on any previous disaster in US history.
Likewise, the Florida GOP is seeking $1.5 billion for damages suffered by the citrus industry when Irma came roaring across the peninsula. That’s especially rich because hurricanes are surely a known cost of doing business in Florida, and orange and lemon producers ought to buy insurance or self-insure, not ding taxpayers in Fargo North Dakota.
In any event, as Bloomberg explains below, the GOP’s stalwart conservatives from Florida, California, and Texas are on the case because this time is apparently different:
The aid likely would be attached to a government spending bill that must be passed this week to keep the government open after Friday. The disaster spending is being pushed forward by Republicans from Texas, Florida and California who threatened to oppose the spending bill if hurricane relief wasn’t included……“The dollar figures I hear are fine,” said second-ranking Senate Republican John Cornyn of Texas. “How it’s distributed may need some changes”.
House Rules Committee Chairman Pete Sessions of Texas predicted that conservatives will support the bill, despite a lack of offsetting spending cuts, because they understand the urgent need for aid. The Texas port on the Gulf of Mexico, through which military armaments pass, is “still in shambles”, he said.
Florida has requested $1.5 billion to help its citrus industry recover from hurricane Irma. Texas Governor Greg Abbott has requested $61 billion in aid for his state, while officials in Puerto Rico have sought $94 billion.
Still, there are at least two more budget shoes to drop just around the corner, as well. The first is the House GOP leadership’s plan to bust the sequester caps for defense via a rider on the Christmas Eve CR, but to leave the cap on domestic appropriations frozen at existing levels.
Needless to say, it won’t fly. The Dems have already rejected what they are calling Ryan’s defense and disaster plan—-yet the sheer vote math in the GOP caucus is prohibitive on a strictly partisan basis. This means that to raise defense spending by about $75 billion per year or 12%—either in the current CR extension or the next one in early January—will ultimately require at least a $25 billion or 5% increase in domestic appropriations in order to obtain at least some democratic votes.
Like in so many other cases, the Speaker will lose votes from among the 40-50 member Freedom Caucus owing to the lack of off-sets for the giant disaster relief rider and would simultaneously face defections from the 50-member Tuesday Club if defense appropriations are raised by 12% while domestic appropriation for education, community development, health services and research etc are kept frozen at sequester levels.
So we expect that he will end up cobbling together a majority by pacifying the GOP moderates and buying off the requisite Dems to obtain the needed 218 votes to keep the government open—-even if only a few weeks at a time.
That baleful outcome is more or less baked into the cake based on how McConnell auctioned off the votes for the tax bill in the Senate. Specifically, he made an ironclad promise to Senator Collins to fund the ObamaCare insurance subsidies at around $20 billion per year.
Yet given that his majority will dwindle to just 51-votes after Alabama, he has no way to renege. That’s because the RINO from Maine was negotiating for Senator Alexander and a handful of other GOP Senators who insist on “stabilizing” rather than repealing ObamaCare. But when the insurance company bailout comes back to the House, there will be huge defections by the anti-ObamaCare stalwarts of the Freedom Caucus.
In all, then, we expect FY 2019 outlays to rise by upwards of $200 billion from CBO’s most recent baseline projection. That would include $75 billion for defense, $65 billion for disaster aid, $25 billionfor increased of domestic appropriations above the sequester cap, $20 billion for the ObamaCare subsidies and another $15 billion for interest on higher spending and lower revenues.
Those kinds of spending increases are now virtually certain, and will take total FY 2019 outlays to around $4.575 trillion. That happens to be nearly 20% more than the $3.85 trillion spent during FY 2016 during the run-up to the presidential election—-when the GOP politicians loudly denounced the runaway spending of the Obama Administration.
And that get’s us to the tax bill and what the Wall Street Journal has dubbed “Sunset Boulevard”. What that means is the biggest tax cut occurs on the front-end in FY 2019. Thereafter, the tax bill devolves into an endless sequence of gimmicks, sunsets and implausible out-year revenue raisers that were designed to shoehorn the 10-year cost into the $1.5 trillion deficit allowance which enabled a 51-vote reconciliation process.
So the Sunset Boulevard depicted above amounts to the most blatant and dishonest abuse of the budget reconciliation process since its enactment in 1974, and we will elaborate on that in greater detail tomorrow.
But suffice it to say here that the “cliffs” built-into the graph below are not going to happen in the real world. Instead, they will soon lead to political conflicts and fiscal food fights that will make the 2012-2013 tax expiration “cliffs” look like small potatoes in comparison.
For instance, the only semblance of honesty in the claim that the bill is a “middle-class tax cut” is the 2-3 points of downward adjustment in the 7 marginal rate brackets compared to current law and the doubling of the child credit to $2000.
In the sunset year of 2025, however, those measures would save taxpayers $250 billion. compared to current law. Yet if there is any certainty in this world at all, it is that a legislative and political bloodbath will ensue when the Congress comes check-by-jowl with a quarter trillion dollar per year tax increase on 150 million individual taxpayers in 2026.
Likewise, the $53 billion per year cut for pass-thru businesses expires in 2025—-even as the corporate rate cut to 21% (at a cost of $150 billion per year) stays on the books forever. That’s not going to happen in a month of Sundays, either.
From the other side of the equation (i.e. payfors), the limit on interest deductions for business debt tightens sharply in the out years. This causes the “payfor” gain to nearly double from $20 billion per year to $37 billion (2027), while at the same time a whole new regime of amortization of corporate R&D rather than 100% expensing incepts in 2022—raising a projected $120 billion in the final six years of the bill.
Since the K-Street lobbies and business PACs essentially wrote the current bill, we have little doubt that they will have the clout to “un-write” what amounts to $200 billion in phony revenue increases in the out years when the time comes.
In short, we will demonstrate that the true 10-year cost of the GOP’s tax bill folly is in the order of $2.5 trillion on a honest accounting basis, and that under current circumstances it doesn’t have a snowball’s chance in the hot place of paying for itself with higher growth.
But for the moment, however, the FY 2019 budget disaster also explains why coping with this fiscal monstrosity in the out years in the context of baseline deficits which already total $10 trillion over the period will be next to impossible.
As is evident below, the FY 2019 revenue loss from the final conference bill will total $280 billion, thereby reducing Uncle Sam’s collections to just $3.40 trillion compared to the aforementioned $4.575 trillion of spending.
So there you have it: An FY 2019 budget deficit of $1.175 trillion—and you need to add another $100 billion for off-balance sheet programs that add to the borrowing requirement.
Even under the CBO’s generous estimate of nominal GDP for FY 2019 ($20.7 trillion), the Treasury’s total borrowing requirement of $1.275 trillion would amount to 6.1% of GDP.
But here’s the thing. That would be during months #111-125 of the business expansion that started in June 2009. As we have frequently noted, the US economy has never been there before—with the longest previous expansion during the far more benign 1990s totaling only 118 months.
And that is to say nothing of the fact that this purported record business expansion would be occurring at a time ultra-late in the cycle when the Fed is shrinking its balance sheet by an unprecedented rate of $600 billion per year.
In a word, something’s going to give.
We’d bet a fair amount that one of those “somethings” will be a casino so delirious with momo madness that it is valuing the RUT main street businesses of America at 107X peak earnings.