US Economy Can Handle Trump Budget Deficits

US Economy Can Handle Trump Budget Deficits

US Economy Can Handle Trump Budget Deficits

The US economy can handle the trillion-dollar deficits that are forecast to result from President Trump’s budget proposal released Monday.

“The deficit is going to be 5.5% of GDP for FY 2019. Over 10 years, it’s going to average about 3.5% ,” economist Larry Kudlow said pointing out that the deficit’s portion of economic output will be smaller than it was during the financial crisis and parts of the Reagan era. “In the Reagan years, we ran 6% to finance tax cuts and military spending. I wouldn’t panic over that.”

Deficits are project to grow $7-T over the next 10 years as the United States keeps borrowing money. That number could double if the economy is weaker than forecast, which grows more likely if historical trends on recession and recovery are any guide, or if the $3-T in spending cuts the White House seeks don’t materialize in Congress.

“There’s a lot of tough stuff in the Trump budget that’s probably not going to pass. They are going after large and small entitlements,” Mr. Kudlow said, pointing to food stamps programs that are intended to help poor families.

“The worst part of this was the 2-year deal. The Trump budget’s not so bad, but has to incorporate the 2-year deal which was very bad. That was $300-B, broke the caps, broke the sequester and all the rest of it.”

One concern about the deficits is the effect on interest rates, especially if bond markets are flooded with a massive supply of new debt that cannot find ready buyers. The supply may pressure bond prices, which has the inverse effect of pushing up interest rates.

Plus, the US Treasury will not be able to depend on the Federal Reserve to buy up that debt on the open market, as it did with its QE (quantitative easing) programs after the Y 2008 financial crisis. The central bank bought trillions of dollars in government and mortgage debt to lower borrowing costs and urge businesses and consumers to spend.

“I do not think deficits have much impact at all on interest rates. I don’t think that’s ever been proven,” Mr. Kudlow said. “You’re talking about a global economy with $200 trillion in savings floating around.”

He does forecast that interest rates will go up, mostly because the US economy is going to get stronger following President Trump’s tax reforms that were intended to promote growth. The yield on the 10-year T-Note is likely rise to 3.5% from the current mark at 2.83%.

“One way of looking at it is this: You’re investing in the economy,” Mr. Kudlow said. “The tax cut is an enormous investment in a stronger economy. The military investment is also an investment in our national security, which we need. In that sense, growth is going to rise, and over time, this whole deficit picture is going to look much, much better.”

Stay tuned…

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