Why Trump's Plans Won't Save Us
Why Trump's plans won't save us... A lesson in the 'negative multiplier'... Empirical data vs. Keynesian theory... Doing a 'Hertz'...
Trump won...
Some people are happy. Some people are acting like someone shot their dog. But nobody likes my answer about what Trump means for the markets. So what do I (Porter) believe will happen now?
Well, my answer flies in the face of virtually every modern economist and pundits on CNBC. Virtually everyone believes that government spending and/or tax cuts will have a powerfully positive effect on our economy.
The Republicans believe tax cuts and military spending are the basic formula for economic prosperity. The people cheering today believe that Trump's wall (his announced infrastructure spending), his tax cuts, and his estimated $6 trillion budget deficit over four years will create winners in the stock market and wealth for our nation.
In some limited ways, that will prove to be true. The Pentagon, for example, is the world's largest consumer. It buys more oil than any other entity. And if Trump builds a wall across our southern border, he's going to buy a lot of steel. But in other, far more important ways, the idea that government spending and government debt is a positive force in the economy is completely wrong. Fatally wrong.
We're in the midst of a weeklong series of Digests that I'm writing in order to explain what I believe will be the best and most important series of trades of my entire career. As you surely know by now, it's the idea behind our brand-new service, Stansberry's Big Trade.
I believe we're approaching an important new credit-default cycle, which will create the largest legal exchange of wealth in history. Investors in highly leveraged equities will be wiped out. Investors who can anticipate this massive wave of coming corporate default will make a fortune. And that's my goal – to help you understand why this cycle is inevitable so you can position yourself to profit from these events.
As if on cue, we saw the car-rental companies "blow up" yesterday because of distress in subprime car loans...
It was a superb example of the far-reaching and poorly understood influence of the credit markets.
Today, given Trump's unexpected victory, I'd like to focus on the role government is likely to play in the coming debt crisis.
I want to make sure you understand... no matter who is president, no matter which party is in power... the only thing our government can do about a credit cycle is make it worse.
You only need to understand two economic ideas to see through the media news and know what's really going to happen next. The economic forces I describe below are far more powerful than any particular candidate or political party.
The first economic concept is easy: It's the declining marginal utility of debt.
This won't surprise any subscriber who has ever owned a business or used a credit card. At first, small amounts of debt create large percentage changes in spending and investment. But, as debts add assets and matching liabilities to your balance sheet, additional debts make a smaller and smaller percentage change in growth.
Say you're a college student. Your income may be $10,000 a year, working a part-time job. If you take out a $5,000 loan, you can increase your spending dramatically – a 50% increase. But after your fourth year of college, you will have compiled $20,000 in loans on your balance sheet. This plus your income for the year means an additional $5,000 in debt will only increase your asset base by 16%. And as your debts grow, the marginal increase in utility provided by each additional dollar in debt will decrease.
As your debts (like our government's) tally toward $20 trillion (or more than 100% of GDP), the marginal utility of additional debt can actually become negative.
First things first...
Before we move into the negative implications, let us first prove our contention that, like every other economic variable, debt suffers from declining marginal utility.
Just look at the following chart. We've taken actual U.S. GDP (the total production of our economy each year) and divided it by total public debt. In the 1960s (at the very top of the chart), each additional dollar in government debt produced at least an additional dollar in GDP growth because government spending was a smaller part of the economy and government debts remained small.
Of course, as spending and debts grew, we began to see the effect that the marginal utility of deficit spending started to have. Compared with debt, GDP began to shrink as each dollar of additional debt led to less and less growth in GDP...
This isn't controversial or surprising...
Mainstream economists tend to ignore the marginal utility of debt... But they don't deny the concept. What follows, however, is extremely controversial. Lacy Hunt and a growing number of academic economists have found, using empirical data, that contrary to all conventional Keynesian economic theory, government spending actually hurts the economy over time.
Here's Hunt summarizing the most recent academic data...
Based on academic research, the best evidence suggests the [government expenditure] multiplier is -0.01, which means that an additional dollar of deficit spending will reduce private GDP by $1.01, resulting in a one-cent decline in real GDP.
The deficit spending provides a transitory boost to economic activity, but the initial effect is more than reversed in time. Within no more than three years the economy is worse off on a net basis, with the lagged effects outweighing the initial positive benefit.
Trump's negative impact on GDP...
While Trump's wall-building and tax cuts can temporarily boost GDP, within three years, his spending will cut into GDP at a rate roughly equal to 1% of total government spending.
This is completely counterintuitive. Despite the large number of different academic studies that prove a negative government-spending multiplier exists across multiple countries and time periods, many people can't accept the idea.
Hunt believes it can be explained by looking at how government spending has changed over time. He points out that since the early 1970s, "mandatory" government spending (on social programs like Medicare and Social Security) has grown from being roughly 50/50 with discretionary government spending (like the Pentagon) to being almost 70% of government spending. These kinds of transfer payments can't produce any wealth. They're simply a redistribution of income that's being produced elsewhere in our economy.
An even more fundamental explanation...
Research shows that a negative multiplier only exists when we have a large public debt burden – more than 70% of GDP, according to most studies.
Studies also suggest that the magnitude of the negative multiplier increases with debt load, but in a non-linear way. This can only be explained by the Austrian School of Economics ideas about game theory (as we discussed in yesterday's Digest): As individuals in an economy begin to fear a monetary collapse, they cause additional economic disruption – like buying gold, fleeing a currency, or simply withdrawing from the legal economy.
When you put these ideas together – the declining marginal utility of additional government debt, the negative multiplier of government spending, and the non-linear impact of massive government debt burdens – it's hard to believe that the president can do anything to alter the course of our ongoing credit-default cycle. The only prediction that's consistent with sound economy theory is that the government is going to make this default cycle a lot worse.
Or... to summarize... it's not likely that a government that's facing its own $20 trillion debt burden is going to be able to do much to help the unwinding of $1 trillion to $2 trillion in private obligations over the next three to five years.
Tomorrow, I'll show you how these big macroeconomic themes of the declining marginal utility of debt play out in actual individual companies.
By finding companies and industries that have been completely corrupted by unsustainable debt loads, we can safely hedge our portfolios from the risks of the coming default cycle. We believe that making 20 or 30 times your money in some of these names is likely.
(If you haven't signed up for the free webinar I'm hosting next Wednesday, November 16, at 8 p.m. Eastern time where I'll discuss exactly how to make these life-changing gains, you can click here to reserve your spot.)
When you know that a company cannot ever afford to repay its debts, it's only a matter of time until it defaults. And long before that happens, its stock will pull a "Hertz."
You can either be a winner or a victim when that happens. It's up to you.
New 52-week highs (as of 11/8/16): Axis Capital (AXS), short position in Hertz Global (HTZ), iShares MSCI Global Metals & Mining Producers Fund (PICK), Gibraltar Industries (ROCK), and Sysco (SYY).
In the mailbag... I've promised to answer every question asked about Stansberry's Big Trade and our view of the macroeconomic forces pushing the next big credit-default cycle toward us in 2017-2021. Please take advantage of the time I'm putting toward these efforts by asking any question you have, no matter how big or small. I promise, whatever question you have, there are a few thousand others wondering the same things. Thanks – send your questions here: feedback@stansberryresearch.com
"May I have your permission to forward yesterday's Digest to a few close friends in order to specifically urge them to sign up for your newsletters? Also, are they allowed to sign up for your free webinar for next Wed? I too strongly believe in learning and you are the best ever in the field of finance. They need to hear you and sign up for themselves to save themselves and their families from the chaos that is coming. Thank you for the excellent work you do. In my 70 years, living in both the USA and Europe twice, I have found no one that stands even knee high to you and your staff. Saying well done doesn't cut it. Superb is more appropriate." – Paid-up Flex Alliance Subscriber Steve K.
Porter comment: Yes! Please feel free to forward all of the Digests from this series to anyone you think will take the time to read them and consider these ideas carefully. The more people who understand the impact of the coming credit-default cycle, the better for our country.
"Something that is forgotten... The government can't be understood (or predicted) by the study of groups. It is individuals, making individual decisions to maximize their own utility, that will guide the Government not the other way around. There is no such thing as Government. There are only people using the force of law to effect behavior that helps their personal objectives, regardless of how rationalized as humanitarian or altruistic." – Paid-up subscriber Bill P.
Porter comment: How very Austrian of you. And correct. When politicians start talking about the "national interest," I like to remind folks that there's no such thing. We live in a country of millions of competing interests.
"Damn, that was a good article. Porter Stansberry is a great writer. I'm convinced he could be a great novelist if he ever wanted to add to his achievements. Think about the book and movie opportunity of exposing the political corruption and what it has done and will further do to this country. Think about the updating of Atlas Shrugged. This would reach and influence so many people." – Paid-up subscriber Dave B.
Porter comment: Dave... I don't have to write that book. My friend Doug Casey already did. And what a read! His new novel, Speculator, is the best book I've read in years. Get a copy. You'll thank me. Also, check out my review on Amazon.
"Might as well take this opportunity to thank you for completely changing the way I invest and preparing me for the coming problems. I would be lost without Stansberry Research." – Paid-up subscriber Joshua F.
Porter comment: Thanks very much. I'm very proud of the work we've done, especially of late in regard to the credit cycle. Both our terrific track record on the distressed-debt side (in Stansberry's Credit Opportunities) and our recent short recommendations have generated a huge amount of "alpha" – returns that are not correlated to volatility or the stock market – for our subscribers. I hope more and more subscribers will recognize the quality of our work and begin to take advantage of it for themselves and their families. Nothing makes me happier than to know we've given our subscribers a huge advantage over Wall Street.
"Porter, just a simple and humble thanks for your generous heart and efforts. To share what you know to be valuable tools with people like me who don't have the time or the energy that are necessary to find and understand all the gems in your pockets is a priceless asset that I 've appreciated for the last ten years as a loyal reader and subscriber." – Paid-up subscriber Craig C.
Porter comment: What a terrific testament to our team's efforts over many years. Thank you for your note, Craig. Thank you for your patience, trust, and loyalty to our business.
Regards,
Porter Stansberry
Baltimore, Maryland
November 9, 2016