UCLA Forecast: Get Ready for Trumpnomics Year II
Written by Peter Strauss
Iconic Investments attended the March 2018 UCLA Economic Forecast: Trade, Taxes and Trump, a look forward to the second year of the Trump presidency. The main topics discussed at this forecast were the potential effects of a trade war as a result of higher tariffs, Trump tax cuts in a booming economy, and rising interest rates.
UCLA Economist David Shulman (National Forecast)
According to Shulman, the turbulence that we see in the stock market is what economists call “regime change.” The world that we have been accustomed to for the last nine years following the 2008 financial crisis — slow growth, low inflation, low interest rates — is over. We are moving into a world of faster growth initially, as a result of tax cuts and spending, toward higher interest rates and higher inflation.
Trump’s policies to cut $1.5 trillion in taxes over the next 10 years, along with a $300 billion increase in federal spending, is a fiscal gamble, Shulman said. The economy is already “running hot” and at full employment. Shulman made this analogy about Trump’s fiscal gamble. “You may gain speed in your car. Everything is going o.k. . . . when all of a sudden your car begins to overheat. You then run the risk of blowing a gasket. All of a sudden your car goes off the road.” Overheating will put pressure on the Fed to raise interest rates at a faster pace. Shulman predicts the Fed will raise interest rates four times in 2018, despite Federal Reserve Chairman Jerome Powell saying the Fed will raise rates three times in 2018. We are going from a moderate fiscal policy to an all-out fiscal policy.
The financial markets are beginning to recognize that higher inflation and interest rates are imminent, especially in the bond market. Shulman revised his December forecast to: Sunny in 2018, cloudy in 2019 and rain in 2020. The prediction is that the economy will begin to slow in 2019 and into 2020.
The fiscal deficit is increasing from $600 billion in 2017 to $800 billion in 2018 and $1.1 trillion in 2019 and onwards. To pay for the increased deficits, the treasury will double the number of bonds they issue, while the Federal Reserve is normalizing its balance sheet at the same time. Inflation won’t be the only cause for upward pressure on interest rates. Supply and demand of additional bonds will be another reason why interest rates increase. More bonds, more supply, more alternatives to investments like real estate.
GDP GROWTH FORECAST
2018 - 3% range 2019 - 2.25% range 2020 - 1% range (problem with car overheating)
UNEMPLOYMENT FORECAST: Dropping to 3.5% in 2018 and continuing into 2019
CALIFORNIA UNEMPLOYMENT
2018 - 4.5% 2019 - 4.2% 2020 - 4.3%
UCLA Economist Ed Leamer (Twin Deficits)
Leamer discussed the concept of twin deficits and whether trade tariffs will reduce the federal deficit. Currently, the U.S. Government has a deficit of $800 billion per year, meaning it spends $800 billion dollars more than it takes in. Relative to GDP, the federal debt is at 105%, which isn’t currently alarming.
The twin deficit theory is that there are two deficits: 1) the Federal deficit and 2) the external deficit. To fund the fiscal deficit, the U.S. needs to borrow money from foreign sources, thereby creating a larger external deficit. Trump’s tax plan to reduce corporate taxes will increase the fiscal deficit to $1.1 trillion per year. This will be financed by issuing treasury bonds that are purchased by foreign countries — like China. A major shock to the U.S. economy could happen if one day foreign governments decide not to purchase our treasuries. Trade wars and tariffs would set us backwards.
So how do we lower the twin deficits? The U.S. economy is fueled by consumption. We love to purchase the latest and greatest gadgets and get new cars every three years. We spend more than we earn. Individuals need to reduce spending and increase their savings and investment. Savings in the U.S. is very low. If individuals, businesses and the government increase savings, we can fund investments internally. Over time, this will reduce our large deficit.
Another important point Leamer made is that there is no evidence that higher tariffs with other countries will reduce our trade deficit. In fact, the trade balance will probably remain stable because, as high tariffs reduce imports, exports fall due to the weakening of foreign currency against a stronger dollar. The end result of the tariffs, therefore, will be less trading and less income for U.S. companies -- not trade deficit reduction.
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