What Should Trump Do?—Your Questions Answered

By John Mauldin




This will be a shorter letter, in keeping with the need for holiday fun and relaxation.
 
However, last week’s letter with my thoughts on what Trump should do generated more responses than any other letter had in the last 17 years. As you might suspect, with a topic so controversial, not everyone agreed with me. But there were many good questions and comments and some thoughtful disagreements, so I want to address a few of those. And I will specifically go into why I seemingly deviate from core conservative principles regarding taxes. It’s all about debt and the consequences of debt – that’s the overriding factor for me. And I’ll try to make the case that there are times when we just have to make hard, even philosophically unpalatable, choices.
 
Some comments I will excerpt; others I will characterize in general terms; and where appropriate I’ll copy and paste whole comments. So let’s jump in.
 
 
Allen Jones · Univ. of Arkansas
 
Please explain further corporate tax rate of 15% on income above $100,000 with "no deductions period." Sounds like a 15% tax on sales. What do you mean no deductions? Are operating expenses deductions?
 

Allen, this was probably the most-asked question, and since you asked it most concisely, you get the recognition for it.
 

No, this is not a sales tax. It is a 15% tax on corporate income. That is normal GAAP accounting income. There are something like 3,400+ different, legal, congressionally mandated corporate tax loopholes and deductions. (I can’t find the exact number right now.) Many of those tax loopholes apply to only one company or one very small industry and are favors from a Congressman or Senator to their main constituents. So when I say no deductions, I mean get rid of every one of those loopholes. I know, I know – I will be goring practically every business’s ox in some way or other. And that’s the problem: Too many people think their industry deserves some breaks and one little loophole is not that big a deal, and the next thing you know there are 3400 of these puppies. And then you find General Electric paying less income tax than I do while making multiple billions of dollars a year.
 

I might be run out of Texas, because this would likely mean axing the oil depletion allowance, too. Normal depreciation would still apply. For those who are worried about R&D expenses, I would allow accelerated depreciation on R&D, because those are truly expenses, at least in my mind. But the point here is to have as few loopholes as possible (with the only exceptions to be those that clearly, directly create jobs). I will readily admit to not being an accounting expert, but I have looked at a few balance sheets.
 
Corporations would have to pay taxes on what they report to their shareholders or their bankers or even to themselves. Fifteen percent is not that big of a deal in the grand scheme of things. It is actually slightly lower than the current effective rate (depending on which source you go to). I think that under this plan we would actually take in more taxes because we would see corporations come from around the world and domicile here in the United St ates. And businesses would not go to such drastic lengths to avoid reporting income, so total corporate taxes would increase.
 
Glen Travers  -· London, United Kingdom
 

VAT is a drag on growth – look at UK and EU – as well as difficult for the unhappiest group in all our economies. This insidious tax is an admission of failure by politicians who promise reductions in income tax in return for proposing a “fairer” direct tax instead of controlling populist unaffordable promises.
 
 
Glen, I totally agree with you: a VAT will be a drag on growth. There was a lot of pushback from many readers on the concept of the VAT. So let’s use your question as a springboard into the subject.
 

First, if you asked me 10 years ago if I would ever even think about a VAT in the US, I would’ve said, “Not no, but hell no. Double hell no!” We were still at a point in 2006 where we could have brought the budget under control, got our hands around the entitlement problems, flatlined spending along the lines of Clinton/Gingrich, and dealt with both the deficit and the debt.
 

However, that is not what we chose to do. And now we find ourselves between the devil and the deep blue sea. The devil is the national debt, and the deep blue sea is the crisis that we are sailing into if we don’t figure out what to do about that debt.
 
The chart below goes through 2014, and if it were extended to the end of this year it would show national debt at $20 trillion.
 
 
At some point, Glen, debt in and of itself is a drag on growth relative to income. The economic literature is pretty consistent on that. A debt-to-GDP ratio of 40% is not an issue; but US government entities owe a total of $23 trillion, or over 120% of debt-to-GDP – and that amount is rising every year. We look a lot more like Italy than any of us would care to contemplate.
 

While I agree that a VAT is a drag on growth, that is not the problem in Europe. It is their debt, plus their sclerotic regulatory systems and ungodly heaps of rules and regulations that are destroying jobs and inhibiting new small businesses from starting.
 

As I keep preaching, when (not if) we have the next recession, the will balloon to well over $1.5 trillion and probably closer to $2 trillion. It won’t take long to get to $ trillion, and then we’ll be spending $600–$800 billion of taxpayers’ money just to pay the interest at what I think will be normal rates. Now, if you prefer to use the CBO’s projected interest rates, then add another $300 billion a year, pushing total interest outlays to $1 trillion a year. (The CBO is assuming a much stronger economy than I would at that level of debt.
 
If I am wrong, then the interest payments will be much higher…)
 

We have amassed well over $120 trillion in unfunded liabilities, and if we don’t get our entitlement spending under control, the debt is only going to get worse – much worse. That reality brings up the next, generalized question.
 
You Got to Know When to Fold ’Em
 
John, you know the only real way to solve the crisis is to cut spending across the board. Cut everything. You have to slash entitlements and defense spending and get rid of whole government departments. We have to learn to live within our budget. Stop being part of the mainstream and deal with the real problem: too much government spending.
 

(And there was also the Libertarian variation on that theme: Starve the beast; don’t feed it.
 

To everyone who voiced sentiments along those lines: I get it. I agree with you. If it were in my power, I would do it. But it’s not.
 

There’s a song running through my mind right now. It’s the chorus from Kenny Rogers’ classic song, “The Gambler”: “You got to know when to hold ’em, know when to fold ’em…”
 
Philosophically, I am still as much a small-government guy as I was back in the ’80s. A small-L libertarian. I want government to do only what is necessary to keep the game fair, do the things that we need to do as a group, which can mostly be done on the local level – and for God’s sake keep its thumb off the scales.
 

We fought those battles in the ’80s and ’90s and made huge progress – and we truly lost at a national level when the Republicans took over under Bush II. We Republicans became the party of big government. And while you can get many Millennials and Gen Xers to nod in agreement with the principle of a small government, for them that does not include doing away with government-assisted healthcare, which by definition means a pretty large government. And don’t even try to touch the hot third rail of Social Security.
 
Bush II actually tried to deal, just marginally, with relatively simple problems with Social Security and got slapped down by both parties.
 

Tell Boomers and others they can’t have their Medicare? Or their other “entitlements”?
 

The simple fact is, a majority of the voters in this country want Social Security and healthcare and expect healthcare to be provided to those who can’t afford it. They want pre-existing conditions to be ignored by insurers. And a whole slew of other things.
 

I do believe there is a way to get healthcare spending under control and put our entitlement problems on a glide path to being solved, even as we fully acknowledge that our demographics are working against us. But there is no way it can be done without money. It is going to take a great deal of government spending, no matter how you slice it. The government has only three sources of revenue: taxes, borrowing, and monetization. Borrowing money runs up the debt, and we are getting very close to the point where ballooning debt becomes debilitating. More on monetization later.
 

That means we have to somehow increase revenues if we are going to pay for all that needed spending and bring the debt under control. I don’t like it, but those are just the facts.
 

So then we come to the crux of the matter: How do we raise the necessary revenue in a manner that will still allow us to grow the economy as much as possible? I think the preponderance of economic literature suggests that consumption taxes are in general less of a drag on growth than income taxes.
 

Consumption taxes include value-added taxes (VATs) and sales taxes. Then there is a whole school of thought built around the so-called Fair Tax, which is a national sales tax that would be added on to all retail sales in addition to state sales taxes.
 
Proponents of the Fair Tax would then eliminate all federal income taxes (including the alternative minimum tax, corporate income taxes, and capital gains taxes), payroll taxes (including Social Security and Medicare taxes), gift taxes, and estate taxes.
 

I can go along with this scheme in principle, but in practice I think the equivalent of a 30% sales tax (which is what the Fair Tax would amount to when combined with state and local sales taxes) would send a lot of the economy underground. Just my opinion. When you can deal with your plumber or favorite restaurant for 30% less by paying cash, the temptation looms pretty large.
 

I’ve traveled all over the world, and those countries with high retail taxes or controlled exchange rates end up becoming cash societies to the extent possible.
 
The Argentines and the Greeks and the Italians are lifetime grandmasters at surviving in such an economy. Call me cynical, but at 30%, I think a lot of my neighbors would quickly master the game, too.
 

A VAT, or any of its sisters, has the advantage of being taxed at the business level on the incremental value added to products at each stage of production. It is thus a great deal harder to avoid, so everybody pays. Or almost everybody. It would actually capture a lot of the current underground economy.
 

So why not make the VAT large enough to get rid of all the other taxes, as the Fair Tax folks suggest? For me, it’s is a purely political decision. The VAT is a regressive tax. That means it generally falls more heavily on those with lower incomes. And progressives and liberals will hate that. So we have to come up with a compromise. That means we’re still going to have to have an income tax, but we need it to be as low as possible. My suggestion is 20% on all income over $100,000. (See last week’s TFTF for details.)
 

To make the VAT less of a regressive tax, I propose that we make it large enough so that we can eliminate the Social Security tax. That immediately gives all lower-income earners a 6% pay raise. Plus, it lowers business costs 6%. That takes away a lot of the regressive nature of the VAT.
 

Not starting to pay income tax until you clear $100,000 and not being taxed for Social Security doesn’t mean that those who make between $50,000 and $100,000 don’t pay taxes. They pay taxes in the form of the VAT, plus their local taxes; so their tax burden should not be a lot different than it is now, and they might even see something of a tax cut.
 

Remember, the object here is not just to cut taxes but to figure out how to get more tax revenue with the least possible pain to the overall economy. If your family has ever been faced (as mine has on several occasions) with a significant increase in expenses or decrease in income, you know you had to make some tough choices.
 
On the national level, too, somebody is going to have to pay more, and somebody is going to get less. I remember that when I was starting out in business in my 30s, there were days when I darkly joked, “I’ll pay what I have to, and everybody else will have to wait.” That included my wife and kids and what they wanted or even needed. Reality’s a bitch sometimes.
 

We have a reality to face up to now. And that is our national political process. We have to figure out where to get the money to pay for what our citizens say they want. If a Republican president and Congress do not enact legislation that gives voters something approximating what they feel they need, Republicans will be thrown out and Democrats will be given another chance. Let me tell you straight up that the economists advising the Democrats will not only give us a VAT, they will give us high progressive personal income taxes, and the corporate tax will not come down that much. They simply don’t buy my economic view of the world. They are neo-Keynesians through and through. Think Europe on steroids … even as we watch Europe getting ready to implode over the next four years.
 

There are a number of objections along the lines of, “If we do what you propose, it will hurt me. It’s not fair.” Well, in many cases I agree and sympathize with you. But at this point in the game, our whole political and economic situation is “not fair;” and we’re left with only difficult (but necessary) choices. One especially poignant objection came from a reader who had converted his entire pension plan to a Roth IRA, paid his taxes, and now I was, proposing a VAT that would make him pay his taxes again. He is quite right that this is unfair to him. But I don’t know what to do.
 
It is simply not possible to devise a system that is fair to everyone in every way. We have to make some tough decisions. The needs of the many must outweigh the needs of the few. And I say that with a full understanding that, as Ayn Rand discovered and explained, the needs of the individual are what give rise to the need and possibility for value judgments to begin with.
 

That is the problem with making decisions in a government that is as big and complex as the US system is. We have let its growth get out of control, and going back would be so unbelievably disruptive in terms of lives and fortunes and jobs and futures that the reverse trip is simply not possible. We can’t rewind the clock.
 
As The Gambler told us, “Every hand’s a winner and every hand’s a loser.” We have been dealt the hand we have, and we have to figure out how to play it to make it a winning hand. Folding is not an option.
 
 
What Happens If We Don’t Balance the Budget?
 
And thus we come to the heart of the matter with regard to my VAT proposal. If we don’t bring the budget deficit beneath the nominal growth rate of GDP (which is unlikely to go above 4% in the near future), our debt will explode during recessions; and we will ultimately face a debt crisis. Those never end well. The choices we will have at that point will be far fewer and even more stark.
 

Let’s wargame our situation for a few minutes. What will happen if we increase taxes and cut spending enough to get the deficit and debt under control? Getting there will take compromises along the lines of what Clinton and Gingrich did, but I truly hope we’re capable of them. With our debt as large as it is, we are going to be in a somewhat slower-growth economy; but if we get rid of enough shackles on growth and get the incentive structure right with the proper tax mix, the American entrepreneur can probably get us out of the hole we’re in without its getting too much deeper.
 

With the amazing new technologies that are coming along, we can probably get to a point where we can in fact grow our way out of our debt problem over the next 10 to 15 years.
 

What happens if we don’t? The more benign outcome is that we end up looking like Japan. We grow the debt to the point where we actually have to monetize it.
 
Perhaps not the end of the world but certainly not the high-growth, job-creating machine we would like our economy to be. The income and wealth divide would deepen, and if you think there was pushback in the last election, just wait. We might see even higher taxes and a slower-growth economy; and entrepreneurs, established businesses, and investors would just have bigger headaches. Remember, that’s the best possible outcome if we don’t deal with our deficit and debt.
 

What happens to the value of the dollar in that scenario? Six years ago I would have confidently told you it would go down. Now, as I observe the Japanese experience (and even though I recognize a number of differences between our economies), I suspect that the dollar might rise, not fall. Or rather, it wouldn’t fall relative to the other global currencies, and not nearly as much as my hard-money friends seem to think. We would truly find ourselves in a world for which we have no historical analog.
 

If the country with the world’s reserve currency starts printing money merely to service its debt because people don’t buy its debt, and in a world where most other major economies are also in trouble (as I logically assume they would be), then where are we?
 
And remember, this would be a future in which total global debt would be in the $500 trillion range and global GDP would top  $100 trillion. Monetizing $1–2 trillion a year (we are talking 10+ years out) – roughly the equivalent of what Japan is doing today – might be like spitting in the ocean. Money will be far more fungible and liquid and movable in the financial-technology world that we are evolving to. It would be the height of hubris to think we can know with any degree of certainty what would happen.
 

Now I don’t think the failure-to-act scenario will happen, but we’re in wargame mode, so we have to think the unthinkable. Maybe the world decides it wants another reserve currency or substitutes something new. We don’t know. Lots of things are going to be possible in 10 years that we have no clue about today. In such a scenario, the dollar could in fact lose a great deal of its purchasing power.
 
That would create a great deal of uncertainty and volatility, and I can see a global deflationary debt scenario unfolding, followed by massive monetary creation.
 
I guess the critical factor for me is that I can see no scenario where we don’t deal with the deficit and the debt and enjoy a positive outcome. It’s a binary choice to me.
 
So I choose to suggest what I think is the only politically possible thing to do; and that is to restructure the tax code, balance the budget with an increase in taxation, roll back as many rules and regulations as we can, hope we get the healthcare issue right – and then see what happens.
 

Let me end with a story. I was on a plane going from New York to Bermuda and had been lucky enough to be upgraded to first class. It was 1998 – just a few days after the resolution of the Long-Term Capital Management crisis. The markets had seen a rather harrowing time.
 

The gentleman who was seated next to me ordered Scotch as soon as the wheels were up and basically indicated to the stewardess to keep them coming. You could see that he was emotionally shaken. I engaged him in conversation after a few drinks, and when he found out that I was allied with the hedge fund business and coming from New York, he assumed I knew a lot more about the world than I did. It turns out that he was the vice-chairman of one of the largest banking conglomerates of the time. We all know the name.

 
He began to relate to me the deep background story of what had gone on for the past few weeks, culminating in that famous meeting called by the New York Federal Reserve, where the president of the New York Fed told everybody in the room to play nice in the sandbox. And to whip out their checkbooks. This gentleman had been in the meeting and knew the whole story. I knew I was hearing something special, so I just sat and listened and made sure the flight attendant kept bringing Scotches for him. He seemed to open up more with the downing of each one.
 

Finally, he turned and looked me in the eye and said, “Son, we went to the edge of the abyss, and we looked over. And it was a long way down. It scared every one of us to the depths of our soul.” And then he ordered another Scotch and laid his head back and tried to rest.
 

As I look back on that 1998 crisis, which we all thought was so huge at the time, it brings a smile. We were talking hundreds of millions that had to be ponied up by each of the big banks, several billions of dollars total. It was manageable within the private system. Just 10 years later, in the 2008 crisis triggered by the housing bubble, we were talking hundreds of billions if not trillions in losses, and the private system was not capable of dealing with it.
 

If we don’t handle our debt problem, the crisis into which we’ll plunge will resolve the debt in one way or another – and the ensuing turmoil will make 2008 look as minor as 1998 does today.
 

I do not want to my children to wake up in a world where we are frog-marched to the edge of the abyss and forced to look over. We still have the opportunity to secure the future for our children, but only if we seize the moment. If we don’t, it will be unusquisque pro se – every man for himself.
 

A few thoughts on investing in an environment like this (since investing in the economy is supposedly what this letter is mostly about). With all the current and emerging challenges we face, investing will still be difficult even if we deal with our debt issue, but those challenges will be far more agreeable than the extraordinarily difficult choices we’ll be left with if we don’t handle the debt. With the tools and strategies that we have available to us today and with even more powerful tools being developed for the future, I think investors who are properly prepared can figure out what to do in either scenario. But average investors who are expecting the future to look somewhat like the past? They’re going to be severely damaged.
 
Their retirement futures are going to be ripped from them. And they are going to be profoundly unhappy.
 

None of that has to be, of course. Things might turn out just fine. But I have a strong suspicion that the massive move we are seeing from active management to passive management strategies in the past year is going to turn out to be one of the all-time worst decisions by the herd. But that’s a topic for another letter.
 
Howard Ruff, RIP
 
 
I was truly saddened to learn this week that my old friend Howard Ruff had passed away.
 
He was 85 and suffering from Parkinson’s. Howard Ruff is a name that my younger readers (under the age of 40) will likely not recognize, but those of us who were around for the investment world of the ’70s and ’80s were certainly influenced by Howard. He was one of the true founders of the investment publishing world and was clearly the rock star in the ’70s and ’80s. His main newsletter was called the Ruff Times. This title was appropriate, as his first three books were Famine and Survival in America (1974), How to Prosper During the Coming Bad Years (1979 – NYT #1), and Survive and Win in the Inflationary Eighties (1981) – all solidly in the gloom and doom camp.  Howard believed (as of his 1979–1981 writings) that the United States was headed for a hyperinflationary economic depression and that there was a danger that both government and private pension plans were about to collapse. His mailing list grew to over 200,000 subscribers (unheard of for a newsletter at the time), and he had a following that was amazing. He was part of the hard-money crowd and rode the wave of gold and food storage, preparedness for the coming crisis, throughout the ’70s and into the ’80s. He made a series of remarkable calls, and people thought he knew what he was talking about. I think that sometimes even Howard himself did. (You can read a fuller reminiscence by our mutual friend Mark Skousen here. (Also includes a link to a New York Times piece on Howard.)
 

I remember the first time I saw him. I was at an investment conference in New Orleans (the “gold conference” which in its heyday would have 4,000 attendees and was founded by another legend, Jim Blanchard), and I noticed a small crowd (100 people or so) focused on an individual in a hallway. It was Howard holding court, answering questions, just being his entertaining self. And people leaning in to listen – enraptured. I saw that scene repeated at other times during that and other conferences, all throughout the ’80s.

 
And then things changed. The markets changed, and Howard’s message didn’t. His subscriber list began to shrink. The crowds got smaller (and older). You have to understand, Howard was a complicated man. He went through multiple bankruptcies and came back to make millions. He was passionate about everything he did. The business setbacks were simply opportunities to move on to something else. Onward and upward.
 
He was always upbeat.
 

He was a devout Mormon who had 14 children, 79 grandchildren, and 48 great-grandchildren at the time of his passing.
 

Sometime in the middle of the last decade I was speaking at an investment conference in Las Vegas. Howard called me and asked if he could come down from where he lived in southern Utah to give me a copy of his new book (which he wanted me to review). You can’t tell a force of nature no, so I told him to come on down. We agreed to meet at a booth on the exhibit floor in the afternoon. The floor was rather busy, and I was talking with friends and attendees at the back end of the aisle. I looked down the aisle and saw Howard walking toward me, and it wasn’t until he was about 10 feet from me that I realized that no one had stopped him to have a chat. Howard was still the same person, but the world had moved on, and he had not moved with it. I vividly remember thinking sic transit gloria. That lesson, the thought that it could happen to anyone, has been seared into my brain over the last 10+ years.
 

He wrote a biography in which he talked about his successes and failures, and we compared notes on his career and mine from time to time when we had opportunities to get together. I had jumped in near the beginning of the investment publishing business but on the management side, and I didn’t begin to really write my own material until the late ’90s. Howard was glad to mentor me and freely talk about his ups and downs.
 

He shared what he considered to be his biggest mistake. In the early ’80s, and certainly by the mid-’80s, he began to realize that inflation was truly not coming back and that gold might be challenged. But he had well over 100 employees and a subscriber base that would rebel if he changed his tune. Changing his message meant he would have to lay off scores of people, including many friends and family members, and he just couldn’t bring himself to do it.  “I knew it, in my heart, but I just couldn’t get myself to damage the company that badly.”
 

We had that conversation several times. I have had the unique advantage of being friends with a number of writers and publishers over the last 35 years. I’ve seen writers get big and then fade. Other seemingly stay on top of their game, riding the wave wherever it takes them. The biggest mistake that leads to downfalls is believing in your own investment magic (or, as we are wont to say in Texas, believing your own bullshit).
 
Howard was a true, one-of-a-kind marketing genius; and if he had changed his tune when he knew he needed to, he would have lost half his readers, but he would have built his list back up. The lesson: Be true to what you know and believe, and let the chips fall where they may. Don’t tell the people what they want to hear, Howard would say, but what you really think. Just make sure you believe it.
 

Howard was a friend to everyone he met, forever generous with his time and resources.
 
Those of us in the investment publishing world owe a great debt, whether we know it or not, to Howard Ruff. Your publishing business has Howard’s DNA buried deeply within it.
 
May he rest in peace.
 
Washington DC, New York, Atlanta, and Florida
 
I have rarely asked my readers to connect me with someone; but when I have, I have never failed to get that email address or phone number. So with that hope in mind, could someone please give me email and/or phone connections for both Matt Ridley and Bill Gross? You can send them to mary@2000wave.com. Thanks.
 

Week after next I will make my way to Washington DC and New York for a series of meetings and then to Atlanta for a Galectin Therapeutics board meeting. Then I’ll be home for the holidays. I’ll be in Florida for the Inside ETFs Conference in Hollywood, Florida, January 22–25. And then I’ll be at the Orlando Money Show February 8–11 at the Omni in Orlando. Registration is free.
 

It’s time to hit the send button. After writing such dramatic and emotional content, I think I’ll go watch the latest Harry Potter movie and simply be entertained. I am still utterly amazed that I can make a living doing what I enjoy doing – writing and thinking and talking. Every time I sit down at this computer to write my letter, I truly do think, “Dear God, don’t let the magic stop this week.” But then the real magic is you. It’s been 17 years, and I still enjoy every step of our journey together. Thank you.
 

Remember, I really do read your comments and take them to heart. So if you want to tell me something, go right ahead. In the meantime, you have a great week. It will be interesting to see how Trump transitions from showman to President, from a candidate who can say anything to “Oh my God I have to make decisions, and this is the real world.” Maybe I’m asking for the triumph of hope, but I believe he can.
 

Your whispering memento mori analyst,


John Mauldin


King of Debt Takes the Reins

By: Peter Schiff


The election of Ronald Reagan in 1980 provides the best recent precedent for the unexpected triumph of Donald Trump (in my opinion, the other post-war Republican takeovers of the White House -- Ike in '52, Nixon '68, and W. in '00 - did not constitute a real break from the status quo.) As many people expect great changes from Trump, it is worthwhile to look at what the Reagan Revolution actually wrought.

Both Reagan and Trump were better known to many as entertainers rather than politicians, both came from outside the Republican mainstream, and both engineered hostile takeovers of the Party. During the 1970s, the Republican Party was dominated by "Rockefeller Republicans," the Ivy League-educated liberal Eastern elites. Reagan was the Western heir apparent to Barry Goldwater, the deeply conservative standard-bearer who went down in flames in 1964. In 1976, the brash Reagan had the nerve to challenge incumbent Republican President Gerry Ford in the primary, thereby weakening him in the general election, which he ultimately lost to Jimmy Carter. While Reagan was simply too conservative for the Rockefeller wing, Trump's various positions are similarly inconsistent with much of the mainstream neo-conservative orthodoxy. Both candidates also capitalized on a weak economy as a catalyst to encourage voters to cross traditional party lines. Many of the rust belt "Reagan Democrats" came home to Trump.

While books have been written about the cultural and political legacy of Reagan's presidency, harder facts can be found in his budgetary record. Despite the economic revival that his tax-cutting and deregulation tendencies delivered, the national debt ballooned as it never had for any other peacetime President. Although the fiscal imbalances have gotten significantly worse since Reagan left office, the Gipper gave plenty of cover for future Republican presidents to run up red ink. President Donald Trump, the self-proclaimed "King of Debt", now appears to be perfectly positioned to test the limit of how much debt the world's largest economy can issue.

Leading up to the election of 1980, Reagan and the conservative economists who supported him, warned that Federal debt, which had risen to approximately 26% of GDP, had grown too heavy to bear (data from Congressional Budget Office, July 2010) Reagan brought the spirit of Milton Friedman into the Oval Office, and his campaign was based on a clear intention to roll back the nearly 50 years of socialist government expansion that had occurred since Roosevelt's New Deal.

But when Reagan came to Washington he was confronted by a strong Democratic majority in the House of Representative led by House Speaker Tip O'Neill, a skillful and forceful defender of big government. Reagan soon discovered that the political price was always very high when government expenditures are being restricted. And so, Reagan decided to move on the tax cuts (a perennial political winner) but never really got around to the spending cuts. As a result, the 26% debt to GDP ratio that he inherited when he came into office expanded to 41% by the time he left. (data from Congressional Budget Office, July 2010) This was not the complete conservative victory for which his backers had hoped.

Trump comes to office with similar expectations for significant changes. The good news for him is that he will face far fewer restrictions than Reagan had to face. Most importantly, both houses of Congress are now Republican. The Supreme Court is currently split along ideological lines but is likely to swing conservative after Trump's appointment to the open Scalia seat.

On the taxation side, Trump has proposed cuts in personal and corporate tax rates that could likely sail through Congress. How much these moves will add to the deficit depends on how much growth they generate in the economy. Such predictions are very hard to make. But if the tax cuts are assured, the growth is not. However, there is no need to make algorithmic predictions on the budgetary implications of spending decisions. They are what they are, and their impact is immediate. Trump plans massive increases in Federal spending, initially in the form of a trillion dollar infrastructure spending over ten years, and billions to build his border wall and pay for his planned deportation force. On the spending side, Trump could likely get whatever he wants, and more. Had a smaller infrastructure spending plan been proposed by President Hillary Clinton, it would have likely been voted down by "fiscally hawkish" Congressional Republicans. Such scruples could fall by the wayside when the spending requests come from a Republican President.

Although the years of trillion dollar plus deficits we experienced during the first Obama term have been pared down to the $500 -$700 billion dollar range, the Congressional Budget Office's Summary of The Budget and Economic Outlook, 1/19/16, currently predicts that we will officially return to trillion dollar levels by 2022. (In truth we are already there. Over the last 10 years the actual expansion of the debt has averaged $1.1 trillion per year, about $300 billion more than the average deficit of $790 billion over that time). (TreasuryDirect; usgovernmentspending.com) The CBO's projections are based on no unplanned spending increases between now and 2022, steady GDP growth in the 2% to 3% range, and no dip into a recession (even though the current expansion is already far longer than the typical postwar expansion). Given this very optimistic set of assumptions, and Trump's announced plans on taxing and spending, we should absolutely expect a massive expansion of the Federal debt over the next four years. The more difficult question is how it will be financed.

When making a comparison to Reagan, it is important to realize that he financed his debt expansion the old fashioned way: He sold long-term government debt to private investors. In the early 1980s, savings levels in the United States were much higher than they are today. The average American actually had money in the bank. And those with the means to invest were less inclined to dabble in stocks than they are today (there was no eTrade to make the process easy and transparent). The stock market had essentially made no gains between 1966 and 1980, (Dow Jones Industrial Average data) so investors could be forgiven for having given up faith. Bonds were a bigger part of the mix up and down the investment spectrum. And those investors who stepped up to the plate to buy those 30-year bonds in 1981 to finance the Reagan deficit ended up making some of the best portfolio decisions.

It seems impossible to believe in our current low interest world, but in 1982 the U.S government sold 30-year bonds with a 14% annual coupon. That's right, a guaranteed, principal-protected, 14% annual return for 30 years. Investors today could only dream of something so magical. Of course inflation was higher back then (partly because the government hadn't yet figured out how to recalibrate the Consumer Price Index), but even at its worst, inflation rose only to approximately eight percent. (InflationData.com) This means that buyers of those 30-year bonds were getting a real rate of six percent above inflation. But it just gets better from there.

Over the course of the Reagan presidency inflation and interest rates came down steadily. This meant that those investors who bought in 1982 would see their real rate of return increase every year. By 1988 inflation had come down to 4%, so those bonds offered a real yield of 10%.

The falling inflation strengthened the value of the dollar itself. So in relative terms Americans holding those bonds were seeing a real increase in purchasing power of their principal relative to the falling prices of imported goods. Also, in an environment of falling interest rates investors holding 30-year 14% bonds could sell those bonds before maturity for more than they paid. That's because even at a price above par the bonds would still offer higher yields to maturity than newly issued bonds. But despite the premium, investors were better just to hold them till maturity. Purchasing Treasury bonds in 1982 was an investment in America's future, but it also happened to turn out to be the deal of the Century.

Think about how different it would be today for investors making a similar choice to finance the Trump deficits. 30-year bonds are currently being offered at a rate of just under 3%. If you believe the government inflation figures of just about 2%, this means that your effective yield is about 1% (pre-tax). If inflation is even slightly higher, the real yield could be negative. And in 30 years there is plenty of time for inflation to go, much, much higher. If it does, these bonds would be all but guaranteed to deliver less purchasing power than their original cost, even if held to maturity.

If interest rates were to rise from the current low levels, as almost every economist and investor assumes they must, the value of long-term bonds will surely fall. In another danger to bond prices, Bloomberg News reports that the new Trump economic team will likely put pressure on the Fed to reduce the amount of bonds on its balance sheet. To do so in any meaningful way will require that the Fed sell off portions of its $4.5 trillion bond stash of holdings into the open market. This could turn the biggest buyer of Treasuries into the biggest seller.

A sustained period of falling bond prices would mean that if current buyers wanted to cash out before maturity, they would likely have to sell for a loss, not the gain that their fathers would have seen with the 1982 bonds. If rates got as high as five or six percent (and I think they will go much higher) those losses could be substantial. As Jim Grant likes to say, today's long maturity bonds represent return-free risk. Or as Warren Buffet likes to say, it's like picking up pennies in front of a steamroller.

The risks become greater still when you consider how America's fiscal position is much worse today than it was in 1980. When Reagan took the oath of office America was the world's largest creditor nation. Today it's the largest debtor. Our debt was just 30% of GDP then, while today its 105% and projected to go much higher over the next generation...even without Trump's taxing and spending plans factored in.

But arguing the investment merits of long-term government bonds is a bit pointless in the current age. Real investors gave up on bonds long ago. What little savings Americans still have either stays in the bank, or gets directed to stocks or real estate. The bond market has almost become the exclusive playground of central banks. In Japan and Europe, central banks are sucking up the vast majority of government debt. We did the same during our four years of quantitative easing, and the Federal Reserve's balance sheet remains swollen.

If under President Trump annual deficits explode, whom should we expect to buy the trillions in debt we will have to issue to pay for it? In the recent past, the big buyers have been central banks in China, Japan and Saudi Arabia. Should we expect those customers to return? We may be in an allout trade war with China, Japan is already pushing its own QE program to the limit (its central bank is currently buying large portions of the Japanese stock market) and the Saudis are struggling with $50 oil. We may need to find new buyers.

But don't look to Mom and Pop USA. Those investors are tapped out. Don't look to the pension funds. They can't meet their numbers with 3% coupons. Don't look to the hedge funds. They are losing money fast due to bad performance, and their investors expect more nuanced thinking than U.S. Treasuries. What's more, (in contrast to 1982) the U.S. dollar is currently near generational highs. If the dollar should weaken, holders of dollar-denominated debt will be left holding the bag.

When Reagan was elected, the dollar had been beaten down to all time record lows, having lost about 2/3 of its value against currencies like the Deutsche mark, Swiss franc, and Japanese yen.

So high yielding, dollar-denominated Treasuries were attractive investments for foreign savers.

But the dollar has already risen sharply over the last few years based on expectations the Fed would normalize interest rates. Investors should not be under any illusions that the dollar will experience another continued rally. With so many reasons arguing against buying long-term dollar Treasuries, the Fed may be the only game in town.

Given that, it's impossible to imagine that the Fed will ever allow interest rates to rise by any significant amount. (Doing so would devastate the value of their bond holdings and raise debt service costs past the point where the government, or most private borrowers, could pay).

Already more than $4.5 Trillion of Treasury bonds sit on the Fed's balance sheet. Look for that number to balloon during the Trump years.

Debt monetization was the term that used to be used by economists to describe the undesirable outcome of a country's central bank becoming the exclusive financier of its national debt.

Inflation and currency devaluation were expected to be the results of this brash approach to fiscal policy. But this will likely be our future under Trump. Investors would be wise to recognize this and to diversify appropriately.

In 2009, when the first Quantitative Easing program allowed the Fed to buy large quantities of Treasury bonds, then Fed Chairman Ben Bernanke pushed back against Congressional accusations of debt monetization by claiming that the purchases should be considered temporary, and that they would be unwound when the crisis passed. Since then the Fed has not sold a single Treasury and has used every penny of interest and principal repayments to buy more Treasuries. Should the Trump deficits force the Fed's balance sheet into the stratosphere, it will be obvious to all what the Fed is doing.

America was able to survive Ronald Reagan's debt experiments because we started borrowing from a position of relative strength. But the debt took its toll, and we are now a shadow of our former selves.

Yet rather than reversing course before it's too late, Trump may just step on the gas, assuring we go over the cliff that much sooner.


Fillon win sets up bitter battle with Le Pen over future of France

Far-right National Front leader to tilt further left to appeal to disenchanted working-class

by: Anne-Sylvaine Chassany in Paris


François Fillon secured an emphatic victory in France’s centre-right primary by shifting firmly to the right on the economy, social issues and law and order. But taking on Marine Le Pen in next year’s presidential elections could prove a more difficult task.

The leader of the far-right National Front is preparing to tilt further to the left and appeal to disenchanted working-class voters in her pitch for the Élysée, exploiting popular anger towards the elites and the breakdown of old party loyalties.
“With Fillon’s candidacy, Marine Le Pen will jump to the defence of the more vulnerable parts of the electorate — those who feel they are the losers from globalisation and who want more protection from the state, not less,” said Bruno Cautres, professor at Sciences Po University.
Mr Fillon seized the nomination for the Republicans by appealing to a well-off conservative electorate seeking a return to authority and a traditional law and order agenda, and who were tempted by his economic platform that involves taking on the unions and slashing public spending.

He also portrayed himself as someone who would bring strength to the presidency after what many view as the weak leadership of the unpopular incumbent François Hollande and vowed to tackle homegrown radical Islam and restrict adoption rights for homosexual

The former prime minister won more than two-thirds of the 4.5m votes in Sunday’s primary run-off, easily beating the one-time favourite Alain Juppé whose broadly centrist pitch included a more liberal stance on Islam and moderate reformist platform.

Victory for practising Catholic Mr Fillon was secured by winning the backing of the provincial middle classes irked by social legislation such as legalising gay marriage and of rural voters demanding a tougher line on immigration.

The success of his strategy underlines a wider rightward shift in the French electorate on social issues, said Luc Rouban, researcher at CNRS. “We are observing a strong desire for authority across all categories of voters, including the working class and parts of the leftwing electorate.”
Supposing Mr Fillon and Ms Le Pen make it into the second round of voting in next year’s presidential election, polls suggest Mr Fillon would be able to defeat the FN leader thanks to support from mainstream voters from the left as well as the right.

Indeed, there are signs of nervousness within the FN that a Fillon candidacy will harm the party’s gains in regions such as the Riviera, where Marion Maréchal-Le Pen, Ms Le Pen’s niece, made big electoral strides in recent local elections with a classic anti-immigrant, pro-small business platform.

Hailed by some as the true ideological heir to party founder Jean-Marie Le Pen, Ms Maréchal-Le Pen has, like Mr Fillon, sought to exploit voter frustration over issues such as gay marriage.

“Fillon is posing a real strategic problem,” she said last week. “He is more dangerous for the FN.”

Yet a Fillon candidacy also helps to legitimise her aunt’s moves to embrace blue-collar workers and accelerate her transformation into a defender of the poor, low-skilled and unemployed.

Since taking over the leadership from her father in 2011 Ms Le Pen has puzzled FN hardliners by developing an economic programme that embraces elements of socialism and statism. She has called for the retirement age to be brought back down to 60, demanded a bolstering of public services and developed a protectionist programme that involves leaving the EU, restoring tariffs and national border controls for people and goods.

This strategy has helped her party thrive in areas of France that have felt the brunt of deindustrialisation, tapping into growing disillusion among traditional leftwing voters who feel abandoned by the mainstream political class. It is also likely to resonate with civil servants who have become Mr Fillon’s primary targets in his spending cuts plan.

Nationwide, about 45 per cent of blue-collar workers and 38 per cent of unemployed people or youngsters seeking their first job say they plan to vote for Ms Le Pen in the presidential elections, according to the latest data from Cevipof.

Whether Ms Le Pen can defy the pollsters who predict she will ultimately lose the election hinges on whether she can mobilise these voters, who make up about 40 per cent of the working population but whose turnout has tended to be low.

“The FN is gaining ground with the blue-collar workers and the lower earning employees,” Mr Rouban said. “Will Fillon be able to adopt a populist stance to attract them in the second round of the elections? Fillon is speaking to the bourgeoisie, the high earners and the business community at the moment.”

Ms Le Pen has remained silent since Mr Fillon’s nomination, leaving it to her lieutenants to go on the attack. “Fillon’s economic programme is extremely worrying,” David Rachline, her campaign manager, said on Monday. “He wants to tear down social security. The most vulnerable will no longer have healthcare.”

But the FN’s shift poses a serious threat to Mr Hollande’s Socialists, who are mired in divisions and torn over how to deal with the political weakness of a leader who has yet to declare whether he will seek re-election.

Mr Cautres said the pressure is on the Socialists to find a way to regain the initiative to fend off Ms Le Pen’s hostile takeover on its core voters. “The left cannot afford to let Ms Le Pen emerge as the main defender of the working class.”

Although polls continue to show that Mr Fillon will prevail and that Ms Le Pen cannot win the presidency, the outcome of the election is more uncertain than ever. “Those surveys are meaningless,” Mr Cautres warned.
 


Sentiment Speaks - We Need To See A Dollar Consolidation (Not Crash) For Gold To Rally

by: Avi Gilburt




- Price action over the past week.

- Anecdotal and other sentiment indications.

- Price pattern sentiment indications and upcoming expectations.
 
Price Action Over the Past Week
 
The market followed through to the downside right towards our long term support regions we have been noting since we identified this corrective downside action.
 
Anecdotal and Other Sentiment Indications
 
Isaac Asimov once said: "Your assumptions are your windows on the world. Scrub them off every once in a while, or the light won't come in."
 
So, let's scrub some assumptions.
 
Many have certain assumptions they hold to be truth. One recent assumption I saw revived by the gold bulls is that "seasonality" will certainly cause gold to rally strongly in the fall this year. Well, I hear no one pointing out that this failed last year and it has thus far failed this year. In fact, the market moved in the opposite direction of such expectations. But, the bigger problem I have is that those who were proffering this perspective just only weeks ago as they were pounding the table about an impending rally have now gone silent to this perspective. Is this the intellectual honesty we should be demanding of those we read?
 
Another common mantra is that gold moves opposite of the dollar. So, when one sees a dramatic move in the dollar, one automatically assumes we will see an equally dramatic move in gold. It really is a shame that history does not support this perspective.
 
The common expectation is that a dramatic move in the dollar will certainly "cause" an equally dramatic move in gold. And, we are hearing this quite loudly in today's market, with many even calling for relative movements in each in a linear fashion. I know that no matter what facts I show, most will still discount my presentation, since they "know" otherwise, but feel free to ignore the facts of history at your own peril.
 
So, for those with an open mind, let's actually look at the history of the two put together on a chart going back over 30 years.
 
DXY/Gold Click to enlarge
As you can see, the price of gold topped in 1980, which was well before the price of the DXY began to rally in 1981. Now, in 1981, when the dollar began its powerful rally, the price of gold was around $400 an ounce. And, after the initial 2 year rally in the dollar, gold still closed the year of 1983 near $400. Also, take note of the strong rally seen in 1982 in the dollar, with gold also seeing a rally during the year at the same time. Not possible, right? Well, we have seen this happen many times in history.
 
Now, the first major move down we have seen on this chart was a drop in the dollar of almost 50% starting in 1985. Yes, this was the most dramatic move by the dollar during this entire time frame.
 
Yet, during that dramatic dollar decline, gold could not even muster enough power to move back over the highs it struck in 1980. Heck, it could not even muster enough power to move back over the lower high it struck in 1983. Let's be honest here. The most dramatic decline in recent history in the USD saw almost no relative correlative movement in the price of gold.
 
Would not a true correlative or causative relationship almost require gold to have strongly exceeded the high struck in 1980 with such a dramatic decline seen in the dollar? This alone should make you question this theory, but there is more.
 
Between 1995-2002, the DXY experienced another strong rally. Yet, during that time, did we see a commensurate strong price drop in gold? No, for the most part you can say it had a downward bias, but for the largest part of that dollar rally, it mostly just went sideways.
 
Then in 2001, the dollar did top and gold did bottom. But, take note that the bottom was just below the bottom struck in 1985 when the dollar hit is major peak. Is this the type of correlation we would expect?
 
And, then, we saw one of the largest and strongest rallies in gold's history. Yet, during that same time, all the dollar did was consolidate sideways. Is that the type of correlation we would expect?

In fact, if you look closely at certain periods of time, you would even note times where the dollar and gold both rallied over 10% together!
 
I guess the most honest perspective we can glean from this chart is that when one of these instruments moves big, the other is likely consolidating. That is probably the most honest "correlation" I can come up with. But, to assume that a rally in the dollar will certainly "cause" a commensurate drop in gold or vice versa is simply not supported by market history over the last 40 years. But, I am sure many will disagree since they "know" otherwise.
 
Price Pattern Sentiment Indications and Upcoming Expectations
 
As long as the market holds over our primary long term support regions, I still maintain the perspective that we are completing a corrective pullback in the complex. The ideal supports are the 16 region in silver, 111/112 in GLD and 19.80 in GDX. As I have noted before, we can certainly see a spike below those ideal support regions to scare investors, but if we see a relatively immediate reversal from those spikes, that is usually the sign we see when the market forms a bottom.
 
At this point in time, I still have many signals that we "should" be bottoming. And, as long as we remain over support, I maintain that this is just a corrective pullback in a larger bull market mover off the December/January lows, with an estimated 70% probability. Should we see silver break down below 15.50 and GDX break below 16.50, it shifts the probabilities towards new lower lows seen in the complex.


Europe Against the Ropes

Ana Palacio

Havel statue in DC


MADRID – On November 8, as Donald Trump was sealing his shocking victory in the United States presidential election, a conference in Brussels commemorated the legacy of the late Václav Havel, the first post-communist president of Czechoslovakia (and later the Czech Republic). As the world enters the Trump era, that legacy could not be more important, especially for Europe.
 
It is hard to imagine two figures more different than Havel and Trump. The former was an artist and intellectual who fought his entire life for truth, working tirelessly to bring out the best in people and societies. The latter is a self-obsessed huckster who rose to power by playing on people’s basest emotions.
 
Havel’s values have much in common with those that drove, after World War II, the creation of the liberal world order, which has brought unprecedented peace and prosperity. Trump’s election, however, suggests that the US may no longer uphold those values, much less continue to fulfill its post-WWII role in maintaining international order.
 
The resulting strategic lacuna creates an opportunity – indeed, a desperate need – for some other global actor to take up the mantle of leadership. The European Union – which, more than any other global actor, has internalized and operationalized the ideals and principles that undergird the liberal world order – should be the one to do it. The problem is that, for now at least, the EU does not look like it can.
 
The EU has made valuable contributions to the liberal world order, from setting an example on climate change to helping push forward a workable deal to contain Iran’s nuclear program.

But, so far, it has not shown a capacity for real global leadership. Consider the disastrous 2009 Copenhagen climate-change conference, the bungled Libya intervention, or, most painful, its inadequate response to the ongoing migration crisis.
 
In short, while Europe has been a solid team player, it has not been a very good team captain.

This is not for lack of hoping. Establishing the EU as a pole of global power was the goal of the much-maligned 2003 EU security strategy, to cite one example. Following Trump’s victory, EU High Representative for Foreign Affairs and Security Policy Federica Mogherini declared that the EU is becoming an “indispensable power.”
 
But, as so often happens in Europe, there is a huge gap between rhetoric and reality. The poorly attended emergency meeting of European foreign ministers following the US election is a stark reminder of just how far Europe has to go to fill the gaping hole that Trump’s abdication of America’s global responsibilities would create.
 
The truth is that the EU lacks both perspective and clout. To be a pole requires magnetism, produced by either hard or soft power. During the early 2000s, the heyday of EU enlargement, Europe had this pull. And it may have had this pull as recently as the 2013 Euromaidan protests, when young Ukrainians died in the name of their country’s potential links with the EU. Today, as the EU and its member states look inward, that attraction is gone.
 
Now, as Brexit plays out and the transatlantic partnership becomes unmoored, the EU could well unravel. If not, the most likely alternative is that it becomes a platform on which its hegemon, Germany, can stand and lead. In some ways, the EU is already well down this road. It is a truism that nothing gets done in Brussels these days without the German government’s acquiescence. Chancellor Angela Merkel’s unilateral pledge to welcome refugees and the German-led EU deal with Turkey to stem refugee flows underscore this reality.
 
This outcome would be highly problematic – even tragic. The EU was supposed to be a supranational endeavor, shaped by the spirit of collective action for the common good that Havel championed. Though Germany is surely a benign hegemon, mono-national domination of Europe controverts the very basis for the EU’s creation.
 
On a more practical level, Germany will not be a strong enough international champion for Europe.
 
In our increasingly Hobbesian world, demonstrations of conventional strength are needed.
 
Germany’s traditional aversion to hard power will hamper its ability to project its influence – and Europe’s – globally.
 
There are, to be sure, ways the rest of Europe can help. Most notable, the long-stalled effort to coordinate and streamline European defense could be reinvigorated. Fortunately, there have been signs of life on that front in recent weeks, with European foreign and defense ministers agreeing to move forward on cooperation. Placing those efforts under de facto German leadership is not optimal, but it may be the best possible outcome, given the circumstances.
 
Ideal outcomes in Europe are not realistic. And, as Havel pointed out, clinging to optimism – the belief that things will end well – is pointless. Instead, we must find grounds for hope – the belief that things will eventually make sense. The only way to do that is to be honest with ourselves and take a sober look at what we can and must do to ensure the most that can be achieved.
 
Europe has the potential to play a leading role in the world, but lacks the self-confidence and dedication to make it happen. It is time to recognize that, and to acknowledge the real threat that the liberal world order faces. Only then can we figure out how, realistically, to safeguard our interests and ideals in a challenging world. This, I believe, would be Havel’s message today.