If there is one quote that thoroughly explains the outcome of the recent presidential election in the US, it is this classic by von Hayek. I believe that above all else, people voted against the seemingly inexorable rise of the administrative state and the centralized control and high cost such a rise engenders.
While more than half the country is happy with the outcome, moving away from the stability of the all-powerful state will come with tremendous cost starting with the capital markets. I believe our political transition will be accompanied by a serious bout of deflation, not only in the stock market but also in the credit markets.
Yet if the US is successful in transitioning towards a more decentralized power structure, with the attendant increase in bureaucratic efficiency, the US will take a dramatic leap past the rest of the world in terms of wealth and power. No country on earth will be able to vie with a lean, competitive United States.
There is nothing inevitable about this; success depends on reducing the power of an extremely powerful federal bureaucracy which has been building since the New Deal. I don’t know if it’s possible.
Trust Busting II
Behind the ostensible government sits enthroned an invisible government owing no allegiance and acknowledging no responsibility to the people – Theodore Roosevelt
There are many similarities between Teddy Roosevelt and Donald Trump that warrant using TR’s years in office as an analog. Both were/are mavericks with big personalities and both lean left of the traditional Republican Party. It was Roosevelt who first coined the term “muckraker” to describe the media of his day which is comparable to Trump’s “fake news.”
Ironically, the Trump Administration has targeted a couple of federal agencies for reduction which were introduced by Roosevelt. Robert Kennedy jr. is tasked with reforming the FDA, or Food and Drug Administration. Trump has also tapped Lori Chavez-DeRemer, who is pro-union, to head the Labor department. This suggests a potential shift in the Labor-Capital power struggle.
It’s been 120 years since TR went after the railroad trust and Standard Oil using the Sherman Antitrust Act of 1890. I suspect the Trump Administration will employ the legislation to go after Google, Microsoft, Meta, and Amazon along with the major health insurers. These are all companies where the principle-agent and regulatory capture problems appear to be running rampant.
All these companies have extraordinary market power even where there is an appearance of competition. I imagine there will be others. The important point is that there appears to be a kind of cyclicality in the process of breaking dominant organizations after a profitable run and the timing sort of rhymes with work of Strauss & Howe on generational cyclicality.
The implications for the stock market and our domestic economy are enormous. These companies have been the stalwarts of the stock market expansion for the past five years. In addition, these companies are responsible for much of the capital spending in our economy, ranging from data centers to healthcare facilities and lots in between.
It’s clear that the Trump Administration is keenly aware of the importance of maintaining and expanding returns in the stock market. This is why I don’t expect him to move on trust busting until after we experience a bout of deflation. If he’s lucky, the weakness will start in Asia or Europe, allowing him to partially escape the blame.
Cyclical Excesses Everywhere
Everything in excess is opposed to nature – Hippocrates
When deciding on our long-term expectations amidst the financial crisis of 2008, I predicted two potential paths. The first was that the US would allow market forces to clear the excesses of the previous cycle, with some amelioration to soften the impact. That never happened.
The second option was to choose to inflate aggressively. In choosing door number 2, the government started with inflating asset prices through the banking system via the Federal Reserve expanding its balance sheet. When that failed to provide a broad economic recovery, they tried to inflate the real economy through expanding government transfer payments. The result is an asset bubble and consumer inflation that hurts most young families.
The reason I suspect the Trump Administration can be successful reducing the size of the federal bureaucracy and decentralizing our national power structure is that we’ve reached the point where additional government expansion leads to untenable consumer inflation. We have too much of it; think of government as a desired service yet subject to the forces of diminishing marginal return. Each new unit of government activity is adding to the rise in consumer inflation.
With government borrowing saturated, the administration must free up cash flow from operations to spend on election promises. This means cutting operations where marginal costs exceed marginal benefits - from a centrist or populist perspective. To date, it’s just been low hanging fruit but if successful we’ll witness a reversal of the principle-agent problem that resulted in much regulatory capture as discussed in the second installment of this series. Here’s a link. https://geovestadvisors.com/after-the-harvest-ii/.
Until now, nobody has taken a close look at government spending for decades which is why there is a TON of expenses to be cut. To date, the administration has caught Washington by surprise by moving quickly. Washington does not move quickly as a rule so has been slow to respond. This will change.
I have little doubt that the new administration will be able to fund their campaign promises. My only doubt is whether Congress will be willing to approve the legislation to fund new initiatives.
Bureaucracy
If you’re going to sin, sin against God, not the bureaucracy; God will forgive you but the bureaucracy won’t – Admiral Hyman Rickover
The federal bureaucracy has tremendous leverage with Congress. The Washington bureaucracy can make it impossible to accomplish anything by virtue of regulations, operations, and the courts. They represent Goliath guarding a formidable barrier to exit.
The difference this time is that public opinion favors these changes yet public opinion is fickle. Inflation sparked anger against the federal bureaucracy but it can be forgotten quickly if economic and market volatility can cause enough fear in the electorate.
For the past 30 years, every problem in the US economy has been solved by increasing federal debt. As stated, we’ve hit the limit on expanding debt which is why the Trump Administration is effectively flying without a parachute even as the global economy is about to hit a major deflationary downdraft. Who knows how the electorate will react to the inevitable pain?
This becomes clear when you view the chart of federal debt included below. The growth rate of federal debt ticked up after the tech crash of 2000 and remained constant until the crisis of 2008. From 2009 through 2019, the rate of change was faster than the period up through 2008. Then Covid sparked federal debt growth faster than the post Great Financial Crisis period. Every bump in the economic road since 2000 has been met with growth in federal spending. Every increase in federal spending, empowered the federal bureaucracy further. That is, until it sparked consumer inflation.
Even the most hardcore libertarians have enjoyed this period of low volatility that growing federal debt obligations made possible. If it gets taken away, we’re looking at a Brave New World.
Conclusion
Most human beings have an almost infinite capacity for taking things for granted – Aldous Huxley
If the Trump Administration can succeed at reorganizing the federal government, the US economy has the potential to succeed at the expense of the rest of the world. This will prove critical because I believe global economic growth cycle is finished.
Since 1948, the federal government has acted as a governor on the US economy, limiting growth to allow Europe and Japan to catch up. Whether they will admit it or not, the federal bureaucracy has followed a Keynesian path that allowed Europe and Japan to maintain parity with us.
China destroyed this model 30 years ago as its willingness to sell below cost shattered the value of labor in developed countries and made many capital-intensive industries uncompetitive, particularly in electronics. The result is that US, European, and Japanese citizens are highly dependent on their respective federal bureaucracies and financial establishments.
This is why I am only guardedly optimistic about the new Administration. They have won some initial battles but the war is far from over.
Philip M. Byrne, CFA
