Is Bannon a Mistake?

In the past 10 days since Trump was elected, there has been a mass scramble by investors and traders to determine what his policies will mean for the country as well as asset prices. I had an inkling that Trump’s presidency would not be what voters hoped for because he’s pursuing failed economic policies, but I gave him the benefit of the doubt by reviewing his infrastructure plan which ended up having good ideas because it relied on the private sector. I said I would listen to news reports to see what the direction the administration would go in. The latest quotes from Steve Bannon are deeply concerning.

Steve Bannon was selected as Trump’s senior counselor and chief strategist to the White House. There was a lot of coverage over whether Bannon was an anti-Semite or a racist, but little coverage about his economic statements. Personally, I think it’s a waste of time to delve into his innermost thoughts to determine if he hates a specific group, while I acknowledge that any of these types of actions would be reprehensible.  What I find more interesting was the statement he made today because it gives us a picture of how the next 4 or 8 years will go. The reason this economic statement wasn’t covered heavily is because it jives with what most economists and media personalities believe. They only want to cover policies they deem ‘outrageous’ because it generates more clicks and views.

The quote reported on CNBC is the following “The conservatives are going to go crazy. I'm the guy pushing a trillion-dollar infrastructure plan. With negative interest rates throughout the world, it's the greatest opportunity to rebuild everything. Ship yards, iron works, get them all jacked up. We're just going to throw it up against the wall and see if it sticks. It will be as exciting as the 1930s, greater than the Reagan revolution — conservatives, plus populists, in an economic nationalist movement." It’s scary that someone high up in the Trump administration thinks the 1930s was an exciting time considering it was the period of the Great Depression.

I have been trying to determine the political implications of how Trump going against the conservatives in the GOP will work out. Many conservatives are thankful to Trump for helping them get re-elected which is why they want to work with him. Conservatives viewed their election in 2010 as a strong statement to oppose Obama’s spending plans. This is how conservatives rationalize supporting spending hikes from one president while opposing them from another. One of the leaders of the government debt ceiling shut down was Ted Cruz. He claimed Trump’s election showed overwhelming support for Trump based on his big Electoral College win. We will see next year how that translates into support for legislation. It sounds like Cruz is willing to support Trump’s proposals even if they would raise the debt.

Getting back to Bannon’s statement, the reason why I think it is outrageous is because he fails to understand why interest rates are as low as they’ve been. Congress hasn’t previously done a stimulus because rates would skyrocket if it decided to do one. Bannon may want to check interest rates again because we’ve seen the biggest two week decline in the Barclays Global Aggregate Bond Index in the past 26 years. It has fallen about 4%. Trump’s statements are the main reason for this decline.

The idea that low interest rates allow the government to spend more money than ever before is a fantasy. Trump’s monetary policy statements during the election contradicted themselves. He claimed the Fed artificially lowering interest rates created a phony recovery with asset bubbles. In the same breath, he claimed the government should issue as much debt as possible to take advantage of low interest rates. These statements contradict each other because if low rates are creating a bubble, it implies they aren’t real. If they aren’t real, the government can’t borrow against them.

Trump is right about the interest rates being artificial and Bannon/Trump are wrong that the government can borrow at these low rates. It’s common sense that no one would want to give money to a government at possibly below the inflation rate. The reason interest rates are negative in some countries is because of central bank buying. The lack of a stimulus bill in America along with quantitative easing was actually an example of fiscal and monetary policy working in concert because fiscal spending would necessitate even more bond buying.

You can see the 10 year treasury’s response to this situation in the chart below. The yield will go even higher if these illogical policies continue to be proposed. Part of this response is caused by monetary policy which has gotten more hawkish. The chances of a rate hike in December are now 95.4%. The Fed needs to raise rates to combat the Trump inflation.

In previous months leading up to rate hikes the focus was on whether the equity market could handle it. The Fed and market participants watched with horror at how a quarter point rate hike led to a rout in stocks leading it to be, at one point, the worst start of the year ever. This time the December rate hike is causing angst in the bond market instead of the stock market. If yields continue to rise, the government will have a tougher time being able to afford the interest on the debt. Stocks which were bought because of low bond yields will eventually be sold and the bubble will burst.

Conclusion

Steve Bannon’s statement about economic policy is potentially dangerous because he doesn’t seem to articulate very well why interest rates are this low. Some voted for Trump because at least he understood the economic problems. He may not have had the solutions to get the economy going, but at least he felt the pain of everyday workers. Now we’re seeing, that maybe he doesn’t understand the problem. We’re seeing a change in the narrative which will, at best, lead to QE 4 and at worst lead the government to restructure the debt.