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The Fatal Flaw in Trump’s Economic Plan……

Does Trump’s economic plan carry the seeds of its own demise?

Trump’s blasted Janet Yellen and the Fed for keeping interest rates artificially low. But if he’s going to spend over $1 trillion on national infrastructure over the next decade, he might have to whistle a different number…

Trump’s plan calls for a combination of public and private investment in roads, bridges, airports, utilities, etc.

Low interest rates are the key. Says Wilbur Ross, billionaire investor and Trump economic adviser, “With interest rates so low, this has got to be the best time from a break-even point of view, from a societal point of view.”

But Ross indirectly points out the joker in the deck: “With interest rates so low”…

Trump’s massive spending proposals have raised the specter of inflation at long last. But those same inflation expectations have the Fed ready to pounce. Fed funds futures are showing a 91% chance of a rate hike next month.

If Trump’s plans make it over the hurdles and inflation starts flexing its muscles, the Fed might have to start raising interest rates aggressively to put a lid on it.

But could those rising interest rates play the devil with the entire proposal? Could they, in fact, sabotage the whole thing? Trump’s proposals seem to make sense only in a low interest rate world. Their assumption of cheap money may be the fatal flaw, the hole below the waterline…

Goldman put the Trump plan under its microscope. It concluded that “Mr. Trump’s infrastructure plan implies that a significant increase in interest rates could be a hurdle for the plan’s feasibility.”

And Kessler Investment Advisors says that “the Trump administration [needs] low rates to try to sell fiscal stimulus to the nation…”

Here’s why…

When interest rates rise, so does the cost of servicing debt — not just new debt, but old debt that gets rolled over in the form of freshly issued Treasuries. And they’re rolled over at the going rate, not the old one. So the cost of servicing all that debt rises if rates rise.

Despite the mounting $19 trillion national debt, servicing that debt has been a manageable affair for the past several years.

Last year, for example, Uncle Samuel forked over $223 billion to keep the chains of debt around his neck. That’s less than he paid to service his debt 10 years ago, when the national debt was only about 40% of today’s.

The difference? Low interest rates. The Fed’s monetary contortion acts over the past eight years have nailed rates to the floor. So despite the higher total debt, it’s actually cost less to finance.

If rates start rising, a different… darker… picture emerges…

The Fiscal Times reports the findings of the Committee for a Responsible Federal Budget. Those findings show that if 3-month Treasuries rise to about 4% by 2018, and if 10-year Treasuries rise from today’s 2.24% to roughly 5.2%, “interest payments on the federal debt will soar to $505 billion in 2018.”

That’s $282 billion higher than last year. The point being, debt doesn’t seem to matter… until it does. University of Chicago finance Professor John Cochrane:

Here’s the nightmare scenario: Suppose that four years from now, interest rates rise 5%, i.e., go back to normal, and the U.S. has $20 trillion outstanding. Interest costs alone will rise $1 trillion (5% of $20 trillion) multiplying already unsustainable deficits! This is what happened to Italy, Spain and Portugal. Don’t think it can’t happen to us. It’s even more likely, because fear of inflation — which did not hit them, since they are on the euro — can hit us.

Macro economist Richard Duncan is a Daily Reckoning contributor. Bear in mind Richard’s a boomer for quantitative easing and ultra-low rates. But he says in no uncertain terms that interest rates must not be allowed to rise to normal levels. Richard recently fired off a letter of advice to President-elect Trump. From which:

You have… been elected at a time when the global economy is in grave danger of collapsing into a depression, one from which it might not recover for decades — if ever… If interest rates go up significantly, the bubble will pop and the New Great Depression will begin. One wrong move on your part and the economy will spiral out of control into a depression. It won’t be short and sharp like 1921. It will be long and devastating like 1929–1945.

One wrong move doesn’t allow much wiggle room. Richard says Trump can’t impose trade tariffs or cut taxes, which are both planks of his agenda. They’re both inflationary in Richard’s estimate. And inflation will bring higher interest rates…

Tariffs would drive up the price of imports and fuel inflation. And cutting taxes would increase the budget deficit, forcing the government to borrow more. Trump needs to spend on infrastructure, says Richard. But he has to get it right, no tariffs or tax cuts… or else face the above scenario.

We don’t pretend to know if Richard’s right or how it all plays out in the months and years ahead. But of this we are certain: Donald Trump, president, cannot be Donald Trump, reality show star.

The only question is… can he successfully switch roles?

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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