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Can Hope Trump Reality?

By David Scott | Tuesday 18 April 2017


The U.S. government is poised to shut down on Day 100 of Donald Trump’s presidency, unless Congress can pass a new spending bill or a continuing resolution before the current one expires on April 28. Since Congress is currently on a two-week recess, there will be a sense of urgency to get a new bill passed once they reconvene on April 25. Leaders in both chambers will have four days to craft a new proposal that each side can agree on and get it on the president’s desk for Trump to sign. Whilst the Republicans control the White House, the Senate and the House of Representatives, any bill to fund the government is going to require 60 votes in the Senate.  

The “nuclear option” that the Republicans just used to push the Gorsuch Supreme Court nomination through is not available in this case under current Senate rules because a spending bill of this nature would not qualify. So the Democrats have significant leverage, and they plan to use it to the maximum.  It will be tough for Congress to come to terms with its budget. The debate will open old wounds and gouge new ones. Already, the federal budget deficit is expected to average $1 trillion a year over the next 10 years. Trump will want to spend more. We need to spend more on infrastructure, on the military… and to revive the economy… he’ll argue. Many House Republicans, especially the idealists in the Freedom Caucus, will find it difficult to go along.
In the US Germany’s biggest bank is coming under increasing pressure to provide further details on its lending to Donald Trump and meetings it has had with the administration. Democratic senator Chris Van Hollen has written to Deutsche Bank asking for assurances that it will not use the president’s outstanding multimillion-dollar loans as “leverage”. He is also demanding to know whether the bank has restructured Trump’s debt or sold it to “foreign entities”. Trump currently has two loans and two mortgages with Deutsche Bank and owes it about $340m (£270m).

The bank has also extended another $950m to a venture in which Trump owns a 30% stake, the Wall Street Journal reported in January. Van Hollen, who sits on the Senate banking committee, said he had “great concern” about possible conflicts of interest between Deutsche and Trump and questions about whether the bank’s role as the president’s largest creditor could influence multiple ongoing investigations into the German bank. Deutsche Bank faces ongoing investigations by the Department of Justice into alleged money laundering involving Russia. It is also in settlement talks with federal officials over its alleged role in the mortgage crisis.  In January the New York Department of Financial Services fined the bank $425m for failing to prevent $10bn of Russian money laundering. The “mirror trades” scheme was run out of its Moscow office. The UK’s Financial Conduct Authority imposed a £163m fine – it’s biggest ever – for the same offence.  

The previous month Deutsche paid $7.2bn to settle a decade-old toxic bond miss-selling scandal with the US Department of Justice. In March it emerged Deutsche played a prominent role in a second Russian money-laundering scandal. It was one of dozens of western financial institutions that processed at least $20bn – and possibly more – of criminal Russian cash. The scheme, “the Global Laundromat”, ran from 2010 to 2014. It is also known that some of Trump’s immediate family members were clients of Deutsche, including the president’s daughter Ivanka, her husband, Jared Kushner, and Kushner’s mother, Seryl Stadtmauer. Jared Kushner, has a multimillion-dollar line of credit with the bank. Deutsche has provided $370m in financing for a Kushner Companies’ property in Time Square.
Financial markets are starting to have doubts about Donald Trump. The initial euphoria that sent share prices on Wall Street to record levels has quickly dissipated amid fears that the new president is dangerously unpredictable. Evidence that Trump is moving away from his earlier agenda is mounting by the day. The failure to get Congress to agree to a repeal of Obamacare was the first sign of trouble, as it raised questions about whether the White House would be able to pass an economic stimulus package. Then there was the U-turn over Syria, then the sabre rattling over North Korea. Now Trump has decided, in flat contradiction of what he said on the campaign trail, that China is not gaining an unfair trade advantage through the manipulation of its currency. Not only did Trump backtrack on China’s alleged currency manipulation in an interview with the Wall Street Journal, he hinted that Janet Yellen might after all get a second term in charge of the Federal Reserve and said he thought the dollar was getting too strong. On this last point there is some sense in what the president says it is all very well talking about the imposition of tariffs and putting taxes on imports but a rising currency would reduce the impact of any protectionist measures by making US exports dearer. 
At first glance last week’s US monthly budget statement was disappointing. In March the US Treasury got income of $216 billion, below the $228 billion last March, versus spending of a record $392 billion, resulting in a deficit of $176 billion, more than the $167 billion expected, and $68 billion more than the previous year. For the fiscal year through March 31, the total US budget deficit was $527 billion, compared to $459 billion on year ago. Declining government revenue and long-term costs associated with an ageing population are expected to continue pushing up the deficit. Over the past 12 months, the deficit stood at $651.5 billion, compared with $460.6 billion a year ago, an increase of over 40%. As the US government had its biggest one month outlay ever, spending a record $392.8 billion, $57 billion or 17% higher than a year ago. The breakdown of March spending was as follows; Defence: $58 billion, Social Security: 79 billion, Medicare: $75 billion, Interest on debt: $30 billion and other: $151 billion. However, the most concerning picture is when you look at the annual change in the rolling 12 month total. Like last month, in the 12 month period ended March 31, total federal tax revenues, fell $3.264 trillion.

This amount was 1.3% lower than the $3.31 trillion reported one year ago, and was the fourth consecutive month of declines. This was also the biggest drop since the summer of 2008.  Every time since at least 1970 when government tax receipts have turned negative on an annual basis, the US was on the cusp of, or already in, a recession.  The last time government receipts turned negative was in July of 2008. The collapse in receipts is due to a double digit Percentage fall in corporate income tax, which raises the question what really are corporate earnings?  While we are told that EPS are rising for IRS (i.e. Tax) purposes, corporate America is in a recession. The biggest contributor to government revenue is individual income taxes and As of February, the year to date number was $695Bn, just fractionally higher than the same period a year ago. What we do know about the US economy that GDP barely grew in the 1st quarter. Stock valuations are at all-time highs. The auto industry has begun to turn downward. Corporate profits are falling. Retailers are declaring bankruptcies and closing stores at a depression like rate and Wages for the average person are stagnant. But most important of all real household income is declining when using real inflation numbers. At the same time, the Atlanta Fed’s GDPNow forecasting model is now projecting that U.S. GDP growth for the first quarter of 2017 will be just 0.5 percent on an annualised basis.
At the national level, most western nations are already insolvent, meaning liabilities exceed assets.  They have been spending way beyond their means for decades and decades, amassing a tremendous amount of public and private debt (as well as entitlement promises) along the way.  Bankruptcy is a legal process, and it’s not possible for an entire economy to enter a legal process. In reality all the claims represented by all the debt and excess printed currency have to be destroyed, or reduced, to bring economies back into balance. The Austrian economist Ludwig von Mises said it best: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

Since 2008 there has been no willingness on behalf of our national leaderships for “voluntary abandonment of further credit expansion”. In fact, it’s been the exact opposite and the ‘plan’ has been to expand credit even more aggressively than before. Since the last financial crisis, the U.S. national debt has nearly doubled, corporate debt has doubled, stock valuations have reached exceedingly ridiculous extremes, the student loan debt bubble has surpassed a trillion dollars, as has the auto loan bubble. In addition the US is facing the largest unfunded pension crisis in U.S. history, and in many parts of the country (particularly the west coast) the US is facing a housing bubble that is even worse than the one that burst in 2007 and 2008. Even with all of these bubbles, U.S. GDP growth has been absolutely anaemic.  Even if you believe the grossly manipulated numbers that the federal government puts out, the U.S. economy grew at a “miserably low” rate of just 1.6 percent in 2016.
In a recent note to his clients, John P. Hussman the rebound US fund manager and strategist stated that his team is projecting that by the end of this current market cycle “roughly half of U.S. equity market capitalisation – $17 trillion in paper wealth – will simply vanish”.  In order for key measures of stock market valuation (such as CAPE, etc.) to return to their long-term averages, US stocks need to have to fall at least 40 to 50 percent from their current levels.
So as this coming crisis unfolds, it is inevitable that other asset classes will experience astounding downturns as well.  ValueAct's Jeff Ubben, one of the most-respected activist hedge fund managers in the industry is returning capital to his investors because he is concerned about the stock market's high valuation. "The broader market context is explicit to us. The S&P 500's median P/E ratio is 18 times. For most high quality companies we follow, it is much higher," Ubben wrote in the April 3 letter to clients. "These valuations can only be justified by assuming cyclically high corporate margins will persist, a certainty of lower corporate tax rates and a risk-free rate that stays near all-time lows. We are sceptical of all of the above." The hedge fund will return $1.25 billion in capital to its limited partners starting on May 1. Ubben cited the higher-than-normal cash balances in the fund ranging from 10 percent to 29 percent since the end of 2015 versus the 5 percent average during the last decade.
The question is not “if” but “when.” In the end, it will matter little what trigger it was, as, like a string of firecrackers, when one explodes, a chain reaction is set off. The truth is, the world’s financial systems is sick and dying. The current global monetary infrastructure is on its last legs. For years, governments and central bankers have kept the current unstable infrastructure alive with little more than economic witchcraft. But now they’re quickly running out of spells. For years Russia and China have been building an alternative to the dollar dominated global financial system. They’ve built the BRICS financial bloc, they’ve been stocking up on gold, and they’ve been establishing trade agreements that don’t involve the dollar. When this current bubble blows there’s going to be another system waiting in the wings to replace the dollar, which has been the world’s reserve currency for decades. The coming chaos will motivate China, Russia, and their allies, to pull the rug out from under the current dollar dominated economic paradigm and when they do things will change very fast.
At some point the global imbalances will become just too great and the system will collapse upon itself. Once the implosion happens, people are going to get very annoyed.  Anger and frustration is already rising to a boiling point all over the developed world and it isn’t going to take much to push millions of Voters completely over the edge and into the hands of extreme politicians, offering an easy and painless fix. Most. People don’t realise it, but danger is lurking just over the horizon. Take a step back from the media, and Market commentary, for a moment and make an honest assessment of the financial markets today. Does the current strong Bull Run in financial markets appear to be rational? Are individuals currently assessing the “possibilities” or the “probabilities” in the markets?
As an investment professional I am investing clients hard earned “savings” and my job is to invest when prospects look good. But arguably the most important part of my job is to know when to be cautious and take profits in order to keep profits and to be in a position to pick up the bargains when they appear, they always do when bubbles burst.
Just because a crisis is delayed it does not mean that it is cancelled.  Because our leaders have kept making this economic bubble larger and larger, it just means that the coming crisis when it inevitably comes will be even more painful than it otherwise could have been. We are now on the cusp of an unparalleled global economic setback. Our financial system is both fragile and under enormous pressure. This looming crunch will be far worse than the 2008 financial crisis and many people will lose much of what they thought was safe. The good news is you still have time to take steps - like speaking to us - in order to “opt out” of the coming chaos. But this window is rapidly closing.

David Scott is an Investment Manager & Market Commentator at Andrews Gwynne

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