As expected, the American economy is experiencing cracks that are starting to form that will soon plunge the United States back into a recession.
Three factors — rising interest rates, the massive tax cut and tariffs — are likely to send the U.S. economy heading downward in the near future.
When it comes to interest rates, the Federal Reserve has been signaling that it will finally be running a tighter monetary policy after it spent most of the past decade pushing interest rates down to effectively nothing.
“The Fed is taking about $50 billion out of the economy every month, and now raising rates not just above zero, but close to (and perhaps even beyond!).
The tax cuts, meanwhile, have massively slashed the amount of revenue coming into the federal government, as the deficit of $488 billion in the first quarter of 2018 broke the nominal quarterly deficit record — which was originally set back in 2010, when the United States was in the middle of the worst recession in decades.
Combined with the Federal Reserve’s actions, we will be forced to “pay interest on the giant sums that will inevitably have to be borrowed to pay for these tax cuts.”
The trade war with China could be particularly disastrous given that China holds so much of America’s debt.
“But what if slapping 10 percent tariffs on $200 billion of Chinese products hurts the Chinese economy to the point where they can’t afford to keep subsidizing our exploding debt?”
But since the market hit an all-time high on October 3rd, it took a nasty dive. The worst was a two-day sell-off in the middle of last week, during which the Dow Jones Industrial average dropped 1,377 points.
On Friday, the Dow opened with a big round of buying, then plunged again, then wobbled all day before finally ending 287 points up. This allowed the financial world to spend the weekend relief-boozing instead of planning for The End.
The sell-off last week was likely just a mild preview.
The problems:
1. Fed tightening
Massive programs of money-printing and low-to-zero-interest rate lending were implemented to keep markets moving after the 2008 disaster. Terms like “unlimited liquidity” began to catch on to describe the level of central bank support the financial world could expect in the post-crash universe.
Programs like Quantitative Easing in the U.S. (and analogs in Europe and Japan) had central banks pumping an extra $12 trillion or more into the economy over the past decade. The cash was supposed to trickle down to the rest of us in the form of real-world investment. But the vast sums of free money pumped into the economy produced dependably unimpressive economic growth overall (prompting headlines like, “$12 trillion… for this?”).
Who benefited instead? The financial sector.
QE and “ZIRP” (Zero Interest Rate Policy) allowed big companies to borrow recklessly and gorge themselves on buybacks of their own stock, which had the twin consequences of driving down bond prices and sending the stock market soaring.
The central banks of the world are finally trying to end the madness. The Fed is taking about $50 billion out of the economy every month, and now raising rates not just above zero, but close to (and perhaps even beyond!) neutral. The free-money era is over. Once the European and Japanese central banks follow suit, the net effect worldwide will go from “easing” to “quantitative tightening” in 2019.
2. Tax cuts depend on monster growth
Groups like the Tax Policy Center warned, tax cuts would drive new activity at first, but… the impact would be blunted in later years by rising deficits, forcing more federal borrowing.”
A year later, we have had to sharply increase the scale of federal borrowing in order to cover the shortfall in expected tax revenue.
Few noticed when the Treasury borrowed $488 billion in the first quarter of this year, beating the record of $483 billion set in the first quarter of 2010, when the economy was still recovering from a crash. There was talk that the Treasury would roughly quadruple the number of T-bills issued in 2018 versus 2017.
The national debt shot past $21 trillion for the first time last year.
We will have to pay interest on the giant sums that will inevitably have to be borrowed to pay for the tax cuts.
So we have a Fed-tightening colliding with a ballooning public-borrowing need.
3. The new tariffs
A massive tax cut can only be paid for by unsustainably high growth. Immediately, we will increase national borrowing to pay for it.
The traditional Treasury note supply goes up right away, but even that’s not enough to pay the nut. In fact, this week — October 16th, to be exact — the government is going to debut a brand-new two-month Treasury bill, through which it hopes to raise $30-$35 billion immediately.
So we’re going to have to sell more and more Treasury notes. On whom do we depend most of all to buy those notes?
China, which holds about $1.2 trillion in Treasury notes and about $1.5 trillion in U.S. debt overall.
In any trade war with China, the United States would seem to have an advantage. We import a lot more of their goods (last year, about $524 billion in Chinese products) than they import of ours (about $188 billion of U.S. exports). But all of this is moot if China suddenly stops buying U.S. debt, or even just slows down a bit.
Experts claim to think this is unlikely, given China’s own dependence on U.S. Treasuries as a safe destination for its trillions in foreign exchange reserves.
Bloomberg over the summer wrote, “Treasuries are nearly as crucial an underpinning to China’s economic plumbing as America’s.” They quoted a Goldman Sachs analyst who added: “We don’t see any evidence that China is planning to use Treasuries as part of its trade negotiations.”
But what if slapping 10 percent tariffs on $200 billion of Chinese products — hurts the Chinese economy to the point where they can’t afford to keep subsidizing our exploding debt? What if it just dulls their enthusiasm for doing so?
Under Quantitative Easing, we were inventing huge sums of cash to lend to ourselves, with the Fed buying as much as $45 billion in Treasuries every month. This time last year, the Fed had $2.5 trillion in Treasuries on its balance sheet.
Now that source of funding is drying up, and we’re in a trade war with our other major borrower, and we bet this was the time to bet our national economic health on a tax giveaway.
Recession?
Time to short?
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