The US Congress holds the purse strings and wishes to loosen them

US Congress

In theory the President sets out a budget in February and the Congress responds with a Budget resolution in May. In practice the Congress runs the budget, and has just passed a two year budget deal regardless of the White House proposals that crossed in the post with their decisions.

President Trump’s wish to cut domestic programmes to pay for increased military expenditure finds no favour with the Democrats. As the Republican majority usually needs additional Democrat votes to pass a budget the Republicans in the House and Senate need to compromise with their Democrat opponents, which normally means accepting higher levels of domestic spending than they wish. So it has proved in the latest two year budget deal, which provides money for programmes up to March 2019.

There are some elected deficit hawks in the Republican party who do not want to vote for increased spending, but there are usually more Republicans who do want higher military spending. They are willing to compromise to achieve it. The latest deal approved $80bn extra spending on defence in 2018 and $85bn in 2019, in return for an increase of $63bn on non-defence in 2018 and $68bn in 2019. Some of the non-defence spending is wanted by Republicans, and some Democrats do see the need for some increases in the military. The result of all this is to raise the spending totals and increase the deficit.

All of this implies more bond issuance and higher interest rates.

The debates and votes are intense because these budgets are controlled by the 2011 Budget Control Act. This Act resulted from a bruising battle between President Obama and the Republicans, where the Republicans succeeded in imposing spending and debt caps for future years. These have regularly had to be relaxed to accommodate additional spending. This time it has been agreed to raise the budget spending caps, and to lift the debt cap to allow this increased spending to be paid for by extra borrowing. The December debt ceiling at $20.5tn is suspended until March 1 2019.

The President will be able to say he wanted the Congress to be more prudent, but they turned down his many ideas for substantial cuts to domestic programmes. The Republicans in House and Senate are very unlikely to want to put through major cuts in budgets ahead of the midterm elections, and will take comfort in the need to compromise with Democrats by agreeing to simply borrow more. The pressures are to spend more, tax less and borrow more to make the short term politics easier. The midterm elections are unlikely to change the arithmetic in the two Houses in a way which would enable to Republicans to cut domestic programmes to genuflect a bit more to fiscal prudence. As a result large bond sales programmes start this week to fund the growing deficit.

The outturn for the deficit will hinge more on economic developments than on any possible action in the Congress. The White House thinks the US economy will now grow at a 3.1% rate for three years. The average external forecaster thinks it will be around 2.5%, and the Fed just 2.2%. The faster the economy does grow, the stronger will be the revenues and the lower the deficit will go. If the economy stays close to 2% growth the budget deficit goes higher and stays high. Many forecasters are now pencilling in a string of $1 trillion deficits in the next few years. We think there could be a bit more growth which will help with higher revenues.

All of this implies more bond issuance and higher interest rates. It also means an additional fiscal stimulus. In the midterm election year it would be surprising to see major spending cuts. It also makes it more likely both sides will continue to compromise to avoid a prolonged shut down of government, which must lie behind the decision to pass a two year budget fix of a general nature. There will continue to be budget rows as the detail is worked out. The vexed issue of migration rules, numbers of migrants and the Mexican wall continues to divide the Congress and is unfinished business.

 


The above article was previously published by Charles Stanley on 20th February 2018