Goldman Warns On U.S. Fiscal Policy: ‘We Are Heading Into Uncharted Territory’

The reviews on Donald Trump’s ill-timed and ill-conceived fiscal stimulus just keep coming in and they are not, as Trump would have it, “tremendous.”

We’ve spent all kinds of time documenting why piling fiscal stimulus atop an overheating economy is a bad idea. We’ve also gone to great lengths to explain why that is especially precarious at a time when the Fed is attempting to run down its balance sheet and when a combination of factors (including, by the way, misguided trade policies) are conspiring to weigh on foreign demand for U.S. debt.

You can read our most recent take on this in “‘Is Nobody Gonna Tell Him?’ MAGA And The Pedal To The Metal Economy“, but suffice to say he risks pulling forward the end of cycle and forcing Jerome Powell to accelerate the hiking cycle which could in turn destabilize markets that are depending on a gradualistic pace of monetary policy normalization.

Well, Goldman is out with a new piece called “What’s Wrong With Fiscal Policy?” and again, “the reviews” Trump’s getting are not any semblance of “tremendous”.

“Federal fiscal policy is entering uncharted territory [as] Congress has voted twice in the last two months to substantially expand the budget deficit despite an already elevated debt level and an economy that shows no need for additional fiscal stimulus,” Goldman writes, adding that “while most of the recent fiscal expansion has not come as a surprise to us, this nevertheless raises new questions about the plan for US fiscal policy.”

Right. And see that just underscores what everyone ends up saying about this administration no matter what they’re talking about. It always starts out like this: “It doesn’t come as a complete surprise, but…”

Goldman goes on to note that “US fiscal policy is on an unusual course.” Here’s the projected deficit and debt-to-GDP ratio:

And here’s Goldman explaining what’s so unusual about this:

This stands in contrast to the typical relationship between the economic cycle and the budget balance, as shown in Exhibit 2. The result is a cyclically adjusted budget balance that we project to be wider over the next few years than at any time over the last 50 years with the exception of the 2009-2012 period following the financial crisis. In our view, this gap is driven by a combination of longer-term factors as well as the recently enacted tax cuts and spending increases.

As noted there, Goldman attributes this to a variety factors, but spending increases and the tax cuts are among the culprits.

Gary Cohn and Steve Mnuchin’s old employer goes on to note that interest expense is likely to rise sharply over the next eight years although Goldman does remind you that “the US has historically benefited from a negative rate-growth differential, which has allowed the federal government to run a modest primary deficit on average without increasing the debt/GDP ratio.”

Goldman goes on to compare what’s going on in the U.S. to other examples of similar scenarios witnessed abroad. They have to do that because an apples-to-apples comparison isn’t possible by virtue of the fact that Goldman is “unaware of any period in the last several decades when the US cyclically adjusted primary deficit expanded as we expect it to at the same time that the debt load had already been growing, as appears likely now, except for periods in or near recessions.” Here are some historical examples from around the world:

And then it gets really fun when Goldman breaks out the outlier charts. “While there are some comparable examples from the past, the US looks like more of an outlier at the moment compared with other developed economies, as shown in Exhibit 10,” the bank writes. Here is Exhibit 10:

But the best chart of all comes when Goldman shows you what’s about to happen in terms of interest expense relative to debt level if we stay on the current course. To wit:

The US also appears to be headed into uncharted territory–at least for US fiscal policy–regarding the relationship between interest expense and the debt level. As shown in Exhibit 11, interest expense considerably exceeded the current level during the late 1980s and early 1990s, though the debt level was moderate. By contrast, the debt level was slightly higher during and just after World War II than it is today, while the level of interest expense was similar. However, we project that, if Congress continues to extend existing policies, including the recently enacted tax and spending legislation, federal debt will slightly exceed 100% of GDP and interest expense will rise to around 3.5% of GDP, putting the US in a worse fiscal position than the experience of the 1940s or 1990s.

You get the idea. And of course, this is all in the service of short-term gains at the expense of long run sustainability. As Goldman concludes, “overall, we now expect fiscal policy to boost growth by 0.7pp in 2018 and 0.6pp in 2019 on a Q4/Q4 basis, however, we anticipate that the growth effects will fade later in 2019 and turn slightly negative by 2020.”

Note that last bit: “turn slightly negative by 2020.” Now recall what we said in a piece for Dealbreaker earlier this month:

The problem here is glaringly obvious. Steady-as-she-goes growth is not only not acceptable under MAGA, it’s explicitly forbidden. There is nothing “great again” about growth that’s less spectacular than it’s been in the past. Growth that’s lower than yesteryear is the exact opposite of “great again” if you equate “great” with growth.

So come hell or high deficits, Trump is going to restore that bygone era of American “greatness” and in his Simple Jack world, that’s as “easy” as tax cuts and fiscal stimulus. And you know, if we weren’t where we are in terms of the cycle and we weren’t nearing what certainly looks like a peak in economic momentum, that might be fine. But we are where we are and so what he’s doing is going to juice things further in the short-run at the expense of the medium- and long-term.

Of course that may make sense for Trump, because at this point, he probably figures that by the time the chickens come home to roost in 2020, he’ll either be in prison or hiding in a cottage outside of St. Petersburg under the protection of the Kremlin.

Nothing further.

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