Submitted by Eric Peters, CIO of One River Asset Management, as excerpted from his Weekend Notes letter to investors
“Three things drive changes to your deficit,” said the CIO. “Economic growth, unemployment and military spending,” he continued. “At the 2000 cycle peak, all three were around today’s levels, yet back then America ran a 2% budget surplus.” The Bush tax cut, equity collapse and recession soon flipped surplus to deficit.
“But now you’re running a 4.5% budget deficit, which if you cyclically adjusted to the 2.3% surplus at the 2000 cycle high, you’re running a 6.8% deficit at the height of your 9yr expansion. America’s numbers make no sense.”
“When you’ve lent money to someone whose numbers no longer make sense, you look for things to cut,” continued the same CIO. Only entitlements, healthcare and military spending cuts have a material impact on US deficits.
“Then you need to assign a probability to any of these things being cut.” He laughed, because we all know there’s a 0% probability that the US will cut anything.
“So your numbers won’t work, which means the adjustment will come through a bond collapse which the Fed will prevent, or a dollar collapse, which it can’t prevent.”
“Trump is channeling Reagan, but from a far worse starting point,” continued the same CIO. “The 1970s and 1980s had very high tax rates, and a case was made that cuts paid for themselves.” They didn’t.
“Now tax rates are much lower, and debt-to-GDP is much higher.” Asset prices are dramatically higher, interest rates are far lower, infrastructure is crumbling. Reagan spent 6.5% of GDP on military, the US spends 3.5% now, heading higher too.
“Nothing you’re doing makes sense. And it will lead us all back to the dollar volatility of the 1970s-80s.”