11/04/16
By Filippo Lecchini, Phillip Capital Inc.
The Elections are upon us and a lot of the concerns that people have revolve around the economy. Free market, trade deals, taxation, spending…these are the recurring topics. Let’s focus on one that is so often misunderstood and used by politicians to deceive the public: fiscal policy.
On every given year the Government spends (infrastructure, military, welfare, etc.) and collects money (taxes). If the Government spends more than it collects there is a deficit, a surplus otherwise
At the end of the year a deficit will increase the public debt while a surplus will decrease it. In reality it is a bit more complicated because debt can be issued along the way but that’s the idea.
This very simple fact uncovers an obvious fallacy of a lot of the political debate: promising to spend money on anything cannot come with promising to reduce taxation and balancing the budget. An honest candidate that supports spending in a certain area should explain how she or he expects to fund the projects. That can only be by raising taxes or cutting spending somewhere else unless issuing debt is the chosen way of funding. There are reasons why debt can be a convenient way to go, particularly in times where exceptional spending is needed and smoothing is desirable, but that also is a decision for which politicians should take responsibility. We all find taking a mortgage a perfectly acceptable way to home ownership however most of us would agree that the amount of borrowing should be somehow sustainable based on the income level. We often hear about funding by reducing wasteful spending and that’s a good thing, although it should be considered that many people consider “wasteful” whatever they don’t care for, whether that’s intrinsically inefficient or not.
What is ultimately the difference between funding spending with taxes versus debt? Debt simply transfers the current outlays to the future at a certain interest rate. A way for the current generation of tax payers to shift the responsibility for spending to the next and a way for the President in Office to shift the blame for the higher taxes that will inevitably come to his successor.
What about unfunded tax cuts? Cutting taxes is equivalent to issuing debt when the economic conditions or the political environment do not allow reducing the outlays. We all like lower taxes and that might make us pay less attention to a rather opportunistic way to fund the budget without displeasing the electors with reduced spending.
Whether spending is good or bad and what kind are political considerations, different people feel differently about different things. Here are some official figures and a good article:
https://en.wikipedia.org/wiki/History_of_the_United_States_public_debt
As the debate rages in the United States with different candidates bringing different visions, thinking about China, where fiscal policy is at the core of the economy and the Government is in charge, seems like a reasonable extension as the world, for better or for worse, is growing more integrated.
Headlines are going around every day that the Chinese economy is slowing down, but is hard to tell what the data are saying. Sometimes they seem conflicting and there is limited transparency when it comes to the sources.
What is less controversial is why it matters to us: an immediate reason is the global demand that supports all sort of businesses, we all think of Apple and Facebook but do not forget Caterpillar and General Electric. As the barriers to international trade are progressively removed, the strategies and expectations become more global betting on a higher degree of integration.
A lesser known reason is US Debt holdings: outside the US, where the domestic owned share of debt grew significantly during the years of quantitative easing (the Government issued debt and the Federal Reserve bought it), China is the largest holder. As a the role of the Public Sector plays a central role in the Chinese economy, a liquidity crisis could trigger a massive sale that would cause the yields to spike and ultimately the US Government to spend significantly more to fund its debt. This is an extreme scenario, not a prediction or immediate concern, but it reflects how integrated the world has become and how hollow some calls for isolation, that come in various form and shapes, are.
Those are concerns but we should not forget the opportunities that thinking outside of a border logic warrants: international demand translates into more profits for American companies and ability to offer US debt to foreign holders opens to a larger pool of lenders and lower cost of borrowing.
Here at Phillip Capital we all fully aware of the opportunities that being an international firm affords: we are in 16 Countries and access to Asian markets is our specialty. We recently had our yearly event “Trading Asia” where we bring together global players, the investors, and local operators, the exchanges, to make the most out of the opportunities that looking at new market offers. As sophisticated and complex as the financial industry has become in the US there are a lot of possibilities still to explore.
Nov 8th is Election Day in the United States. The anticipation has been building for the last year and we all want to see what happens. That will also determine the relevance of the economic events and decisions to come like for example rates decisions in the United States.
RISK DISCLAIMER: Trading in futures products entails significant risks of loss which must be understood prior to trading and may not be appropriate for all investors. Past performance of actual trades or strategies cited herein is not necessarily indicative of future performance. The information contained herein is provided to you for information only and believed to be drawn from reliable sources but cannot be guaranteed; Phillip Capital Inc. assumes no responsibility for errors or omissions. The views and opinions expressed in this letter are those of the author and do not reflect the views of Phillip Capital Inc. or its staff.
