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Let’s talk about markets

US budget wars ahead

John Redwood, Charles Stanley's Chief Global Economist, looks at the implications of Donald Trump’s new budget.

US Budget Wars

John Redwood

in Let’s talk about markets


President Trump’s budget proposals are, in part, political theatre designed to evoke criticism and complaint from the Democrats in Congress. The continued search for money for his Mexican wall is just the most provocative in a package which also include substantial cuts in non -defence programmes beloved of the Democrats. As we have seen before, the President proposes cuts to spending the Democrats will not accept, in order to blame them for the subsequent compromise which will boost the deficit and lead to more borrowing. President Trump will claim to his fiscal conservatives he tried to keep the deficit tight by restraint on spending, only to have that blown away by Democrat profligacy and intransigence.

For their part the Democrats will counter by saying Mr Trump could reverse his tax cuts to try to collect more revenue, and he could cut defence spending instead of non-defence. The two sides do not agree at all about the impact of the tax cuts. The Republicans claim lower tax rates will lead to increased revenues, as they will stimulate a faster rate of growth. They fear higher taxes from the Democrats would damage the US economy. This disagreement is part of the clash of forecasts, with the White House anticipating faster growth and lower deficits than the more cautious and now Democrat-influenced Congressional Office of the Budget. For 2019, Congress forecasts 2.4% growth and the White House 3.2%. For 2020, the White House is on 3.1% and the Congressional Budget Office on just 1.8%. The White House looks forward to a US economy with $22.54 trillion of GDP in 2020, whilst the Congress Office expects only $22.24 trillion.

The construction of a budget is not just complicated by the dislike and different views between the two parties. It is also an intricate legal battle over the enforcement of two budget laws, the Budget Control Act of 2011 and the Debt Ceiling. At various times in the past, Congress has tried to impose limits on itself and future Presidents by limiting the amount the US can borrow and by requiring cuts in expenditures in future years. Congress is then forced to debate these matters under the cosh of needing to amend its own past law, as it regularly does. The bipartisan Budget Act of 2018 and the Consolidated Appropriations Act of 2018 duly raised the limits placed by the 2011 legislation on spending, but only for 2018 and 2019. The President persuaded the Congress to allow a large increase in defence spending, taking it up to $647bn for discretionary defence spend in 2019. The Budget Control Act requires that to be cut to just $576bn for 2020. The Debt Ceiling has been re-imposed after a period of suspension, so is rebased to the current gross level of $22 trillion. The Congress Budget Office forecast an average federal deficit of 4.4% of GDP up to 2029, requiring substantial increases in debt above the ceiling.

The scene is set for another row between a Democrat-led House of Representatives and the President. They will disagree over the forecasts of how big the deficit will become. The President will demand a much larger defence budget than the Democrats favour, and the Democrats will demand much more spending on everything else other than walls than the President proposes. They may well disagree over how big a change to make to the permitted amount of debt and to the permitted amount of spending under past control legislation. They will need to reach an agreement because neither side will get its spending wishes without legislation to permit the bigger spend, the larger deficit and the increased borrowing.

It is tempting to assume the same will happen this year as before. There will be a row, maybe a few stand offs and difficult times, threats of government close downs, but in the end the compromise will mean more spending on both defence and non-defence, and more borrowing. The long-term forecasts from the worried Congress Office of the Budget do not make good reading. With low economic growth estimates they see federal spending going up from the long-term average of 20.3% of GDP to 23% by 2029, with a surge in debt levels. Even on very optimistic White House assumptions about growth, there will be a big debt build-up. The White House forecasts $5 trillion extra borrowing in the period 2019-23.

There is the risk that it will not be that easy. We are entering a more bitter political period, as President Trump gets ready for the long run up to a possible re-election, and as the Democrats decide how to use their newly-acquired power in charge of the House of Representatives. In the field of the Budget, Congress has plenty of leverage, as it is needed to legislate for whatever is agreed. The Democrats are struggling to find a Presidential candidate, and are subject to allegations about anti-Semitism as their party argues amongst itself about how far left their policy pitch should be. The Republicans are living with President Trump, though many in Congress have misgivings about him and his style of government. They have their own internal divisions between fiscal conservatives, big spenders on an enhanced military and tax cutters.

It seems likely that in the end there will be compromise around spending and borrowing. It is also likely the President is too optimistic with his economic forecasts and the Democrats too pessimistic. Getting to these conclusions, however, may be a bruising experience with down days in markets when a lack of progress rings alarm bells.

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