- Both Presidential candidates’ fiscal plans are likely to result in continued increases in the U.S. debt-to-GDP ratio, necessitating increasing amounts of debt monetization in order to prevent bond yields rising.
- Biden’s proposals in particular would require extraordinary amounts of money printing to finance and real GDP growth would likely be further undermined by increased government involvement in the economy.
- As spending increases further in excess of tax revenues, bond issuance would rise and more debt monetization would be required to prevent yields from rising, creating a potential vicious cycle.
- We would expect the gold/SPX ratio to surge higher as stagflation pressures build as has been the case in the past.
Both President Trump and Joe Biden’s fiscal plans are likely to result in continued increases in the U.S. debt-to-GDP ratio, necessitating increasing amounts of debt monetization in order to prevent bond yields from rising. Biden’s proposals in particular would require extraordinary amounts of money printing to finance and, contrary to mainstream opinion, real GDP growth would likely be further undermined by increased government involvement in the economy. We would expect the gold/SPX ratio to surge higher as stagflation pressures build as has been the case in the past.
Biden’s Plans Would Double Spending Over The Next Decade
A recent article by Rabobank posted by Zerohedge provided a good summary of the fiscal policy platforms of the two candidates. They estimate that Biden’s plans would increase spending by $5.6-6.7trn while raising revenues by 3.5trn over the same period. Even at the lower end of the spending estimate, this would more than double Federal outlays and the fiscal deficit over the next decade from pre-Covid levels. For comparison, Trump’s plans would reduce spending by $1.4-3.2trn while cutting revenues by $2.9-4.1trn over the next decade.
There’s No Such Thing As A Positive Fiscal Multiplier
The majority of economists, including Biden economic adviser Jared Bernstein, appear optimistic that increased government spending will boost economic growth owing to positive fiscal multipliers which will allow increases in spending to effectively pay for themselves via increased growth and the tax base. This is highly unlikely to be the case.
There are finite resources available to an economy and the greater share of resources that are controlled by bureaucrats at the behest of politicians, the fewer resources available for the private sector to satisfy consumer demand. When profit and loss motives are taken out of the equation, decisions regarding resource allocation tend to be much less efficient.
The principles of resource scarcity and the threat posed by excessive government spending used to be widely acknowledged by economists but now tend to be lost on most. Many economists now believe in a positive fiscal multiplier. The San Francisco Federal Reserve Bank calculated earlier this year that the fiscal multiplier on state and local government spending is 1.5, meaning that every $1 given to those governments increases GDP by about $1.50.
Imagine if this were actually true. The more money the government spends the more real GDP growth that results, the more tax revenues we generate, and the larger surplus we run. It is a wonder why government spending as a share of GDP has risen for decades alongside weakening real GDP growth, widening fiscal deficits, and a rising debt-to-GDP ratio.
The Green New Deal Cannot Pay For Itself
If the U.S. was a developing economy with low levels of government spending and a primitive infrastructure, then an increase in government on infrastructure spending could ‘crowd in’ private investment. In other words, under certain circumstances, increased government infrastructure spending could allow greater amounts of private sector production. However, this is unlikely to be the case with the proposed investments in green energy investment.
Biden has proposed as much as $1.7trn for green energy investment to combat climate change, including research funding, tax incentives, subsidies, and direct federal purchases. Regardless of whether these initiatives are worthwhile from the perspective of combatting climate change, they come with a huge economic cost. It is tempting to think that if purchases are made from domestic companies and green investment infrastructure increases, then economic growth and tax revenues will increase. However, as an increasing portion of the nation’s land, labour, and capital are diverted towards clean energy investment, the resources available for the rest of the economy will decline along with tax payments. That these industries require subsidies and tax incentives reflects the fact that they are not economically efficient. From the perspective of GDP, unproductive investments are indistinguishable from productive ones, but the ultimate burden will be seen in the slower growth of consumer goods production.
Debt Monetization Set To Explode
Should the Biden government manage to push through its fiscal proposals, we would likely see fiscal deficits and government bond issuance surge as spending increases far exceed any increase in tax revenues resulting from higher tax rates. If Biden’s fiscal plan were to have been proposed in the absence of central bank bond-buying, we would likely have already seen government bond yields spike as investors would require much higher yields to compensate for the risk that government debt would rise exponentially and default would become likely. Such a rise would signal to policymakers that Biden’s spending proposals are not economically viable. However, the fact that the central bank has the ability to buy bonds means that the threat of default is negligible.
Inflation To Result
As spending increases in excess of tax revenues, bond issuance would rise and ever more debt monetization would be required to prevent bond yields from rising. The more debt monetization that takes place, the greater the more inflation pressures are likely to build. As inflation rises further, bond investors would likely demand higher yields on their bonds, and to prevent this happening, more debt monetization would be needed. It is easy to see how inflation could quickly spiral out of control.
Gold To Surge Relative To Stocks
As we argued here, over the long term, the ratio of gold to the SPX has been closely tied to the so-called misery index: the rate of inflation plus the unemployment rate. As the chart shows, stocks tend to perform very poorly during periods of rising inflation, while gold performs well. As the government and Federal Reserve increase their involvement in the economy, stagflation and gold price outperformance awaits.