IN FAVOUR:

The United States is once again approaching a debt ceiling that, as before, will likely be raised again. However, when Trump’s budget director, Mick Mulvaney, says the country’s $20 trillion debt is a “national crisis,” he is right. At a rate of more than $500 billion a year in deficits, the risk to the economy increases and the likelihood of increased taxes soars. Meanwhile, the failed policies of the past have cut potential growth, jobs and middle class wealth (read here).

The Obama administration doubled the country’s debt despite the largest monetary stimulus in history. Interestingly, in 2008, Obama himself said that having increased debt by four trillion in eight years was “irresponsible” and “unpatriotic” (see video here ). Now, the administration needs to make tough decisions. As we have already explained, Rex Tillerson is already taking measures to slash the “Deep State” (a parallel administration, almost a shadow government, created in recent years). Mulvaney’s budget plan follows the same principle, and is especially focused on cutting political spending.

What is political spending? All those programs that follow an ideological or political agenda, as well as programs that could be financed entirely by the private sector but politicians prefer to manage themselves, to accumulate power. Many of these items are hidden under “unquestionable” areas like education or healthcare. Mulvaney’s budget leaves no stone unturned and aims to cut everywhere.

If you read Mulvaney’s budget  without paying attention to the details, it would be easy -and wrong- to attack it. “It raises military spending, cuts education and environmental programs”, would be the simplistic analysis. The reality is very different.

The principles that inform this budget plan are “sound money” and “the State should take care of security, and little more”, things that the members of the current administration have always defended, even before they were appointed.

As such, in the face of another debt crisis, the Trump administration aims to carry out the largest budget cuts in US history while keeping essential services.

The 10% increase in defense is unquestionable, and some have criticized it. Nobody that understands the complex security risks faced by the US has questioned it, though. Yes, the US has an enormous defense budget. And keeping the country safe demands it. By the way, it would be smaller if the rest of the Western countries contributed their fair share, but that is a different matter. Moreover, the increase in Defense is exactly what Trump promised during his campaign. $54 billion, or a 10% increase, to combat ISIS and regain the US military position in the world. It may be debatable, but it is exactly what the electorate, military experts, the GOP and Trump supporters demand. In fact, even some Republican critics consider the increase as too small. Increasing aid to veterans by 10% ($ 5.3 billion) and national security by 6.8% is simply a matter of justice to the ones who have served, and logic, considering the threat of terrorism.

But there is something more important. Mulvaney’s budget plan seeks to meet those goals without increasing the deficit. This is a critical difference to all previous budget plans of the past thirty years.

Let us take a look at the largest cuts in US history since Ronald Reagan:

Health. The biggest cuts, $ 15.1 billion, focus on two items, the National Institute of Health and the Office of Community Services, which are not finalist expenses, and have been often criticized – even by some Democrats -. It only eliminates discretionary spending, not the mandatory items. as such, the provision of services is guaranteed.

Department of State. $10.9 billion less to finance conferences and discretionary spending on “Climate Change” which had rocketed in the last eight years, and have no real impact on clean energy or the environment. An item most would agree with is an aggressive cut of funding to the World Bank, which is often regarded as a dinosaur political entity. No one can deny that diverting taxpayer’s funds from parallel administration, doubtful initiatives on climate change and the World Bank to defense is a logical decision, considering the urgent needs of the country and the economy.

Education. Reducing 13.5% without affecting the Pell Grant program that gives scholarships to people with financial difficulties. This eliminates 20 programs and grants that can and should be funded by the private sector.

Housing and Urban Development. A 13% cut in low priority grants, which even Democrats have criticized, such as the Home Investment Partnerships Program. Again, the idea is that these programs can be financed from public-private collaboration, without resorting to taxpayer money, thanks to the forthcoming tax deductions.

Agriculture, Labor, Transportation and Energy have a cut of subsidies of 20.7%, 21%, 12.7% and 5.7% respectively. All subsidies that interfere with each State’s affairs are eliminated and those that generate excessive bureaucracy, inefficiency, or duplicity are cut off. It includes eliminating investment in transportation or energy that should be financed by the private sector via tax cuts, not with more public spending.

Commerce is reduced by 15.7% consolidating statistical agencies into other federal ones, and eliminating subsidies. Interior gets 11.7% less, including subsidies to abandoned mines, or purchase of land for public purposes. Justice gets 3.8% less in subsidies, but an increase in personnel and resources. Treasury sees a cut of 4.1% in staff, but sees an increase in resources for the Treasury secretary to eliminate public bailouts. Finally, reducing the EPA budget by 20% is essential to achieve energy independence, cut red tape and eliminate politically motivated programs.

​​Mulvaney’s budget plan is that the programs that can be financed by private initiative, do so without resorting to tax increases.

It is clear that this budget’s goal is to eliminate subsidies and discretionary spending. Eliminating subsidies limits the power of politicians, who must seek other alternatives to finance such programs without assaulting the pockets of taxpayers.

This plan seeks to maintain quality and service maintaing mandatory spendings. Let us face it, after constant budget increases in the past years, a 10% cut is not massive.

During Obama’s mandate, Federal outlays increased more than $1 trillion while there were more than $1.5 trillion in new taxes. This budget plan seeks to eliminate the “parallel administration” that generates billions of dollars of spending simply from existing and perpetuating itself.

You can say that savings could also be achieved in defense, and the idea is precisely to enter into a process of savings – among others in hiring and greater competition between suppliers -, while recovering the lost ground.

Reducing bureaucracy and unnecessary regulation, limiting political power and eliminating duplicate or political expenses, to put more money into the citizen’s pocket should never be bad news.

There are many positive things in this budget plan, and the purpose of this article is to focus on them. It does not increase the deficit, seeks savings in duplicities and useless subsidies, eliminates programs with noeffective content and ends clientelistic networks of some international agencies. All this is done without reducing essential expenditure, maintaining public service.

In today’s world, there are two ways of looking at a government budget. As an ever expanding thing that constantly requires a higher tax burden, or a prioritized plan to use less tax funds. Taking money out of citizen’s pockets or allowing people to keep more of their own money.

I, personally, applaud the titanic effort made by Mick Mulvaney and his team trying to achieve a balanced budget and focus on the efficient use of taxpayer’s hard-earned money. We’ll see if they let him carry it out. Returning to money printing and massive deficit spending would only hurt the US more than it has already done.

Daniel Lacalle is a PhD in Economics and author of Life In The Financial Markets, The Energy World Is Flat (Wiley) and Escape from the Central Bank Trap (BEP).

THE OPPOSING VIEW:

“On Thursday morning, President Donald Trump unveiled his preliminary discretionary budget for the fiscal year of 2018. His budget director Mick Mulvaney made clear that the proposed budget does not balance the budget but merely reallocates resources in accordance to the administrations priorities.

Most striking is the $54 billion surge in defense spending already announced earlier. While it is not yet clear how these funds will be allocated, Republican lawmakers, most notable Senator John  McCain, have vented their anger with the  insufficiency of the increase. For most outside observers US defense spending has reached a simply irrational level.

Not only does the US lack immediate military threats that could not be countered with current capabilities, but it also already possesses a defense budget larger than that of the following seven countries combined (of which five are allies). Interestingly, America’s long-term adversary Russia has just announced a massive military budget cut of 25%. If the US military truly is in a bad state, it would be a matter of inefficiency and mismanagement, not of underfunding.

Throughout his campaign, President Trump has slammed past foreign interventions and prompted most of America´s allies to take on more responsibility for their own security. So what is the real purpose of this drastic increase in military expenditure?

In fact, it marks a new dimension of US military keynesianism, which has been practiced by administrations of both parties. Trump has constantly badmouthed the state of the US armed forces to suggest the necessity of a massive increase in military investments.

With this economic policy, Trump can stimulate economic demand and create jobs throughout the military complex. While the majority of Republican lawmakers oppose non-military keynesianism, military deficit spending is always approved due to the close entanglement of the GOP and the defense industry.

To finance this policy, Trump has proposed to cut positions in the budget which are both more relevant to American security and also promise higher returns in the long-run.

The World Economic Forum’s Global Risk Report 2017 for instance sees extreme weather conditions as the number one global risk in terms of likelihood and number two risk in terms of impact. Moreover, it estimates the potential costs of climate change for investors upwards of $2.5 trillion. Nevertheless, the administration has drastically eliminated funding for both national and international programs on climate research.

Global epidemics such as the Zika virus are equally considered as amongst the biggest threats to international security today. However, Trump’s proposed 19% budget cut to the National Institute of Health (NIH) as well as cuts to international health cooperation programs and health institutions could undermine the US’ capability to adequately react to an outbreak.

The NIH is also key to developing treatments for cancer, Alzheimer, obesity and other common diseases. Investing into health research rather than slashing it would be a promising policy to counter the exploding costs in the US health care system.

Notable is also the drastic cut in the state department budget, which besides foreign aid mainly affects funding for international organizations. The administration has a point when arguing that the US has disproportionately contributed to programs and the budget of the UN and related organizations. To demand a fairer burden sharing is therefore absolutely legitimate. However, simply abandoning current obligations instead of renegotiating budget contributions puts many international programs of peace-keeping and poverty reduction at risk”.

Daniel Reinhardt is a Communication and Project Manager at The Club of Rome

Image courtesy of FRED

Published by @Hedgeye (here)

The biggest bubble in financial history is about to end. With rate hikes, a stronger dollar and the return of inflation, bond inflows are normalizing, sell-off in negative yield fixed incme continues, and real rates increase despite central planners’ financial repression.High

High-yield bond funds saw their biggest outflows since December 2014 last week, as investors withdrew $5.7bn , according to EPFR Global.

Meanwhile, the total value of negative-yielding sovereign bonds fell to $8.6 trillion as of March 1 from $9.1 trillion at the end of 2016.

Three factors are helping the burst of the bond bubble:

. The price of oil falling to three-month lows on the evidence of the ineffectiveness of OPEC cuts, a record increase in inventories and a stronger dollar is helping to reduce the thirst for high-yield.

. A strong “America First” policy needs a stronger US dollar. The US economy benefits from a strong dollar and rising rates, not the other way around. Believing that the US needs to weaken its currency is a fallacy repeated by mainstream economists. The US exports are relatively small, about 13% of its GDP, and its citizens have 80% of their wealth in deposits. The new administration knows it. They are their voters. The only ones that benefit from a weak dollar and low rates are bubbles, indebted and inefficient sectors. If a rise in rates of 0.25% negatively impacts a part of the economy, after more than 600 rate cuts, it means that such part of the economy is unsustainable. Increasing rates is essential to limit the exponential growth of bubbles and excesses.

. The European Central Bank. The placebo effect of ECB policy has already passed. With more than € 1.3 trillion in excess liquidity and a dangerous environment where economic agents have become “used” to unsustainable rates to perpetuate low productivity sectors, it is inevitable that the central bank will begin to unwind its Monetary laughing gas sooner rather than later.

That dollar strength and US rate hikes, reinforced by the Trump administration’s capital repatriation policy, is exactly what the country needs if it really wants to “make America great again.” If you destroy the middle class with financial repression, you will not only lose its political support, but the policy will not work either.

Strong dollar, normalized rates and repatriation of capital create the vacuum effect. Higher demand for dollars is triggered and the attractiveness of low yield bonds outside the US is reduced.

… In Europe, we are not prepared for the bond bubble to deflate.

The vacuum effect can mean a loss of up to a $100 billion just from repatriations. If the top five technology companies repatriated half of their cash back to the US, it would mean more than $240 billion leaving the rest of the world and returning to the US.

But, moreover, rate hikes make it less attractive for investors to buy bonds from European and emerging countries.

At the moment, growth prospects in the Eurozone, and the US-European inflation differential keep the flow of investment in the European Union because in real terms it still offers a decent mix of risk and profitability. But the Eurozone has a problem when governments have to refinance more than a trillion euros and have become used to spending elsewhere the “savings” in interest expenses achieved due to artificially low rates.

Those savings have already been spent, and when rates rise, and it will happen, many countries do not seem to be sufficiently prepared. Same with many companies. The rise in inflation and rates, which has given some breathing air to banks, holds another side of the coin. Non-performing loans have not been adequately cleaned, and remain above 900 billion euro in the European financial system. Banks do not have enough capital cushion to undertake the deep provisions that would entail cleaning up such a hole and have relied on the recovery to try to sell these loans. The improvement in NIM (net income margin) coming from inflation and a rate increase does not compensate for the increase in NPLs and their provisions. A rate hike of 0.25% means an increase in NIMs of 17% for Eurozone banks, but the clean-up of NPLs would completely wipe out that benefit.

The European Central Bank should analyze the risk of fragility. Because it has not been reduced.

Europe continues to suffer from three factors: Industrial overcapacity, high indebtedness and excessive weight in the economy of low productivity sectors.

These sectors -industrial conglomerates, construction- have absorbed most of the new credit. The ECB and governments were too obsessed with increasing credit to the economy to worry about where that credit was going to. When Eurozone economies and companies are afraid of the impact of a hike of just 0.25%, it means we have a problem – really big.

Do you have a business? Are you prepared to pay 1-2% more for your financing in the next five years? Yes? Congratulations. You have nothing to worry about.

Do you have a variable rate mortgage? Are you prepared to pay a few hundred euros more per year in the next few years? Yes? You have no problem.

Do you have a country where net financing needs are going to continue to fall as rates rise? Yes? Congratulations, you are fine.

Do you think that the ECB will have to keep or lower rates because everyone is so entrapped that it needs to be more dovish? I wish you luck.

The big mistake of central banks has been to create bubbles, then deny them, and afterward try to perpetuate them with the same policy that created the initial problem. Lowering rates and increasing liquidity has been the only policy.

Now central banks face a new US administration that sees currency wars and beggar-thy-neighbor policies as what they are, assaults on the middle class. Financial repression did not work in the past, and failing to adapt economies to normalized rates is dangerous.

Investors should really pay attention because real and nominal losses are more than evident in bond portfolios. 

Daniel Lacalle, PhD, economist and author of Life In The Financial Markets, The Energy World Is Flat )Wiley) and Escape from the Central Bank Trap (BEP)

Image courtesy of Google Images.

If you read articles and books about the crisis, I am sure you will find a common denominator about the main cause, at least in mainstream press “Taking an excessive risk”. And it is partially correct. But, on many occasions, commentators fail to explain why this happens. Why changes in our brain that takes us from a natural cautious attitude to diving into excess?

The widespread perception that risk does not exist.

And how can this absurd idea be generated in the collective subconscious? It cannot come from any other source than from the government’s monetary and fiscal policy. A “take more risk, I will limit it” message. And that’s just the spark. All economic agents feed the fire and participate in the creation of a bubble, while the accumulation of risk is multiplied by the confirmation bias. “Everyone says so.”

Mainstream studies will devote entire books to explaining why manipulating the cost and amount of money is not a problem. Families, businesses, banks, governments, and agencies will mutually convince each other that nothing can fail, because “everyone” accepts that “this is a new paradigm”, endless explanations to deny evidence and logic.

Rates are artificially reduced from five percent to one percent and a global crisis is generated? Let’s lower them from one to zero, or better, negative. It will surely work. Does the credit and money supply expand disproportionately? Obviously, the solution should be to “flow credit” and increase the money supply, of course.

Do credit and money supply expand disproportionately? Obviously, the solution should be to “ease access to credit” and increase the money supply, of course.

If tens of thousands of pages of regulation could prevent crises, these would not exist.

The publication Ten Thousand Commandments analyzed, for twenty-five years, the accumulation of regulation. According to their analysis, there has been a new federal regulatory measure every two hours and nine minutes-24 hours a day, 365 days a year, for the past twenty years. About 81,000 pages per year, only in the US.

It is estimated that before the crisis the European Union generated an average of 4,500 rules and regulations for the financial sector each year. Only the Fédération Européenne des Conseils et Intermédiaires Financiers (FECIF) received 500 pages a month.

Regulators tried to compensate basic imbalances with tons of paper without addressing the root of the problem.

There is no way to avoid a crisis by adding rules and regulations while at the same time manipulating the quantity and price of money by injecting huge amounts of liquidity and lowering rates more than six hundred times.

A crisis is not avoided by setting maximum bankers’ salaries if perverse incentives are imposed by others that benefit from a system of privilege in credit and access to liquidity. Governments.

Regulators and legislators, by definition, are magnificently equipped to avoid the crisis that just happened, not the next. And we find ourselves in that same situation today. Because regulation, unfortunately, does not attack the origin of the problem. Financial repression as an instrument to artificially “force growth.”

Interest rates have been cut more than six hundred times in recent years. Zero or negative rates do not reduce risk, they increase it. If you really think that Alan Greenspan was evil for lowering rates to one percent, yet Bernanke or Yellen are saviors lowering them to zero, you have a diagnosis problem.

If you think that with Greenspan there was no regulation and that today everything is under control, you are seriously uninformed.

If you believe the fallacy that Trichet “created” the European crisis by raising interest rates to -oh, the calamity- 1.5%, you have a case of bubble behavior.

If you believe that there is a crisis because the financial system creates money artificially and that the solution is that money continues to be artificially created, but only by the government, allow me to sell you the New York Statue of Liberty at an exceptional price, just for you.

But there are more important risks.

There are no laws or regulations that control the risk generated by the institutionalized fallacy that “public debt is not at risk.” And that ridiculousness is, for example, the pillar of the European Union. This affects bank balance sheets, the composition of pension plans and the perception of all economic agents.

Preparing to avoid the previous crisis does not solve the next. Crises are always generated in assets that we consider of extremely low risk.

It is impossible to accumulate disproportionate risk unless economic agents, governments, and central banks think that such risk does not exist. Hence real estate bubbles, allegedly low-risk bonds, “guaranteed” technologies, “bullet-proof” infrastructures, “risk-free” subsidized public companies …

Of course, you can say that the financial system creates complex products that can be very risky. But the root of those time bombs is always found in ideas like “house prices never go down,” “the government guarantees it” or “long-term, everything goes up.”

Regulation never supplements financial culture. And even financial culture does not prevent some mistakes.

Financial repression is creating the basis for the next crisis. Are you not terrified to see that governments, companies, and families accept negative rates? Are you not scared to see money supply grow twice as much as nominal growth?

Thousands of pages with thousands of rules will not prevent the creation of an excessive risk accumulation… when rates are NEGATIVE!

Does that mean there should be no regulation? Not at all. Regulation should be effective, simple, easy to implement, understandable, direct and, above all, to facilitate economic activity without trying to cover every aspect and prevent any risk, because it ends up achieving nothing and preventing less.

In the US the Republican party is already in the process of forcing the Federal Reserve to follow a Taylor Rule to avoid continuing to perpetuate bubbles , but much more is needed.

I’m going to break a spear in favor of the regulators. They work with what is in front of them and do what is required of them. It is not they who dictate monetary or fiscal policy. I remember a conversation with a good friend of a regulatory body who, before the launch of the last mega stimulus, told me “let us see now how we contain this tidal wave.” “You cannot,” I said. And they could not.

When the imbalance generated by the madness of monetary laughing gas, they will tell us again that it was a problem of “lack of regulation”. And that the solution is to repeat the same imbalances with ten thousand more pages of rules.

The best regulation is to stop believing that two plus two equals twenty-two.

Daniel Lacalle. PhD in Economics and author of “Life in the Financial Markets”, “The Energy World Is Flat” (Wiley) and forthcoming “Escape from the Central Bank Trap”.

Image courtesy Google.