Is Steven Mnuchin A Step In The Wrong Direction?

I want to continue my discussion of Steven Mnuchin to fully contextualize his impact on the Trump administration. With the decision to hire Mnuchin as Treasury Secretary, we have received a great amount of information on how the next four years will look. I will explain the two possible directions the administration can go in based on Trump’s comments on the campaign trail. These directions determine fiscal spending and monetary policy decisions. The pick of Mnuchin tells us which direction Trump is choosing.

The first direction is a capitalist one where Trump would make sure all the infrastructure spending is paid for with spending cuts. Trump floated the idea of the Penny Plan which would cut discretionary spending by 1% per year. He also spoke about how the Fed was politically motivated and low interest rates were creating bubbles. The inference to this conclusion is Trump was in favor of winding down the Fed by having it sell the bonds on its balance sheet and let interest rates be controlled by the free market.

While Trump spoke about the Penny Plan and criticized the Fed, I recognized the chances of him executing on these proposals were less than 50%. The problem is there would be a massive correction in markets and extreme disillusion in the public sector if Trump wanted the restructure the economy to be a capitalist one. Any politician who has these goals needs to be more committed to having a limited government than Trump is. Trump does not have an ideological core, so I expected him to not follow through on those promises.

The second direction is the one Trump will go in which is a pragmatic one where the political landscape and practical implications are considered. This means the Trump infrastructure plan will add to the deficit by including public works projects which create jobs. Trump will not make big changes to the Fed because he needs the Fed to keep rates low to pay for this deficit spending. This type of pragmatism means it is practical ideologically; it can get passed by Congress with bipartisan support and the support of the American people. However, it is not practical in terms of arithmetic.

When will Steven Mnuchin realize the government can’t afford to increase deficits and cannot extend the duration of the debt? This plan is like a debtor deciding he will borrow more money at higher interest rates. If the government is already running deficits of $600 billion, there is no way the country can afford to switch from issuing T-bills to 30 year treasuries which are carrying higher interest rates by the minute in anticipation of this potential switch. There are even talks of a 100-year duration treasury bond. That would likely have an interest rate of higher than 5%. There is no mathematical way the country can afford to pay that interest rate unless big entitlement cuts are made.

Another point I must make is a correction of my article yesterday. I thought when Mnuchin was making the point that he wanted to privative Fannie Mae and Freddie Mac that he wanted to remove the government relationship with the agency. That would be the actual definition of privatization. However, it looks like he wants to revitalize the agencies and keep their government guarantee. If this is the case, this will create another housing bubble. There is especially no need to revitalize these disastrous agencies given the fact that low interest rates have already stimulated the Case-Shiller Home Price Index to the previous peak. If the Fed allowed interest rates to normalize and the government stopped backing mortgage loans, there would be a much bigger collapse than in 2008. This potential collapse is why the Fed will likely be buying mortgage loans to stop the bleeding if interest rates continue to move higher.

A second point I must emphasize about Steve Mnuchin’s plan is it calls for tax cuts on the middle class, but none on the upper class. This isn’t like Reagan’s tax cut which cut rates for the rich as well. Cutting taxes for only the middle class is a political stunt, but does not grow the economy. It is Hillary Clinton’s concept of growing the economy from the middle out which is impossible. Capital doesn’t care about economic fairness. If tax cuts for the rich were made, they could make investments which would create jobs. Tax cuts for the middle class encourage them to keep spending money which only boosts prices. High inflation would be deadly for the stock and real estate markets because it would mean the Fed would have to raise rates and burst their bubbles. My prediction that the Fed will have back stop any of these deficit policies with QE will likely come true next year. While I keep referring to ways the market bubble can burst, if the size and scope of QE 4 is large enough, we can see asset prices levitate further.

There have been news reports boasting about how how Trump prevented a United Technologies plant from moving over 1,000 jobs to Mexico. The breakdown was 800 manufacturing jobs and 300 engineering and headquarter jobs. Trump boasted about the corporate tax cuts he would bring and gave the firm $700,000 per year for a few years in state tax incentives to stay. This is unsustainable as every corporation can’t get benefits to stay in America. It is a moral hazard because any company can claim it is going to ship jobs overseas to get a tax benefit even if it never planned to go through with the action. The chances of Trump getting a 15% corporate tax rate are not 100%. Taxes are a complicated subject which are debated heavily. I can foresee Trump negotiating a 20% tax rate which may end up being too high for corporations to stay in America.

Conclusion

Steven Mnuchin is not a symbol of Trump #DrainingTheSwamp as he has a similar ideology to Republicans in the past. The plans Steven Mnuchin has discussed are mathematically impossible. I guess when a private sector business person moves to Washington, he loses the ability to do math. The interest rate on 100-year bonds would be too high for the government to pay. The 30-year bond yield is already skyrocketing in anticipation of the new supply from Trump’s deficit spending. It has risen to 3.10%. Imagine how high a 100-year bond yield would be!