Trillion Deficits Cure the US Economy, but Tank the Dollar?
By the Curmudgeon
After winning both Senate seats in Georgia, Democrats are now in control of BOTH chambers of Congress. In addition, the Dems will have control over the Presidential appointment confirmations - including appointments to regulatory positions, cabinet, and judicial positions. More important for the economy and markets, is that the Dem sweep in Georgia clears the way for the use of reconciliation to set spending and tax levels without threat of filibuster. All of that make fiscal stimulus spending much more likely to occur in the first half of 2021. However, there are unprecedented risks for both the Biden administration and the Fed.
A $1 trillion COVID federal stimulus bill might be fast tracked this winter, while $2-$4 trillion infrastructure spending package could come later in 2021. That could further pressure the declining US dollar and cause the Fed to taper its current purchasing of $80B of US Treasuries and $40B of Mortgage-Backed Securities (MBS) each month.
As this is a time for healing, reconciliation, and harmony, we will NOT pursue the proverbial “fly in the ointment” or “knock in the motor” that is characteristic of the Curmudgeon. Instead, we briefly address the issues noted above and wish all readers to hope and pray for America to come together again.
Prospects for US Fiscal Policy:
President elect Joe Biden has pledged to begin talks on an additional economic support via a bigger fiscal stimulus package once he takes office, building on the more than $900 billion in pandemic aid that Congress and President Donald Trump agreed to last month. Biden called the $600 checks to individuals just “a down payment” on what they might eventually receive which is presumably a total of $2,000 which the House approved in the last days of 2020, but the Senate did not take up that measure.
Biden told reporters at a briefing on Friday that one of his first priorities is pulling together a plan to spend trillions more money to bolster the economy, as the coronavirus rages. "We need to provide more immediate relief for families and businesses now. People are really, really, really in desperate shape," he said. We see this every day in Santa Clara, CA (the center of Silicon Valley), where the homeless population is at an all-time high!
"The overwhelming consensus among leading economists left, right and center is that in order to keep the economy from collapsing this year and getting much, much worse, we should be investing significant amounts of money right now to grow the economy," Biden added.
Along with economic support from American individuals, families and small businesses, Biden will push Congress for funding for vaccine distribution. "I will immediately move for the most urgent need of asking the Congress to give me the financial wherewithal to deal with the virus," Biden said Friday. "I'm committed to get 100 million shots in people's arms in the first 100 days."
B of A Research believes the Biden administration will pursue several policy goals, such as infrastructure expansion including green initiatives, as well as social goals such as access to healthcare and increased social and economic equality. The bank thinks that the Dems could inject $2-4 trillion in deficit spending with much of it frontloaded within the 10-yr budget window.
Moody’s is more cautious. The ratings firm notes that the Dems remain far short of the 60 votes needed to overcome the Senate's filibuster rules, which likely will limit the Biden administration’s ability to fully implement its policy agenda. While the Senate could change the filibuster rule, some Democrats have previously stated that they would oppose such a move. Moreover, maintaining unanimous party support on major bills may also prove challenging.
Accordingly, passage of meaningful legislation will still require bipartisan cooperation, although initiatives related to near and longer-term fiscal support or broader economic stimulus may now get more traction or could be passed by a simple majority in the Senate through the budget reconciliation process.
However, the Dems slight control in the Senate will help further Biden's agenda in that Democrats will be able to decide what bills make it to the floor of the chamber and to confirm the new administration's cabinet and judicial nominees more easily.
Challenges for the Biden Administration and the Fed:
Biden’s presidency will start in the context of fiscal deficits and debt levels at highs not seen since World War II. The federal budget deficit rose to $3.1 trillion in the fiscal year ending in September and that doesn’t include “off budget spending.” The 2020 budget deficit was more than triple the shortfall recorded in fiscal year 2019. The deficit in 2020 was equal to 14.9 percent of GDP, up from 4.6 percent in 2019 and 3.8 percent in 2018.
While fiscal policy will remain extremely accommodative as long as economic conditions are weak, the challenge for his administration will be how to phase out fiscal stimulus measures once the economy recovers.
The Federal Reserve is also faced with that challenge but seems likely to continue the never ending free money party and bubble blowing it’s done for well over a decade. The Fed is sounding content to put the onus on fiscal policy with Vice Chair Richard Clarida saying there would be no change soon to the $120 billion of debt the Fed is buying each month. Could the PONZI scheme of the Fed buying more of U.S. debt to fund multi-trillion-dollar budget deficits continue indefinitely?
Another challenge for the President and Congress is how to finance proposed spending priorities without further weakening the government's fiscal position in the short term. Can the US budget deficit increase to infinity without a collapse in the US dollar? Please see US Dollar section below.
One challenge over the medium term will be starting the process of stabilizing the rising debt trajectory. Additional challenges relate to the rising focus on issues related to social, racial and income inequality. The latter has risen to unimaginable levels with speculative markets enriching the already rich, while everyone else is struggling to survive financially. Inequality in employment opportunities and incomes has also risen steadily, especially during pandemic induced lockdowns where so many Americans are out of work or working far fewer hours than before.
Biden has put forward a number of proposals that focus on addressing underlying income and racial inequalities. These proposals include plans for expanded access to healthcare, earmarking federal funding for underserved communities, expanding housing assistance and affordable housing, and providing more education assistance for low-income individuals.
Fiscal Stimulus Impact on the US Dollar:
B of A Research says “the first order effect of a Democratic blue wave will be an acceleration in the pace of USD depreciation to begin in 2021. Accordingly, we expect a sharply weaker USD on the order of 2% over the next couple of weeks, bringing EUR/USD to our 1.25 year-end forecast quite quickly. In the medium run, the case for sustained USD weakness becomes much less clear and a rally more likely due to fiscally-driven better growth and potential worries over tax and regulatory shifts, in our view.”
The Curmudgeon believes that the Greenback’s “safe haven” status will come under pressure in the near term if Congress delivers additional trillion + dollar fiscal support package.
Dollar weakness in the intermediate term is less clear for B of A. “We expect a fiscally-driven higher US relative growth profile to provide fundamental support to the US dollar, particularly as the US curve steepens and US rates rise relative to the rest of the world (emphasis: the Euro Area).”
Also, the bank believes the rise in US Treasury interest rates will continue. B of A warned stimulus would further pressure the dollar and cause Fed tapering to begin later this year. The bank’s Mark Clarida wrote in a note to clients: “An early Fed taper creates upside risks to our year-end 1.5% 10-year Treasury target and supports our longer-term expectations for neutral rates moving towards 3%.”
A More Positive US Economic Outlook:
The prospect of additional aid from Congress under Democratic control has led economists to increase their GDP forecasts in 2021 to as high as 6 percent. That would be the fastest rate since the Reagan administration.
If Democrats can push through additional stimulus of about $1 trillion, it would add one or two percentage points to gross domestic product growth for all of 2021, depending on timing, said Michelle Meyer, head of U.S. economics at B of A. “That leaves us flirting close to 6 percent” growth for the year, Ms. Meyer said. “These are very large dollar amounts,” she added. Not too bad indeed!
Try to remember what we recited each morning as US school children: “I pledge allegiance to the flag of the United States of America and to the Republic for which it stands, one nation, (under God), indivisible, with liberty and justice for all."
Good health, stay calm, safe, persevere under stress, and till next time….
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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