As the Fed is slows US Treasury bond purchases, and doggedly pursues its policy of tapering, thus driving up interest rates, 58% of Treasury securities held by the public will be maturing over the next four years.
This means that the US Treasury will be rolling over a huge amount of debt into a higher-interest rate environment. The benchmark 10-year U.S. Treasury Note has moved from a yield of 2.06% (November 9, 2016) to over 3% now.
Mortgage rates correlate to the 10-year Treasury and they have moved up significantly since last September, causing a slowdown in home sales with knock on effects on consumer spending on durable goods. This will impact Treasury revenues.
Meanwhile, Trump’s trade war with China will at least put a dampener on East Asiatic demand for Treasuries for the foreseeable future, and there will be little promise of respite from those quarters for Treasury securities markets, ensuring upward pressures on rates and yields.
All this has to be understood in the context of what the May 3, 2017 General Accountability Office (GAO) report on the U.S. government’s fiscal outlook said about the impact of interest rates on the Federal Budget:
“While health care spending is a key programmatic and policy driver of the long-term outlook on the spending side of the budget, eventually, spending on net interest becomes the largest category of spending in both the 2016 Financial Report’s long-term fiscal projections and GAO’s simulations.”
While it has been clear since 2011 that the Fed has been aiming at a programme of tapering its quantitative easing programme and reversing it in order to “normalise” its balance sheet, the Trump tax plan itself will make it impossible for the Fed to respond counter-cyclically to worsening economic performance, in view of the historically unprecedented fiscal deficits that will result from this plan.
The irony of this situation is that the Trump tax plan was in part intended to disguise and offset the effects of Fed tightening. But it clear from the above that it will consume itself. It is remarkable that the US Treasury, unlike Trump officials and GOP luminaries, stayed silent on this policy, unwilling to issue any reports or statements whatsoever on one of the biggest tax giveaways in history.
In a single week, $4 trillion in global stock market value has vanished. The stock market had become complacent toward the fierce rise in U.S. Treasury yields. Trump’s tax cut plan was clearly going to drive yields on Treasuries up by impacting the supply and demand at a time when the Federal Reserve was cutting back on its own purchases of Treasuries in order to normalize its bloated balance sheet in a hurried acceleration of its QE unwind.
Doves on the Federal Open Market Committee (FOMC) like Minneapolis Fed President Neel Kashkari regularly voted against rate hikes in 2017 because inflation was too “low.” As inflation edges up now, the story will change. In its statement after the January 31 FOMC meeting, the Fed specifically pointed at the “low” unemployment rate, and some Fed governors have said that the unemployment rate, at 4.1% for the past four months, might inch down to 3.9% by the end of the year and stay there in 2019, and that these levels would put further upward pressure on wages as employers might have to raise wages to attract workers.
But it is Trump’s political future that will ultimately be the biggest story for the markets. Up until now, Trump has been supported by a calm stock market regularly scaling new heights. No longer, not with the looming mid-term elections. The Republicans having nailed themselves to Trump’s mast will face problems, as Bradford de Long writes, extraordinary or not, Trump is ‘… playing to lose’. While he was insisting that his tax cut legislation had “set off a tidal wave of good news that continues to grow every single day,” actually the markets were reassessing how much that tax cut was actually going to add to the U.S. deficit; how much it would mean in new issuance of Treasury bills, notes and bonds; and weighing how far interest rates would have to rise so that this massive doubling of debt issuance would find buyers.
The Trump tax cut legislation reduced the corporate tax rate from 35 percent to 21 percent. The nonpartisan Congressional Budget Office has estimated that it will add $1.5 trillion to the deficit over the next decade. Now the chickens are coming home to roost, and the chaos of this presidency, and volatility in the markets, will begin to feed off each other. A new Gallup poll put global approval of US leadership at just 30%, behind China at 31% and Russia at 27%.
But as Wolf Richter writes: ‘What’ll happen next? Dip buyers will come in, maybe at this very moment, or maybe later, and some of them will likely get plowed under, but there is way too much cash lined up in hedge funds specifically set up to profit from sell-offs. And dip-buyers have been rewarded relentlessly over the past eight years, and it’s not until the dip buyers get massively destroyed and stop dip-buying that the market is in real trouble.’
We will see considerable turbulence which will probably feed off the ups and downs of the Trump political journey, with a bias to the downside as money will seek rising yields in the Treasury market.
A cause for concern should be that Robert Shiller’s cyclically adjusted price-earnings ratio (CAPE) is now above 30 – a level previously reached only twice, at the peaks of 1929 and 2000 (see chart below), both of which were followed by stock-market crashes. Also if CAPE is particularly high for the US compared with all other countries, the reason is share buybacks by corporations. So if anyone tells you that the “fundamentals” of the economy are strong, you should know that shares prices and fundamentals have disconnected a long time ago. In a world of financial engineering they have nothing to do with each other.
10th February update: See Pam and Russ Martens for the observation that– on Thursday, February 8, the Dow and the NASDAQ traded in almost complete lockstep. Why would a far riskier market trade in lockstep with the far safer Dow during a market panic? This recalls the bust that began in March 2000. So there seems to have been indiscriminate, wholesale dumping of stock portfolios by traders desperate to raise cash any way they could. The monster difference between the volume of advancing stocks versus the volume on declining stocks also suggests wholesale dumping. Dow Jones’ MarketWatch reports that yesterday the New York Stock Exchange (NYSE) saw 2,683 stocks decline while only 342 stocks advanced. Similarly, Nasdaq saw 2,525 stocks decline while 453 advanced. Trading volume was swamped by declining shares. On the NYSE, declining share volume reached 4.74 billion while advance volume came in at a meager 556.45 million. Nasdaq’s volume tallied out at 2.35 billion in decliners versus 363.15 million in advancers.
The key thing is that hedge funds seems to be liquidating stock portfolios to meet margin calls, that would help to explain the inability of the stock market to sustain a rally. This is what was noted on this siteback in December 1, 2017.
The US government is essentially being managed by Goldman Sachs employees (in Matt Taibbi’s famous phrase representatives of the “great vampire squid“). Their goal is to make as much money for themselves as possible. Stock buybacks have been what the banks and major companies have been spending their profits on almost exclusively since the last crash (besides paying just enough dividends to keep stock market investors interested). This pushes up stock prices, reduces the size of the stock market, and increases executives stock options (and so their wealth). Until Ronald Reagan came along stock buybacks were illegal in the US. After deregulation, Quantitative Easing (QE) since 2007/8 has given the banks and corporations the ability to use debt at no cost. It is not surprising that as the Fed announced the end of QE, there should be a massive tax cut to give the corporations the same benefits from the back door.
As Bernie Sanders writes in his book this situation means that the Fed becomes hugely indebted, the corporations become hugely indebted as their share/equity base gets smaller, and now the banks are lending huge sums of money to stock speculators so that they can get hugely indebted as well, buying the shares on margin which need to keep going up for executives at the banks and large corporations to cash in more options at ever higher stock prices. These retail investors will get scalped as usual in due course. As the Fed tired of supporting the markets, the Trump tax cut was a last throw of the dice for the executive class. Any time in the future that interest rates start rising from their historic zero levels and the corporations cannot meet their financing obligations, the executives will have banked their money, bought their mansions, and stocked up on physical gold, probably parked in massive safes in their basements.
The fact that the US economy is being eviscerated by executive programmes for share buybacks (together with internal cost-cutting and disinvestment in the real economy) is clear from the sharp declines in earnings per share (eps) since 1999. Figures show the greatest move downward in eps has been since the last crash in 2007/8, in tandem with stock prices going up (based on the Fed’s QE programme which started back then). Since the corporations make up the larger part of the US economy, clearly their evisceration is what is being reflected in the evisceration of the US economy as a whole. The fact that this is being played out on a huge scale doesn’t mean it is not a scam. Matt Taibbi was absolutely right in 2010 that after the crash Goldman Sachs was going to engineer another bubble.
Pam Martensexplains how this whole process works. To understand how the U.S. central bank, known as the Federal Reserve, is influencing the froth of the stock market, you need to take a few moments to understand the interaction of bond yields with stock prices. Sophisticated investors who predominate in the markets compare the yield on bonds to the cash dividend yield on stocks to determine which is a better value. Following the financial crash of 2008, the Federal Reserve began buying up Treasury bonds and mortgage-backed bonds in the marketplace to the overall tune of more than $3 trillion. This has driven down bond yields and provided an artificial boost to the stock market.
The Fed’s assets swelled from $914.8 billion at the end of 2007 to $4.5 trillion in 2014 from its bond buying program. In just the single year of 2013 the Fed’s assets mushroomed by a staggering $1 trillion — from $2.9 trillion at the end of 2012 to $4 trillion at the end of 2013, according to the audited financial statement of the Fed’s books. As of October 25, 2017, its assets remain in the $4.5 trillion arena, at $4.461 trillion.
The Fed’s active involvement in messing with the stock market as a fair stock pricing mechanism through its massive purchases of bonds was quaintly called Quantitative Easing (QE) and the public was treated to three doses of it: QE1, QE2 and QE3.
Since 2011, the Fed has been jawboning about how it was going to normalize its balance sheet back to something resembling pre-crisis days. It actually began to cut back its bond purchases by shrinking the amount of its maturing bonds that it will roll over into new bond purchases in October of 2017. But its scheduled cuts are so small and gradual that we are not seeing any material shrinkage in its assets.
During Fed Chair Janet Yellen’s September 17, 2014 press conference, in response to a question from Ylan Mui of the Washington Post, Yellen said: “If we were only to shrink our balance sheet by ceasing reinvestments, it would probably take—to get back to levels of reserve balances that we had before the crisis—I’m not sure we will go that low, but we’ve said that we will try to shrink our balance sheet to the lowest levels consistent with the efficient and effective implementation of policy—it could take to the end of the decade to achieve those levels.”
In 2014, the end of the decade would have been 2020. It’s now 2018 and we’re looking at another half decade before the Fed’s balance sheet would normalize under the current schedule. That’s a very, very long time to provide spiked punch to a tipsy stock market.
The Goldman Sachs overlords who have so thoroughly infused themselves into the Donald Trump administration (the Presidential candidate who promised a draining of the Washington swamp) have figured out a way to get another round of cheap money. Instead of calling it QE4 and getting it from the Fed, it’s being called a corporate tax cut and its coming from the American public who will be squeezed in other areas to pay for it. Jamie Dimon, the Chairman and CEO of JPMorgan Chase, quickly recognized it for what it was, stating “think of it as a QE4” at an Axios event in Ann Arbor, Michigan in December.
Republicans have been peddling the tax cut as a boon to the economy. That’s not what’s going to happen. U.S. corporations and, particularly, the biggest Wall Street banks are going to use the extra money to continue buying back their own company’s stock, boosting the bank CEOs’ own stock options and enriching their shareholders to the detriment of business and job creation.
On July 31 of last year, Thomas Hoenig, the Vice Chairman of the Federal Deposit Insurance Corporation (FDIC), sent a stunning letter to the Chair and Ranking Member of the U.S. Senate Banking Committee. Hoenig explained that the 10 largest banks in the country “will distribute, in aggregate, 99 percent of their net income on an annualized basis,” by paying out dividends to shareholders and buying back excessive amounts of their own stock. If those 10 banks had retained a larger share of the earnings they earmarked for dividends and share buybacks in 2017, said Hoenig, they would have been able “to increase loans by more than $1 trillion, which is greater than 5 percent of annual U.S. GDP.”
Hoenig included a chart showing payouts on a bank-by-bank basis. Highlighted in yellow on Hoenig’s chart is the fact that four of the big Wall Street banks are set to pay out more than 100 percent of earnings: Citigroup 127 percent; Bank of New York Mellon 108 percent; JPMorgan Chase 107 percent and Morgan Stanley 103 percent.
Hoenig adds that if just the share buybacks were retained by the banks instead of being paid out, the banks could “increase small business loans by three quarters of a trillion dollars or mortgage loans by almost one and a half trillion dollars.”
Stock buybacks also perform another magic trick for Wall Street bank CEOs like Jamie Dimon whose compensation is based on overall performance. By shrinking the number of shares outstanding through buybacks, it makes the bank’s per share earnings look more robust because they are spread over a smaller number of shares.
According to JPMorgan Chase’s 2017 proxy statement, “Based on Mr. Dimon’s performance, the Board increased his annual compensation to $28 million [in 2016] (from $27 million in 2015).” Notably, according to the proxy, the portion of Dimon’s compensation that was in stock awards was $20.5 million for 2015 and $21.5 million for 2016. Thus, Wall Street CEOs are highly incentivized to keep those stock prices aloft.
Senate majority leader Mitch McConnell sells the lie that the Trump tax cut is going to be good for small business.
When U.S. Treasury Secretary Steven Mnuchin spoke about the Trump administration’s tax plan at the Institute of International Finance, he said the plan would pay for itself without adding to the national debt. This, he said, would be based on what he called “dynamic scoring”. His projections showed ‘a $2 trillion increase in revenues over a 10-year period. So the plan will pay for itself with growth.’
But the tax plan that has just passed Congress and the Senate, in two different forms which are somehow to be merged, shows without all the “dynamic scoring” a $1.5 trillion extra deficit, according to the nonpartisan Joint Committee on Taxation (JCT).
In the past fiscal year, the U.S. deficit was $666 billion. That follows deficits of $585 billion in 2016, $438 billion in 2015, $485 billion in 2014, $679 billion in 2013 and more than $1 trillion in deficits in each year from 2009 through 2012, despite extraordinary efforts to stimulate the economy following the 2008 Wall Street financial collapse.
The JCT study found the Trump tax cut would only return $458 billion of the $1.5 trillion cost over the 10 year period. Meanwhile, as Senator Elizabeth Warren noted in a letter to the Inspector General of the Treasury Department, there is no study whatsoever coming out of the US Treasury on the subject.
Mnuchin’s “Goldman Sachs bluster” with the hackneyed trickle-down metaphors being trumpeted (excuse the pun) all over the media, is intentionally deceptive.
As Professor Ha-Joon Chang at Cambridge University tells us, “trickle down” – the theory that making a few rich creates wealth across the board for everybody – is a totally broken theory. See him in the short clip below.
Mnuchin’s deception is not limited to this. The bill he has rammed through Congress and the Senate, which Republicans jumped at and turned into law in record time because they are worried about their chances in the upcoming 2018 mid-term elections, is actually a massive $6 trillion tax-cut over the coming decade, funded by tax rises which will destroy local economies across the US.
The tax-cut raises $4.5 trillion in taxes on ordinary people, so that the rich can get the $6 trillion, which is the actual full amount of the scam for the corporations and the 1%: a historic number that would have made both Reagan and Bush cringe.
The Tax Policy Center estimated that about 80 percent of the benefit of the tax plan will go to the top 1 percent, with $1.5 trillion going to slash the corporate tax rate, $700bn going to cancel the ‘alternative minimum tax’, paid almost exclusively by the rich, and $150 billion going to repealing the estate tax, which currently exempts the first $11 million of the deceased’s estate, so nobody even remotely middle class pays it.
Furthermore, more than $200 billion in cuts goes to a provision that allows a greater deduction for dividends on foreign earnings, and $600 billion goes to reducing taxes on “pass-throughs” and other businesses not set up as corporations -such as law firms, lobby shops, and doctors’ surgeries.
If some $200bn will be going to allow higher income bands to claim tax credits, whilst individual and family tax rates are cut by about $1 trillion, these are the only elements in the package likely to filter through to the middle classes. As the New York Times noted, by 2027, people making between $40,000 and $50,000 would see a combined increase of $5.3 billion in taxes, whilst, on the other hand, people earning more than $1 million would see their taxes collectively cut by $5.8 billion a year.
The tax rises made to underwrite the $6 trillion giveaway
(1) The tax rises include some $300 billion allowances for companies with offshore profits to repatriate them at a lower rate. Although that cash goes straight to dividends for shareholders and stock buybacks, it gets counted as a tax increase.
(2) Unbelievably $1.6 trillion is raised by repealing the personal exemption everybody gets on their tax returns.
(3) Another $1.3 trillion is raised by going after deductions for state and local taxes, mortgage interest, charitable contributions, interest on student loans, medical expenses, teachers’ out-of-pocket expenses (e.g. for paper and pencils for students). This will devastate local economies.
(4) The new law gradually raises $128 billion in (stealth) taxes by changing the way inflation is calculated, so that your taxes slowly creep up over the years as the brackets come down.
(5) Finally, the law adds about $1.5 trillion to the already eyewatering debt over the next 10 years, and the interest payments that will entail.
The joke: what comedian Will Rogers meant by “trickle-down” during the Great Depression
In 1932, Will Rogers comments on Hoover’s defeat at the hand of Roosevelt:
“The Republicans didn’t start thinking of the old common fellow till just as they started out on the election tour. The money was all appropriated for the top in the hopes that it would trickle down to the needy. Mr. Hoover was an engineer. He knew that water trickles down. Put it uphill and let it go and it will reach the driest little spot. But he didn’t know that money trickled up. Give it to the people at the bottom and the people at the top will have it before night, anyhow. But it will at least have passed through the poor fellows hands. They saved the big banks, but the little ones went up the flue.”
Will Rogers was just telling us what Ha-Joon Chang is saying today.
Looking at what projects will be launched in the Trump infrastructure foray can eventually tell us which companies will benefit. But will Americans in general benefit as Steve Bannon claims they will? For, the “great political movement” he envisages to keep Republicans in power for 50 years, as he wants, does require that the country at large benefits. There are two problems to look out for:
Instead of just allocating needed resources in a traditional across the board approach, the Trump team seem to be proposing to offer $137 billion in tax breaks to private investors who want to finance toll roads, toll bridges, or other projects that generate their own revenue streams. Since the plan depends on private investors, it can only fund projects that spin off user fees and are profitable. Rural roads, water systems, and public schools don’t fall into that category. Neither does public transit, which fails on the profitable criterion (it depends on public subsidies). Yet investment in all these things is necessary to keep ‘the great political movement’ on the road.
Trump’s tax giveaway plan delivers about half of its benefits to the top 1 percent of households. The Republicans in Congress have a plan they want Trump to consider which is even more lopsided: 76 percent of its cuts go to the top 1 percent. So the campaign rhetoric about the “forgotten little guy” stuff was that … campaign rhetoric.
The impact of the Bush tax cuts, which were smaller than the Trump tax cuts, were shown to have had no positive effect on the economy. Fiscal economists Gale and Orszag wrote that “…as a result of these design flaws—from the perspective of providing stimulus—the tax cuts had at best a small positive bang for the buck relative to other options. The most comprehensive studies … imply that the tax cuts reduced GDP and employment in 2001 and had virtually no effect … in 2002.”
As Cambridge economist Ha-Joon Chang has shown in Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism and in 23 Things They Don’t Tell You About Capitalism tickle-down economics is pure guff.
So will Trump just be a flash in the pan, create waves, make tons of money, and then leave it to a (hopefully reformed and wiser) Democratic Party to come back? Or Will Steve Bannon’s idea be seen through?
“I’m not a white nationalist, I’m a nationalist”, he tells me. “The globalist gutted the American working class and created a middle class in Asia. The issue is about Americans not getting [done] over. If we [the trump White House] deliver, we get 60 percent of the white vote, and 40 percent of the black and Hispanic vote and we’ll govern for 50 years. That’s what the Democrats missed. They were talking to these people with companies with a $9bn dollar market cap, employing nine people. It’s not reality. They lost sight of what the world is really about.”
“Like [Andrew] Jackson’s populism, we’re going to build an entirely new political movement”, he says. “It’s everything related to jobs. The conservatives are going to go crazy. I’m the guy pushing a trillion-dollar infrastructure plan. With negative interest rates throughout the world, it’s the greatest opportunity to rebuild everything. Ship yards, iron works, get them all jacked up. We’re just going to throw it up against the wall and see if it sticks. It will be as exciting as the 1930s, greater than the Reagan revolution — conservatives, plus populists, in an economic nationalist movement.”
The Trump presidency is extremely important as a reaction to a neoliberal order that has been with us since Bill Clinton eviscerated the Democratic Party to become the party of corporations from 1993 onwards (followed by Tony Blair in the UK from 1997). In other words, even though the neoliberal order was ushered in by Reagan/Thatcher, it was Clinton/Blair who ensured that it had no opposition in the main democracies.
Hillary Clinton lost to Trump purely on electoral college votes, and it did so primarily because the Democratic Party cheated Bernie Sanders’ populist base by rigging the primaries in favour of Clinton. What made this worse is that this atrocious behaviour was made public with the leaks of all those emails hacked from the Democratic Party server. Steve Bannon may have been the evil genius who engineered the Trump win, but really he was surfing home on the wave of a Democratic Party suicide mission.
The Trump presidency is ‘fascistic’, but this aspect of it will engender so much opposition, encouraged by the fact that Hillary Clinton got 1.5m more of the popular vote than Trump, that it will be mitigated.
The important thing for anybody who wants to survive financially in the coming 8 years is to realise that Trump will turn the US economy around, and this must inform everybody’s financial decisions. Joseph Stiglitz is right that re-importing jobs won’t be that easy, because technology has changed since the 1980s. But it is not necessarily only that aspect that will change the economic picture, as Trump focuses on infrastructural development.
Extraordinarily his presidency starts with the US Geological Survey confirming the Wolfcamp shale oilfield as the largest ever find in US history, on truly Saudi Arabian proportions, which turns the energy clock back to the pre-1970s when the US was a net US oil exporter.
So, in the sense that Trump wants to be re-elected, the US economy soaring will mean that he will be. While Obama was an unlucky (and weak) President, Trump, it looks like at the moment, will be a lucky one. This unfortunately will embolden a ‘fascistic’ style, possibly better described as the ‘feudal’ style common among corporate CEOs, than as Mussolini-type fascism. Ivanka Trump sitting in on her father’s meeting with the Japanese Prime Minister will be a typical event, and one which will rankle with most Americans.
So also, the democratic counter-attack will have its work cut out for it, and this will logically mean that great changes are in store for the future. Given that the Islamic community in America will be at the centre of the storm, this will tie Islam with the future democratic resurgence and change the very nature of the Islamic dialogue itself. It is a sign of things to come that Democratic Party chairman will most likely be a Muslim American, Keith Ellison.
The resurgence of the US economy will mean that the Federal Reserve will be able to come off the floor on interest rates, sucking capital from stock markets across the world into the US, and trashing fixed interest instruments like bonds, and the stocks of highly leveraged firms. China may have caught up with the US, but the US is still absolutely the largest economy in the world.
The U.S. Geological Survey just published an assessment of oil reserves for a section of the Permian Basin, revealing the largest estimate of continuous oil that the agency has ever assessed.
The Wolfcamp shale in the Midland Basin, which is part of the Permian Basin, is one of the most prized shale formations in the United States, and for good reason. The USGS estimates that the West Texas shale formation could hold an estimated mean of 20 billion barrels of oil, 16 trillion cubic feet of associated natural gas, and 1.6 billion barrels of natural gas liquids. Those figures are the largest for any single continuous pool of oil the USGS has ever surveyed.
Joseph Stiglitz writes that Trump is unlikely to effect a carbon tax, empower trade unions and make tax rates more progressive, all of which are necessary to see a real impact to his increased investment plans for America.
Prof. Stiglitz concludes: “My very cloudy crystal ball shows a rewriting of the rules, but not to correct the grave mistakes of the Reagan revolution, a milestone on the sordid journey that left so many behind. Rather, the new rules will make the situation worse, excluding even more people from the American dream.”
Robert Skidelsky writes that there will be benefits to Trump’s approach.
Prof. Skidelsky says: “Trump has… promised an $800 billion-$1 trillion program of infrastructure investment, to be financed by bonds, as well as a massive corporate-tax cut, both aimed at creating 25 million new jobs and boosting growth. This, together with a pledge to maintain welfare entitlements, amounts to a modern form of Keynesian fiscal policy (though of course not identified as such). Its merit is its head-on challenge to the neoliberal obsession with deficits and debt reduction, and to reliance on quantitative easing as the sole – and now exhausted – demand-management tool.”