Investment Views

Spend and borrow. Rinse and repeat.

Before the year is out major countries including Mexico, India, Iran and the UK will all have witnessed electoral contests that, like the European Parliamentary elections in early June, will have a significant bearing on domestic and regional affairs, but none will have as much global impact as the US Presidential election in November.

A repeat of the 2020 “battle royale” between Presidents Biden and Trump will see both candidates pursue a second term. Whoever resides in the White House this time next year, the only thing guaranteed is that America will be run by its oldest ever Commander-in-Chief. Come inauguration day, in late January, Biden will be 82 with Trump being just four years younger. Interestingly Bill Clinton, who hung up his Presidential boots over 20 years ago, is younger than both candidates.

The campaign trail is sure to be fractious, unpredictable and replete with near constant character assassinations, yet the economic policies of the two rivals are much closer aligned than they would have you believe.

Take trade as an example. During his first term, President Trump adopted an overtly protectionist stance, implementing “America First” policies that saw average trade tariffs rise from 3% to 19% on his watch. A trade war “redux” is all but guaranteed should he secure a second term, but another Biden administration would likely follow suit. Few, if any, topics muster bipartisan support like the US/China trade relationship and last month saw the Democrats evidence their own protectionist bias with 100% tariffs being imposed on Chinese electric vehicle imports and other “green energy” goods.

Common ground has also emerged across fiscal matters. The federal budget deficit began trending higher as soon as Trump took office with the total national debt rising from U$20trn to U$28trn between 2017 and 2020. Admittedly, the bulk of the acceleration came in his final year as the Covid pandemic triggered an unprecedented scale of fiscal support, which saw the budget deficit explode to 15% of GDP; a peacetime record. That said, the trend of higher borrowing was already well underway with Trump’s flagship “Tax Cuts and Jobs Act” single-handedly adding U$1.5trn to the country’s debt load in 2017.

Team Biden has also been a prolific spender during both bad economic times and good. Here too, the initial stimulus (the 2021 “America Rescue Plan”) was justified by the lockdowns with a U$1.9trn package of tax credits and direct household payments helping to stave off a major economic shock.

However, fiscal profligacy has remained a constant feature despite the strong, post-Covid bounce in both GDP and inflation over the past three years. Over U$500bn of additional and largely unfunded energy transition and infrastructure investments have been committed to since the 2021 stimulus, meaning “Bidenomics” has taken the US national debt to a gargantuan U$35trn in short order. That’s a total increase of U$15trn, or 75%, in just seven years.

The resulting budget shortfalls mean US government borrowing is rising by a staggering U$1 trillion every 100 days, which begs the question why? There is always a political imperative for any incumbent government to goose up the economy and garner voter support just before an election, but hefty unfunded outlays have become the norm in recent years, suggesting another rationale is at play.

After decades of continual and accelerated debt use the US economy, like many, is backed into a corner. Even at relatively low borrowing costs, many consumers and businesses struggle to service their debts, which constrains private sector activity and places the onus increasingly on government spending to drive economic growth.

In turn this forces the state to borrow more, reducing the amount of capital available beyond the public sector and, more often than not, forcing sovereign bond yields higher. The result is even weaker private sector activity and the birth of a vicious cycle that is hard to break unless the politically-unappealing option of withdrawing the fiscal support comes to bear.

Simply put, the US has entered an era of “fiscal dominance” characterised by persistently high budget deficits and extreme government borrowing regardless of where executive and legislative power lies. But what does this mean for markets?

The biggest implication of sustained fiscal largesse is the need for the Central Bank to print money and inject new dollar funds into the commercial banking system. These funds are used to buy up the sovereign debt, which comes with the twin benefit of helping the government to finance its spending plans and preventing bond yields from spiralling higher.

Since last year’s regional banking crisis, the Federal Reserve has deployed various tactics that increase the amount of money circulating around the financial system, suggesting they view bond market stability, not low inflation, as their primary aim. This means “backdoor” monetary support is likely here to stay and we expect a variety of pro-liquidity tools will become a permanent fixture over the coming years as the national debt heads towards U$40trn and beyond.

At face value this is a positive for risk assets like equities and precious metals, which tend to act as a hedge against policy excess and the resulting debasement of the US dollar. Indeed the recent breakout in the gold price, which is up 20% over the past six months, suggests a growing number of market participants are wising up to the need for protection against ongoing money printing.

Policymakers’ dovish leanings will be tested if core CPI inflation accelerates well above the 3-4% range that appears to be the new normal. That could well come to pass in 2025 if the next President feels the urge to splurge as soon as his second term begins. Until then, inflation should remain sufficiently benign to keep markets becalmed and with the Biden administration hinting that yet more stimulus could be unleashed before voters head to the polls, the stage is set for another wave of liquidity to emerge and amplify the “risk on” trend in the second half of the year. Just brace for a lot more market volatility as soon as the political barbs begin in earnest, particularly with Trump inching ahead in the polls.