By James H. Nolt
Last week, I promised to explain how rising debt creates an incentive for debt crises worldwide. One of the biggest errors of textbook economics is the assumption that crises are mistakes—the result of bad policy. Nothing in mainstream education explains why crises are a profitable solution for powerful interests. Needless to say, a large part of the reason for this is the chronic neglect of the role of private power in textbook economics.
The media is incapable of guessing what Trump will do next, in part because they pay too much attention to words and too little to economic context. Business interests are often better informed about the likely future than either the media or voters, so it is worth paying attention to market reactions.
The stock market reaction to Trump’s election was mixed. Not surprisingly, trade-dependent stocks were nervous, here and abroad, because of concern about Trump’s potential protectionism. But they were not as alarmed as his campaign rhetoric might have suggested, because as Obama has said during his world tour, Trump in power may act differently than Trump on the campaign trail. Obama talks about the restraining effects of vague “realities,” but I interpret those as the political-economic context, including private power.
Some stocks shot up on the announcement of Trump’s victory, most notably private prison companies. There may be plenty of “customers” to lock up, not just illegal immigrants. But financial stocks have also done well. This may seem surprising since Trump campaigned against banker influence, winning over many voters in the process. Perhaps finance is excited because a Republican Congress is likely to decrease the already limited taxation and regulation of finance. I would bet Trump will not veto regulatory relaxation despite campaign rhetoric that seemed to position him as an anti-bank populist.
The other major market reaction to Trump’s victory is a significant fall in bond prices—in other words, a rise in interest rates. Most people understand less about bond markets than stock markets because the media focuses on the latter. Bond prices tend to fall for three reasons: (1) increasing risk that borrowers will not be able to pay; (2) increasing demand for loans, meaning many are trying to borrow relative to those willing to lend; and (3) decreasing willingness of creditors to lend at current interest rates. If creditors believe that they can earn higher returns on their capital investing in some way other than buying bonds, they may sell their bonds and invest in some other asset instead. Selling pressure tends to reduce the bond price and thus increase the bond yield or effective interest rate. All three reasons are currently in play.
As I argued last week, Trump’s fiscal policies are likely to result in a new round of “borrow and spend,” so we can expect loan demand will rise. It will rise even more if Trump succeeds in stoking a private sector investment boom, since rapid investment is typically funded by private borrowing, but I am skeptical about this. Yet, at least, government borrowing is likely to soar.
However, if interest rates are rising, then the cost of funding government debt is also rising. More and more of the government budget will be consumed by debt servicing as interest rates rise. This will tend to squeeze out other forms of government spending, yet Trump has promised to increase spending on the military, border security, and probably infrastructure. If the U.S. is to avoid being caught in a Greek-style death spiral of rising debt and rising debt cost, the cost of interest payments must be compensated by budget cuts somewhere else. If these cuts are not severe, the debt spiral will force the issue, as happened in Greece.
Trump and the Republican congressional leaders have already signaled, for those not deaf to issues of political economy, where the pain of cuts will come. Government employees will be squeezed. Their pay and pensions, not corruption at the top, will be the target of deep cuts. It is always easier to squeeze the weak rather than curb the abuses of those with real power.
Many Trump voters responded enthusiastically to his promise to “drain the swamp” in Washington. During Trump’s tirades, his examples of rampant corruption were “crooked Hillary” and her “pay to play” system of political corruption, exhibited by alleged trading of Clinton Foundation contributions in return for access to Clinton when she was secretary of state. Trump also pointed out (as Bernie Sanders did, too) bankers’ exorbitant payments to Clinton for speeches. Such rhetoric might lead hopeful voters to expect a clean sweep, starting at the top. Don’t hold your breath!
After the election Trump has already proclaimed the Clintons are “good people” rather than rushing to “lock her up,” as was so often chanted at his campaign rallies. Many liberals breathed a sigh of relief. Maybe his bark is worse than his bite. I am not so sanguine. Trump’s promises to voters are easily disregarded. Now that the election is over, he no longer needs the voters, but he does need business confidence for the economy to function adequately.
The search for individual malefactors, such as the Clintons, requires lots of expensive government prosecutors. On the other hand, if the public can be aroused against the supposed laziness or uselessness of a couple million federal government employees, they can be blamed in mass and thus significant spending cuts realized.
Nationwide, among local, state and federal workers, a big target of government bond holders is pension obligations to government employees. These represent not just a demand on current revenue, but also on future spending, when debt problems will bite deeper. Financial interests want defined-benefit pension plans to be replaced by defined-contribution retirement plans familiar to most private sector employees. These plans put the employee’s funds into the hands of professional managers who invest in a portfolio of stocks, bonds, and derivatives—products largely opaque to employees. They are promised that these plans will grow to enable a comfortable retirement, but in the fine print there are no guarantees. Indeed, during the 2008 crisis, employees worldwide saw trillions in their retirement funds vanish. This created a large part of the economic angst that mobilized Trump voters in the first place. Now government workers, who so far have been largely insulated from losses because of defined-benefit pensions, will also lose their protection against the next crisis and at the same time provide financial insiders with the funds to profit from it.
Financial interests benefit in two ways. Pensions under private financial management mean more fee income for financial advisors and financiers. In addition, large pools of funds unattended by their owners are exactly what are needed in a polarized financial economy. Insiders who want to bet in one direction using derivatives are only limited by the search of large pools of “sucker money” that can be invested on the other (vulnerable) side of insider bets, since all derivative contracts are two-sided. Unwittingly, as in 2008, the retirement funds of millions will be bet bullishly in order to fund the growing bearish bets of financial insiders who know a crash is coming and are preparing to profit from it, as before. Next week I will explain how this sort of sucker money funded the bearish bets that profited so richly in 2008. History will soon repeat.
James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.
[Photo courtesy of 401(k) 2012]