The State Of The Economy And Fiscal Policy

by: John M. Mason
Summary

Recently released information supports the expectation that the federal deficit for fiscal 2019 will exceed $1.0 trillion, and is expected to climb in the future.

Most information points to the fact that the economy is not recovering sufficiently to generate government tax revenues that would cover the deficits as planned in December 2017 tax cuts.

The undisciplined use of debt, unless bailed out by inflation, can always come back to hurt you, and this is certainly a possibility in the current environment.

The Congressional Budget Office has confirmed what most everyone was expecting. The federal deficit is running at a pace that will reach more than $1.0 trillion in the current fiscal year.

The first three months of the fiscal 2019 saw that spending was $317 billion than revenue, for the year beginning October 2018. This was 41 percent higher than the same period last year.

One area of increasing revenues stood out: that was in revenues from tariffs. These were up by $8.0 billion from one year ago, an 83 percent increase.

The reduced tax rates coming from the December 2017 tax cuts actually resulted in a decline in tax revenues.

Corporate tax receipts dropped $9.0 billion or 15 percent.

Individual tax receipts fell by $17 billion or 4 percent.

So much for the tax cut paying off the deficit through economic growth. And, annual economic growth for 2018 is expected to come in around 3.0 percent, the highest yearly growth rate in the current recovery.

I have recently discussed the weakness in the argument that tax cuts can pay off the deficit from the revenues generated from higher future economic growth. The theory behind this policy argument is weak and there is little or no empirical evidence that this policy effort actually works.

I believe that we have seen pretty well the full effect of the December 2017 tax cuts on the economy. It seems as if the biggest beneficiary of these cuts went to shareholders and corporations used a lot of the released funds to buy back stock.

In terms of the economic growth of the country in the near term, I have more fully discussed this in my post from earlier this week.

I find one of the most convincing projection for economic growth in the US over this time period produced by the Federal Reserve System. Federal Reserve officials are projecting a rate of growth in the US economy in 2019 to be around 2.3 percent. For 2020, the forecast is for 2.0 percent annual growth dropping to 1.8 percent the following year.

The basic reason for this slower growth is that the supply side of the economy is dominating all other factors, including demand factors. Unemployment is at a level economists call “full employment” and at the lowest level seen for fifty years. Any higher growth rates would require a substantial increase in the labor force participation rate or a turnaround is the falling rate of growth of labor productivity. Major increases in these measures are not expected.

A further drain on the government’s budget is that interest costs are rising. For the first quarter of fiscal 2019, interest costs on the debt increased by $16.0 billion, a 19.0 percent rise. Just in December alone, interest costs were up by 47.0 percent from December 2017.

These are not good signs and are expected to get much worse as the deficits increase and/or if interest rates were to rise.

It appears as if things will become a lot worse before they get better.

Debt can always come back to hurt you especially if you don’t have an inflationary environment to bail you out.

For most of the latter part of the twentieth century, 1970 on, issuers of debt experienced an extended period of credit inflation with bailed out many, many debt issuers, especially those working in the real estate area. Oh, there were periods when some particularly excessive users of debt got caught, but by-and-large, credit inflation set the tone for the economy.

We seem to be caught in a different position now. Inflationary expectations seem to have become deflated over the past several months, apparently tied, to some degree, to the declines in the price of oil toward the end of the year.

As I have written many times recently, that the inflationary expectations built into the bond markets have dropped into the 1.70 percent to 1.80 percent range for the 10-year time horizon. Not long ago, these inflationary expectations were around 2.10 percent or slightly above.

And, the current numbers are even below the target level of inflation of 2.0 percent that the Federal Reserve is using.

If inflation does remain at these levels, the government debt burden is only going to grow.

But, as some have suggested, the future debt problems will be someone else's concern.

Or, not.

That is the concern. This summer the economic recovery will become the longest in post-World War II, United States history. The recovery may continue for another year or so, but it is still one of the weakest recoveries experienced.

There are two immediate policy concerns. One, if the federal deficit is increasing at this time, how can the government create even greater deficits if the economy does slow down or tank.

Second, the Federal Reserve has been raising short-term interest rates, but they are still relatively low historically. And, the Fed’s securities portfolio is huge. How much ammunition does the Fed have to work against an economic slowdown…or worse.

Finally, world economic growth seems to be slowing and this too can impact the US economy in a big way. For example, this morning we read about how Germany's slowdown raises eurozone fears. Further slowing in the global economy is not going to help the US carry its debt load.

My experience as a banker and financial consultant is that the undisciplined use of debt more often than not comes back to haunt you, especially if you don’t have an inflationary environment to bail you out.

This seems to me to be the condition that now exists in the United States.

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.