Donald Trump’s Massive Deficit Could Spark a Financial Crisis in 2018

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News - By Benjamin A. Smith | March 3rd, 2017

Could Donald Trump Trigger the Financial Crisis of 2018?

This is a question on many people’s minds in response to a proposed high-octane Donald Trump budget plan unveiling. Plenty of infrastructure spending and tax cuts proposals are planned, and that’s bad news for the federal deficit. Debt levels are poised to explode again if unencumbered Trumpian economic policies pass through Congress, and this could raise the odds of financial crisis 2018 becoming a reality.

The current U.S. deficit is around $19.8 trillion and rising by about $3.0 million every minute. At a post-WWII high of 106.76% of gross domestic product (GDP), many fiscal hawks within the U.S. government are worried that the cascading debt could lead to a financial collapse if not arrested. This doesn’t even take into consideration the rising cost of social outlays from Social Security, which are increasing rapidly.

Right now, the U.S. is operating under a suspension of the debt ceiling. That is, the government is borrowing without restriction under a deal reached by then-president Barack Obama in October 2015.

With the relevant provisions of the Bipartisan Budget Act ending on March 15, 2017, something called “extraordinary measures” will kick in. These measures would keep the U.S. from technically defaulting on its debt until a new threshold can be established. (Source: “Bipartisan Budget Act of 2015,” U.S. Government Publishing Office, last accessed March 3, 2017.)

As well, on March 16, 2017, the U.S. federal deficit will reset well north of $20.0 trillion to account for all debt issued while the ceiling was suspended. The optics of breaking this rather large, round figure will be unhelpful to a formal Trump budget plan unveiling. He’ll need support of Republican deficit hawks in Congress to carry on with his objectives, despite his Congressional majority.

So what’s in Trump’s budget proposal getting the deficit hawks all in a tizzy? Infrastructure spending and tax cuts-massive amounts of them. This could result in rising national debt, even surpassing rates seen in the Barack Obama years.

While specific details haven’t been released, President Trump has consistently clamored for a modern “public works” program for America. During his campaign, Trump pledged to spend $1.0 trillion on infrastructure modernization throughout America, and has not wavered from that message since. In late February 2017, Trump opined: “Infrastructure—we’re going to start spending on infrastructure big. Not like we have a choice. It’s not like, oh gee, let’s hold it off.” (Source: “Trump pledges to spend ‘big’ on infrastructure,” CNBC, February 27, 2017.)

Irrespective of the politics involved with creating more debt to finance deficit spending, it appears it’s desperately needed.

An American Society of Civil Engineers (ASCE) 2013 report card determined that the U.S. has a significant backlog of overdue maintenance across several areas of infrastructure, and that modernization is desperately required. Their worst grades were awarded to levees (D-) and inland waterways (D-), and they gave the state of American infrastructure an overall grade of D, which is a barely passable assessment. (Source: “Save America’s Infrastructure,” American Society of Civil Engineers, last accessed March 3, 2017.)

With several high-profile cases of public works malfunctions, including the Oroville Dam spillway failure threatening 180,000 lives downstream, public opinion may be on Trump’s side. The reliance on aging infrastructure has simply continued too long, and is literally putting American lives at risk. For example, it’s estimated that, by 2020, the number of dams in the U.S. living past their designed lifespans will reach 65%.

It’s also worth noting that Trump is a builder, having amassed a great fortune in commercial real estate as a private citizen. Building is what Trump knows, and taking on massive loans never stood in his way. As such, it’s likely that Trump will stay laser-focused on increasing infrastructure spending because, quite simply, he has built a successful empire on similar circumstances. There’s little reason to believe he’ll change course today unless he’s forced to do so.

The other Trump budget proposal threatening to blow up the deficit is tax cuts. Quite simply, the proposed cuts are nothing short of mind-blowing, dwarfing the broad-based tax cuts enacted by Reagan a generation ago.

While the top tax bracket would decrease to 33% on federal income (a 16.66% from current levels), the corporate tax rate would be slashed from 35% down to 15%. A bevy of other middle-class tax breaks and incentives would also likely be part of the package. Such a proposal would be among the biggest broad-based tax cuts in American history.

This should be quite positive for corporate America. The problem, however, is that diminishing tax receipts, as a result, would unlikely be offset by increased economic activity. Thus, the foreseen consequences of Donald Trump policies may very well set financial crisis 2018 in motion in the coming year.

According to the right-leaning Tax Foundation’s “Taxes and Growth” model forecasts, Trump’s budget plan would cut federal revenue by between $4.4 trillion and $5.9 trillion on a static basis. Even if we account for stimulatory effects to the larger economy, the Tax Foundation still forecasts that revenues would decrease on aggregate between $2.6 trillion and $3.9 trillion. (Source: “Details and Analysis of Donald Trump’s Tax Plan,” Tax Foundation, September 19, 2016.)

10-Year Revenue Impact of the Trump Tax Plan (Billions of Dollars)

Tax	Static Revenue Impact (2016-2025)	Dynamic Revenue Impact (2016-2025)
Note: Individual items may not sum to total, due to rounding. Numbers are listed with the higher-rate assumption first and the lower-rate assumption second, where applicable.
Individual Income Taxes	-$2,192 / -$3,730	-$1,058 / -$2,458
Payroll Taxes	$0	$520 / 612
Corporate Income Taxes	-$1,936	-$1,958 / -$1,959
Excise Taxes	$0	$44 / $52
Estate and Gift Taxes	-$240	-$240
Other Revenue	$0	$52 / $62
TOTAL	-$4,368 / -$5,906	-$2,640 / -$3,932

(Source: Ibid.)

That’s a lot of money, especially with entitlement program spending and deficit interest obligations rising exorbitantly. The budget deficit by year is already on an unsustainable track, and slashing taxes to achieve higher growth rates won’t help the debt get any smaller. Also, what happens if these projections prove to be over-optimistic?

Keep in mind that when Reagan slashed taxes, debt-to-GDP was far less than a third of what levels are today. And this was with interest rates raging well into the double-digits. With the debt that America has piled on in the last 35 years, there’s much less room to maneuver than in Reagan’s time. The tightrope has gone from three inches in diameter to one.

Thus, it appears that a 2018 financial crisis is brewing, even before it has technically gotten underway.

Financial Crisis 2018

While “financial crisis 2018” is still conjecture at this point, it’s more than a fleeting possibility. Of course, much will depend on what actually gets passed in the upcoming federal budget. But much will also depend on the bond market, and whether the Fed is able to keep interest rates subdued.

Bond prices have been in full-on rally mode since July 2016. The interest rate on the 10-year note has risen from a low of 1.32% to 2.46%, an increase of 86.36%. Although still low by historical standards, rates in the mid-2% range are sending rate-sensitive consumers scrambling to meet payments.

The pressure felt by consumers in a higher-interest rate environment is an established one, but so are government constraints when it comes to debt financing.

For each interest rate of one percent, the annual federal deficit would rise by $190.00 (over $200.0 billion is up-to-date terms). A two-percent increase in rates would increase interest payment obligations by $380.0 billion annually; four percent higher rates, an extra $760.0 billion obligation. In fact, an extra four-percent increase in 10-year interest rates would only result in rates which were only slightly higher than the long-term historical average. A very plausible scenario, indeed.

That’s why interest rates matter so much. With the Federal Reserve looking to unwind its already-bloated balance sheet, the biggest buyer is no longer. Worse still, the biggest buyer now flips to become the biggest seller, and it’s unclear whether the market is liquid enough to absorb the impact.

Blackrock, Inc.’s (NYSE:BLK) Investment Institute has noted that about one-third of the Fed’s Treasury security portfolio ($785.0 billion) comes due at the end of 2018. Unwinding this position outright could spook the market and send benchmark rates skyrocketing. (Source: “The taming of the Fed’s balance sheet,” Financial Times, May 26, 2015.)

Higher rates, combined with growing budget deficits, are the basis on which financial crisis 2018 (and beyond) could be formed.

It’s also unclear how high the Fed will be forced to raise interest rates should the bugaboo of inflation rear its ugly head. Central banks generally want a little bit of inflation, since it eases the burden on existing deficits while promoting consumer spending. But too much inflation has nasty side effects and negative implications for real economic growth. Unfortunately, we may be heading into a scenario in which input price inflation makes its first appearance in almost four decades.

This is due to Trump’s threatening stance on free trade. If proposed tariffs are imposed on imported goods throughout the world, the resulting trade war could send costs for raw materials and commodities skyrocketing, sending finished goods prices through the roof.

A similar scenario happened in 1973 when the Organization of the Petroleum Exporting Countries (OPEC) proclaimed an oil embargo. This severely limited the supply of crude oil to the United States, causing prices to spike. This is when inflation took a turn for the worse. In 1972, U.S. inflation chimed in at 3.2%, which was a five-year low. By the end of 1974, average U.S. inflation reached 11%, which was the second-highest annual inflation number since 1920. This dovetailed into the recession of 1973–1975, with peak-to-trough GDP falling 3.2%, all while inflation was soaring in the opposite direction. These were tough times, indeed.

If Trump and the Republicans aren’t careful, the economic outlook 2018 could take on a similar tenor. The devil will rest in the details, and these should become known as 2017 unfolds. But investors should be aware of the volatile brew of potentially higher rates, higher inflation and lower government tax receipts circling the cauldron.

Your financial independence could depend on it.