Infrastructure spending has been the central growth theme of the Trump administration. Indeed, to the extent that Federal and local authorities implement a $1 trillion infrastructure program over the next decade, it will indeed help propel U.S. growth.
However, it seems to me that the market is rushing to discount such an outcome. And the reason is simple; even if such a program were to be implemented, it will not happen for several years.
To begin with, the government and local authorities first have to map out what infrastructure projects need to be implemented. Then, it has to be decided what the priorities are, because all projects can't be carried out at once. After that, a road map has to be drawn out for each project. And finally, financing has to be procured.
For example, just to upgrade JFK airport, it will take many months for planners, engineers, architects and others involved to come up with a final blueprint. After that, a budget has to be assigned to the project, and funding has to be procured.
We are talking about dozens of airports, hundreds of bridges, thousands of miles of roads, ports and every other type of infrastructure project you can imagine.
Before a single dime is spent on infrastructure, it will take several years to plan, coordinate and find funding. At best, even if President Trump and the U.S. Congress begin today, it might take 2-3 years (at best) before the market sees a dime in spending.
President Trump also says he will cut taxes. While I am all for it, the question is, where is the money for infrastructure going to come from then?
If the U.S. had the debt levels it did when Ronald Reagan came into office, the answer would be deficit spending. However, it's not 1981, but 2017. And the U.S. cannot go on a deficit spending spree.
With total U.S. debt at around 100% of GDP (75% if we take out intergovernmental lending), I think it will be very difficult for the federal government to deficit spend.
Then again, it depends on the dollar amount of the infrastructure spending. If we are talking about several hundred million over a period of 10 years, that's not a problem. If, however, the president has in mind several trillion over the course of the next decade, then it will be impossible for the federal government to undertake such an expense by deficit spending.
The idea of an infrastructure bank is indeed interesting, and will probably be a good way to fund projects. However, this will take time. And from what I understand, all these things will happen soon.
The Fed cannot unwind its balance sheet
Over the past several weeks, we have been hearing from Fed officials that it's time for the Fed to remove monetary accommodation and reduce the size of its balance sheet.
How exactly does the Fed propose doing this? I hope it thinks it can pull a rabbit out of the hat, because it will only happen with magic.
If the Fed started to unwind its balance sheet and the market realizes it, then the market will front-run the Fed. How, you ask? By massively selling U.S. government securities and every other fixed-income security under the sun.
This will increase the cost to service U.S. government debt, and that means less money for everything else.
The above chart depicts the cost of interest on U.S. debt. Currently, it stands at around $240 billion per year.
The above chart depicts the cost to service U.S. debt, which stands at around 1.3% of GDP. As you can see, it's been hovering around record lows for several years now. This despite the fact that total U.S. federal debt is at all-time record highs.
Don't get me wrong, the U.S. government can afford to pay a lot more than 1.3% of GDP to service its debt. However, the question is, what will the above chart look like if interest rates go up by a lot? Also, how will the U.S. government balance the increased cost to service debt with infrastructure spending?
Furthermore, how does all this fit in with the things President Trump has promised? Among other things, a Chinese wall along the border with Mexico, spending an additional $50 billion per year on the military (as if the U.S. is not spending enough already), infrastructure spending and lowering taxes on everyone.
Personally, I think the math does not add up in order for all these promises to be fulfilled. And if the market is betting on all the above fermenting, it is in for a big disappointment.
Deficit spending is possible with the help of the Fed
The only way the current U.S. administration can possibly make good on its election promises is to deficit-spend. However, how is this possible with debt at record levels, and with the Fed wanting to unwind its balance sheet at the same time?
The answer is, it isn't. That's why it is almost impossible for the Fed to unwind its balance sheet. Also, it will not raise rates much, as many think. With the Chinese and Japanese selling U.S. government securities for some time now, the only buyer of last resort might be the Fed.
In order for the U.S. to run sizable deficits for a long time, the interest paid on its debt has to be very low. The only way for this to happen is for the Fed to copy what the BoJ is doing. And that is, to target the rate of the 10Y government bond to 0%.
However, this involves the Fed further expanding its balance sheet, and not unwinding it. It also means U.S. federal debt will rise and not shrink, as many have hinted. This also means a much lower dollar in the long term.
There is no free lunch, as we all know, but the U.S. administration acts as if there is a free dinner. Most of the political rhetoric I have heard does not make sense, and especially, economic sense.
Furthermore, it takes an average 9 months for legislation to be passed into law in the U.S. How exactly is tax reform going to happen in several months? The answer is, it isn't.
While I do not doubt the U.S. needs infrastructure spending, or that it will happen, what I am saying is that it will not happen anytime soon. So, if the market is betting on infrastructure spending, or anything else on the president's spending list anytime soon, I think it will be disappointed.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.