Peter Schiff - EuroPacific Capital

  1. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Thursday, July 20, 2017
    Typically, U.S. Presidents are wary of claiming stock market performance as a referendum on their success. Most have seemed to understand that taking credit also means accepting blame, and no one would want to make the tortured argument that the positive moves reflect well on their presidency but that the negative moves do not. But Donald Trump has shown no reluctance to make any argument that suits his political purpose of the day, no matter its absurdity, and no matter if he has to contradict the arguments he made last year, or last week. Perhaps he assumes, as most investors seem to, that the risks are minimal because the Federal Reserve will jump in to save the markets if things turn bad. But in binding his performance so closely to the markets he overlooks the possibility that the Fed will be far less charitable to him than it was to Obama.
     
    The Federal Reserve’s Quantitative Easing program, which lasted from the end of 2008 to October 2014, was specifically intended to push up asset prices by lowering long-term interest rates and reducing financial risk. This provides a good explanation why the stock market gained nearly 200% from the bottom in March 2009 to October 2014 despite the fact that the U.S. economy persistently performed below expectations during that time.
     
    Many people, myself included, argued that once the stimulus was removed stock prices would have to fall. Two and a half years later that has yet to occur. Although U.S. stocks are no longer rocketing upwards like they were during the QE era (the S&P 500 is up just 19% since the program wound down completely in November 2014), they have yet to experience any type of meaningful correction. Certainly market observers sense danger, but with the Federal Reserve cavalry always ready to ride to the rescue (as they did in January of 2016), markets have been free to drift upward.
     
    Right up until his election, Trump argued, correctly in my view, that statistics suggesting economic strength, such as the employment or GDP reports, were fake news designed to hide the truth of a faltering Obama economy. He similarly argued, also correctly in my view, that stock market gains were evidence of a “big, fat, ugly bubble” created by the Fed in order to bail out Obama’s bad economic policies. But the day after the election, all that changed. Now he claims that the very same statistics (which haven’t moved much over the past year) are proof of his success. Gone are the claims that employment and GDP reports are fakes. Similarly, he has fully embraced the 18% rally on Wall Street since right before his election as proof of his deft economic stewardship. The fact that he is placing his own neck clearly on the chopping block does not seem to deter him at all.
     
    The President’s gambit does present the Federal Reserve with a huge opportunity to exert political power. There can be little doubt that Trump does not enjoy tremendous support from the members of the Fed’s Open Market Committee, who are generally drawn from the center to the center-left of the economic spectrum. Most members, including Chairwoman Yellen herself, are products of the academic world, where wonkish devotion to theory and mild-mannered communications style are the ideals. Trump is the opposite of this profile, and may be the kind of leader who they are pre-programmed to dislike. The fact that Trump has openly vowed to replace Yellen next year likely adds to the bad blood.
     
    This was not the case with Obama for whom the Fed was much more inclined to give breathing room. In fact, even Ben Bernanke later admitted that his optimistic assessments of the U.S. economy, and his dismissal of the housing and mortgage risks leading up to the Crisis of 2008, resulted from his perception that he was speaking as a member of the Bush Administration (he was a Bush appointee), and should therefore not undercut the optimistic narrative put out by the White House. I seriously doubt Janet Yellen fancies herself a member of Team Trump.
     
    The Fed delivered its first rate hike of the current cycle (in fact its first rate hike in nine years) in December of 2015 when it raised rates from zero percent to 25 basis points. Although such a move had been expected for many years, most market observers had been assured that the economy would be on solid ground when it finally came. In fact, when the year began, many expected the first hike to occur in March, with several more hikes happening before year-end. Yet a data-dependent Fed held fire until December. After that first raise, the consensus on Wall Street was that Fed funds would be between one and two percent by the end of 2016. Those expectations were largely echoed in the Fed’s own communications. But when 2016 got underway, economic data began to soften and Wall Street suffered a panic attack, falling eight percent in the first two weeks of the year.
     
    I believe that the Fed, sensing that continued market declines could devastate Obama’s final year in office and make it harder for Hillary Clinton to ride his coattails into office, acted in mid-January and threw out its prior commitments to raise rates and made it clear that it would keep rates low for as long as it took to restore “financial stability.” In other words, it was not prepared to stand by and let markets fall. The shot of confidence reversed the losses, and stocks have been trending upward ever since.
     
    However, Clinton still lost the election. I believe this was primarily because Trump was right in his claims that the economic recovery touted by the Fed, the Obama Administration, and Wall Street, was primarily an illusion, and that the stock market rally was nothing more than a bubble that would inevitably pop.
     
    It is also significant to note that a “data-dependent” Fed used weak economic data as an excuse to delay its long-expected initial rate hike to December of 2015, and then another full year (and a presidential election) to raise them again. In fact, the Fed had consistently used weak current data as an excuse to delay hikes for nearly the entire eight years of Obama’s presidency. But the data is as weak now, or even weaker, than it was then. Despite this, the Fed has already raised rates three times since Trump was elected. Perhaps it has removed the kid gloves?
     
    There could be no easier way to undermine the entire Trump presidency than an official bear market to erupt on Wall Street. In that sense, as I have said in a prior commentary, Janet Yellen presents a much greater threat to Trump than does Robert Mueller or Chuck Schumer. Yet despite these warning signs, investors have not yet shown much concern. They still seem to believe that if anything goes wrong, the Fed will provide the bail out. But that is not a risk Wall Street should be eager to test. My guess is that the “Yellen Put” is still in effect, but the strike price may be much lower than most investors believe, meaning more substantial losses could be required before the Fed acts.
     
    One indication that the markets may be coming to grips with the heightened risk is the way in which new technology IPOs have been treated. These can often be used as a barometer of investor sentiment. Lately the news hasn't been good. Two weeks ago, the highly anticipated IPO of Blue Apron, an online service that delivers pre-packaged baskets of uncooked food so that consumers can prepare gourmet recipes at home, fell flat on its face. In order to debut successfully, Blue Apron’s bankers slashed their initial valuation by 1/3. Despite that, the stock opened flat on its opening day. From then, it’s almost been straight down, with the stock falling almost 35% below its IPO price.
     
    It should have been clear that the company was a bust from the start. Its losses have been staggering, and just about any rival can replicate its services with minimal expenditure. But in good times new technology IPOs have gone up no matter the fundamentals. Yet one week following its $10 per share IPO, a Wall Street analyst slapped a $2 price target on it, which values the entire company at approximately $380 million, just $80 million more than was raised by selling just 15% of the Company to stock investors. Ouch.
     
    Also, shares of SNAP, another high profile tech IPO, have recently come under pressure. The stock went public back in March at $17, quickly surging to a high of $29.44. Yet in recent days the shares have traded below $15 per share, 12% below its IPO price, and half the high price enthusiastic investors paid just a few months ago.
     
    Aside from these IPO flameouts, there is gathering evidence that corporate earnings assumptions will be downgraded. A key factor in the post-election stock market rally was that corporate earnings would benefit from Trump’s anticipated pro-business tax and regulatory reforms. His failure to deliver on these fronts (as well as the failure to repeal Obamacare) have helped lead to a complete reversal of the U.S. dollar rally that began right after the election (the Dollar Index has since fallen 9% since its January high). How soon before stock market investors connect the same dots? With the Fed not only threatening more rate hikes, but also making noises that it will draw down its balance sheet, which would result in "quantitative tightening,” U.S. stock market investors should not be getting too comfortable.
     
    Instead, the falling dollar and the more positive economic results coming from non-U.S. economies might suggest that a move into long-beaten down foreign markets may be opportune. It should not be overlooked that thus far this year the Vanguard FTSE all World ex-US ETF (which measures the cumulative results of all markets outside the U.S.) is beating the S&P 500 by almost 60%.
     
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  2. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Wednesday, June 28, 2017

    Those who claim that the Senate Republican proposal to replace Obamacare will kick millions of people out from health insurance coverage are dead wrong. Yes, it will cause the number of insured people to decline, but that will happen because millions of healthy individuals will be incentivized to voluntarily opt-out of traditional health insurance. For those people, the law will make traditional insurance a sucker bet. Instead of buying comprehensive health insurance policies, as they are currently known, they will either go without insurance for as long as possible or purchase a new type of low-cost insurance that the new proposals will likely create if they become law.

    Let’s be clear. No one really wants to buy health insurance. When you do, you are effectively making a bet with your insurance company that you will get sick while they are betting you don’t. If you do get sick, you get a potential payoff. If you don’t, the insurance company keeps your premium. The same is true with all insurance. No one wants to buy auto or fire insurance, but we do in case we get into a car accident or our house burns down. But if the laws were changed so that fire insurance claims could be made after the fact, then consumer behavior would change significantly. People would simply opt-out, and then put in claims when and if they have a fire. But the only reason insurance companies can afford to rebuild houses is because so many of their customers pay premiums but never file claims. So if fire insurance companies could not discriminate against people with pre-existing fire conditions, they would cease to exist as businesses.

    The architects of Obamacare saw this problem in advance and attempted to solve it by imposing financial penalties on those who made the rational decision not to buy. The Law’s fatal flaw was that the penalties were not stiff enough to stop people from opting-out. (If they were that high the law would have likely been declared unconstitutional). When the healthy individuals left the system, many insurance companies experienced huge losses, forcing them to either exit markets completely or to raise premiums steeply on those who remained.

    Amazingly, despite the many clear warning signs that too many people were dropping out, the original version of the Senate bill did even less than Obamacare to encourage healthy people to stay. That version allowed such individuals to forgo insurance when they didn’t need it, but guaranteed that they could buy, without penalty, when they did. This would have exacerbated the huge losses that insurance companies are already seeing under Obamacare and would have forced the government to step in and transfer those losses to taxpayers. But, on Monday, the Senate belatedly recognized what they should have realized from the start, and came up with what purports to be a solution to prevent people from gaming the system. But like the veiled attempt made by the House, the Senate version falls well short of the mark.

    The House attempts to keep healthy people in the system by imposing a 30% surcharge on insurance for one year after a person with lapsed coverage (of 63 days or more) came back into the system. In fact, it was this provision that prompted Present Trump to call the plan “mean.”  But the 30% one year bump is a small price to pay for those who may go years, or even decades, paying nothing at all.

    Once the Senate realized that they needed some kind of penalty, they devised something that is even “meaner” by Trump’s standards. They now propose a 6-month waiting period on people with a 63 day lapse in coverage. This means those hoping to get a free ride will risk exposing themselves to six months of bills if they get injured or sick. On paper at least, that could be a steep incentive to keep coverage current. But, already, Democrats have jumped on the proposal as unfair.

    But like every far-reaching regulatory proposal, this plan does not anticipate the changes in the market that it may itself create. It is likely that insurance companies will respond to this provision by offering “waiting period insurance” that will pay medical bills only between the time a real health insurance policy is purchased and the waiting period for that policy ends.  To submit a claim under such a policy, the insured would only need to provide proof that he had already purchased an actual health insurance policy. Only then would the "waiting period policy" actually kick in to pay claims during the interim.

    Since these waiting period policies would only provide coverage for a short time period, the risk to insurance companies would be relatively low. That means that the costs to consumers would be considerably lower than long-term plans. Some consumers could maintain such policies for years, and save lots of money in the process. To further reduce costs, buyers could opt for waiting period policies with higher deductibles, or that exclude coverage for things like pregnancy.  The Senate bill makes the cost even lower by providing that premiums on traditional policies do not kick in until the waiting period ends, meaning consumers will never be on the hook for paying both waiting period and longer term health insurance premiums at the same time. To guard against people waiting until they are sick to buy waiting period policies, those selling those policies can also impose a 6-month waiting period of their own on people with pre-existing conditions. This will ensure that only healthy people buy these policies, keeping premiums as low as possible for buyers, while maintaining profitability for sellers.

    People would not opt to buy real health insurance policies until after they were sick enough to need one. But such policies would no longer constitute insurance at all in the traditional sense, as buyers would know the outcome in advance of placing their bets. Since they would only place winning bets, the insurance companies would be guaranteed to lose money on every policy sold. This will create a vicious cycle of rising premiums, more dropouts, and ever-greater government bailouts until taxpayers were responsible for everything.

    While many Republicans originally and correctly opposed Obamacare, their concerns seem to have evaporated in the face of political gamesmanship. In order to achieve some kind of victory they are now promising the impossible. Trump is the leading figure on this bandwagon. He doesn’t seem to care in the slightest what is actually in the law or what it will do to health care. He just wants something to pass so that he can take credit for the victory. But another layer of regulation surely won’t help.

    Over the past half-century, U.S. health care costs have risen sharply because of a raft of government policies and tax incentives that have shifted routine health care payments from individuals to insurance companies. Believe it or not, before the 1960s  a very large percentage of Americans paid for medical care out of pocket, according to a 1963 study by the Social Security Administration called Survey of the Aged. At that point, health care as a percentage of Gross Domestic Product hovered around five per cent.(1) Today that figure is more than three times that at around seventeen per cent.(1) Despite the huge increase in costs, health outcomes are not radically different from what you would have expected in light of the medical breakthroughs, technological improvements and the decline of smoking.

    As it turns out, insurance is a very inefficient way to pay for many of the health care services we use, the vast majority of which are actually highly predictable.  Our current insurance system incentivizes consumers to over utilize health care without any regard for its cost and removes any market based restraints on prices charged by hospitals, doctors, and pharmaceutical companies. As a result, health care costs have risen considerably faster than the rate of inflation.

    The advocates of greater government involvement have always said that health care is too important to be left to the free markets. But you could make the same claims about food, clothing and shelter as well. The free market is perfectly capable of delivering those necessities at costs that fit all budgets. In fact, the relative costs of all three of those things have stayed the same, or come down, over the years. But health care, distorted by regulations, subsidies and tax incentives, has seen costs spiral out of control.

    Republicans are now presented with a rare opportunity to make the radical departure that they promised when they did not control the White House. The best approach would be to seek to eliminate the entire insurance apparatus, reduce regulation, increase free market choice, legalize interstate and international competition, and clamp down on malpractice lawsuits. The money currently being over spent on health and malpractice insurance, excess paperwork and unnecessary defensive medicine, could then be used to fund the kind of charity hospitals that once served as the backbone of our health care system.

    But since Republicans do not have the guts to stand up for the free market principles they pretend to stand for, they should not make the fatal political mistake of affixing their brand to a sinking ship. Better to let the S.S. Obamacare sink, and then come up with a free market system that will actually float.

    1. SOURCE:  Centers for Medicare & Medicaid Services, Office of the Actuary, National Health Statistics Group;  U.S. Department of Commerce, Bureau of Economic Analysis; and U.S. Bureau of the Census.

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    To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy - How to Save Yourself and Your Country, click here.

    For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.

  3. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Friday, June 16, 2017
    All of a sudden the Fed got a little tougher. Perhaps the success of the hit movie Wonder Woman has inspired Fed Chairwoman Janet Yellen to discard her prior timidity to show us how much monetary muscle she can flex when the time comes for action. 
     
    Although the Fed's decision this week to raise interest rates by 25 basis points was widely expected, the surprise came in how the medicine was administered. Most observers had expected a “dovish” hike in which a slight tightening would be accompanied by an abundance of caution, exhaustive analysis of downside risks, and assurances that the Fed would think twice before proceeding any farther. But that’s not what happened. Instead Yellen adopted what should be viewed as the most hawkish policy stance of her chairmanship.
     
    The dovish expectations resulted from increasing acknowledgement that the economy remains stubbornly weak. Just like most of the years in this decade, 2017 kicked off with giddy hopes of three percent growth. But as has been the case consistently, those hopes were quickly dashed. First quarter GDP came in at just 1.2%. What's worse, second quarter estimates have been continuously reduced, offering no indication that a snap back is imminent. The very day of the Fed meeting, fresh retail sales and business inventory data surprised on the weak side, becoming just the latest in a series of bad data points (including figures on auto sales and manufacturing). By definition these reports should further depress GDP growth (much as widening trade deficits already have). 
     
    But despite all this Yellen came out swinging. And unlike prior policy statements that came after periods of economic disappointment, she didn’t even bother to argue that the current softness was transitory, or the result of “residual seasonality.” Instead she chose not to acknowledge any weakness at all, and kept to the tightening path that the Fed had mapped out last year.  But she even went further than that.
     
    For the first time, the Fed set into motion firm plans to reduce the size of its $4.5 trillion dollar “balance sheet.” Such a process has been talked about for years, but many were convinced, myself included, that it would always just be talk. The balance sheet consists of Treasury and mortgage-backed bonds that the Fed amassed during the experiment with quantitative easing between 2009 and 2014. During that time, the Fed injected liquidity into the financial markets by creating money to purchase more than $80 billion per month (at times) of such securities. These efforts pushed down long term interest rates, drove up bond and real estate prices, and set the stage for a massive stock market rally that had little to do with underlying economic fundamentals. Despite several informal hints over the years that these stockpiles were being reduced through bond maturation, the war chest has not decreased in size by one iota. However, the Fed has admitted that these ponderous holdings will limit its ability to stimulate in the event of future recessions. As a result, it wants to shrink the balance sheet down to a more manageable size now, precisely so it can expand it again during the next recession.
     
    To do this, the Fed must essentially perform quantitative easing in reverse. It must sell, or force the Treasury to sell, treasuries and mortgage-backed securities into the current market. This process will reduce the Fed's balance sheet while drawing free cash out of the economy, thereby unwinding prior stimulus. The Fed even told us how large the reductions will be…and it’s a lot. Much in the way that the Fed “tapered” out of its QE program back in 2014, gradually reducing the $85 billion of monthly purchases by about $10 billion per month, the Fed anticipates a similar approach to what is, in effect, a “quantitative tightening” campaign, or QT for short. It will start by allowing it’s balance sheet to shrink by $10 billion per month (total) of mortgage and government bonds, and will gradually increase the reductions to $50 billion per month, or $600 billion per year. Those are very big numbers that will provide very real headwinds to the economy and the financial markets.
     
    But it’s important to realize that the Fed envisions doing this at a time when Federal deficits are likely to be rising steeply. In the next few years, the Congressional Budget Office estimates that Federal budget gaps will be in at the $700 - $800 billion dollar range annually (hitting $1 trillion by 2021 or 2022). These assumptions of course do not factor in any potential any tax cuts, spending increases, or recessions (I think we are likely to get all three). So this means that in a few years, the Treasury will have to sell $600 billion of additional bonds into the market annually to repay the Fed while at the same time selling $800 billion or more to finance its current deficits. That may create some traffic problems. Should we assume that there are enough buyers to step up to the plate, especially if yields stay as low as they are? It’s not likely.
     
    With so much supply hitting the market at once, bond prices will have to fall (and yields rise) in order to attract buyers. This will amplify the tightening effect that these sales are meant to generate. Higher yields will also add a tremendous burden to the U.S. Treasury. With outstanding Federal debt already at $20 trillion, every percentage point rise in rates translates into approximately $200 billion more per year in debt service costs, which also must be borrowed. After the Fed announcement, Mick Mulvaney, the Director of the Office of Management and Budget admitted that quantitative tightening from the Fed had not factored into the Administration’s long-term budget projections.
     
    Assuming some form of infrastructure bill and/or tax cut finally passes in 2018 causing annual budget deficits to once again rise to 1 trillion sooner rather than later, how will the government finance its own rising budget deficits and repay the Fed simultaneously? Remember the last time we had trillion dollar deficits the Fed was providing $80 billion of QE support per month. That meant the Treasury was actually doing no net borrowing, as the Fed was monetizing all the bonds it was selling. But with $50 billion per month in QT, the net borrowing could likely be in the $1.6 trillion range annually. There is no precedent for the Federal Government every legitimately borrowing this much money. An even greater problem would develop if other large holders of Treasuries, such as foreign central banks, decide they want to front run the Fed, and start unloading some of their stash as well before prices fall further. A Fed actually committed to QT could turn a bond bear market into an outright crash very quickly.
     
    Of course the federal government is not the only borrower that will feel the sting of higher rates. Thanks to the Fed having kept them so low for so long, state governments and households are also loaded up with debt. What will happen to the auto and housing markets when higher borrowing costs make purchases more expensive to finance? What about the impact of higher interest payments on student loans? 
     
    If Yellen’s confidence is based on her belief that the markets will tolerate QT, she may have gotten her signals crossed. Although U.S. markets continue to test all-time highs, in recent days the ascent has slowed and the technology stocks that have been some of the Street’s best performers since at least 2013 have instead led other sectors to the downside. If markets are in fact nearing a top, you would expect traders to shift out of the high flyers into the more defensive sectors. If the Fed thinks that unexpected QT can occur without a meaningful drop in asset prices, it may be badly mistaken. Since the Fed itself often credits its QE program for lifting both asset prices and the economy, wouldn’t QT have the opposite effect on both?
     
    Also, if the markets react to the beginning of QT the way they did to the first rate hike of this cycle the Fed has another problem on its hands. Remember the 8% rout that occurred in the first two weeks of January 2016. At that point markets were reacting to the Fed’s first rate hike in nearly a decade (which had occurred in mid-December of 2015). When weakening economic data surprised the markets in January, traders had to digest the possibility of rising rates coming at the wrong time. The slide continued for two weeks until the Fed shifted to solidly dovish policies by mid-January.  Imagine what could happen this time around if the economy continues softening in the face of QT? If that ship actually sails it will be a short journey, with her sister ship, the QE4, following closely behind.
     
    Politics provides one explanation for the Fed’s newfound forcefulness in the face of these risks. Since his election in November, President Trump has continually cited stock market gains as proof that his policies, or intended policies, are working to improve the economy. (Never mind that during the campaign he consistently called the stock market a bubble and downplayed its economic significance.) But even Trump may not be able to get away with saying the gains are his doing but the declines are not. As a result, President Trump owns this market, and it could easily turn around and bite him as badly as his ill-advised tweets. A five percent decline in the Dow would be enough to seriously undercut his claims of economic success. A ten percent correction could completely change the narrative. 
     
    Perhaps the Fed sees an opportunity? Although they may have wanted to spare the Obama administration from the economic turmoil that would have accompanied a hawkish policy, they likely feel no such charity towards Trump. In that sense, Janet Yellen may be a bigger danger to Trump than Robert Mueller could ever be. Wonder Woman indeed.
     
    Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday!
     


    To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy - How to Save Yourself and Your Country, click here.

    For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.

  4. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Friday, April 28, 2017
    Donald Trump has made good on one of his most audacious campaign promises by submitting what he describes as the biggest tax cut in U.S. History. For once, at least, this does not appear to be Trumpian braggadocio. It really may be the mother of all tax cuts. But if passed, what may this bunker buster do to the economy? While I have rarely met a tax cut I didn’t like, this one just may be more likely to send the economy into a downward spiral than it is to send up to orbit.
     
    As I mentioned in my January commentary, Donald Trump’s big-spending, tax-cutting campaign rhetoric threatened to make him the biggest borrower in presidential history. He comes to office at a particularly vulnerable time for budget dynamics. After contracting by nearly two thirds from 2010 to 2015 (from the mind-bending $1.3 trillion to the merely enormous $438 billion), the Federal deficit started expanding again in 2016, moving up to $587 billion (Govt. Publishing Office, Office of Management & Budget (OMB). Current projections have it going up nearly every year over the next two decades. The Congressional Budget Office expects it to permanently surpass $1 trillion annually by 2021 or 2022. But these ominous forecasts were made well before anyone thought Trump had a snowball’s chance of ever becoming president. Now that he is in the office, those projections will be the floor. The ceiling is anyone’s guess.
     
    The forecasts assume that the taxing and spending laws in place during the Obama Administration won’t change. The steep increase in projected deficits towards the end of this decade and into the next is largely driven by the retirement of the Baby Boom generation, which will lead to simultaneous increases in entitlement spending and decreases in tax revenue. This brick wall has been hiding in plain sight for decades but the can-kickers in Washington have serially failed to do anything to avert the inevitable collision. 
     
    (These forecasts also optimistically assume that the economy never again enters recession, inflation never again rears its ugly head, and that our creditors never get concerned enough about our growing debt to demand a premium for the risk of financing it.)
     
    But now that Trump occupies the Oval office, this date with destiny may come much sooner…and she will definitely be ordering the lobster.
     
    Before I go negative, let me give credit to Trump for picking the right taxes to cut. He kills the estate tax, an ugly beast that should have been euthanized years ago. Some may see this simply as a gift to the very rich. But legal wizards have long since devised strategies that offer almost complete protection from the death tax. None of these structures offer any real benefit to the businesses these millionaires typically own, or to the economy in general. Killing the tax will cost the government almost nothing, but it will remove tremendous impediments that have prevented family-run companies from growing over generations. He also kills the Alternative Minimum Tax, a complex parallel system of taxation that few understand but somehow manages to ensnare more and more taxpayers every year.
     
    Most importantly, he brings down the corporate tax rate from the globally non-competitive rate of 35% to the much more manageable 15%. Taxing corporations has always been a bad way to raise revenue. Corporations, after all, don’t pay taxes, which are simply treated as a cost of doing business. The real costs are borne by customers, who must pay higher prices, and employees, who must suffer with lower wages. But high domestic corporate taxes have hamstrung U.S. corporations and greatly contributed to the decline of American manufacturing. A more competitive corporate sector will shower benefits on all manner of consumers and employees.
     
    On the individual tax side, his decisions are much more problematic. Although Trump makes the sensible decision of compressing the seven individual tax brackets into just three (10%, 25%, and 35%), and doubles the standard personal deductions (thereby saving many people from the hassles of itemization), the headline-grabbing component of the proposals has to do with the lowering of the “pass-through” tax rate to the same 15% level that applies to corporations. This means that wealthy business owners, highly paid freelancers, and partners at law firms, medical groups, and management consultancies, will qualify for the 15% rate. This will be a huge windfall to some of the richest people in the country, who typically pay the highest marginal tax rate (currently 39%). And since the top one percent account for nearly 50% of tax revenue, this one provision promises to cost Uncle Sam plenty and to dramatically shake up the corporate landscape.
     
    Small business owners and independent contractors will in fact receive the benefit of the 15% pass through rate. But “Mom and Pop” entrepreneurs rarely have income that is high enough to be taxed at the higher rates. These smaller earners will likely be be trading a 15% tax for a 15% tax. All the big benefits will go to the really big fish. Whereas the vast majority of Tom Cruise’s income would have been taxed at the 39% rate, it will now be taxed at just 15%. His taxes will be reduced by nearly 60% from current law. The same holds true, in lesser degree, to lawyers, doctors, and consultants making more than a few hundreds of thousands of dollars annually.
     
    Is there any reason that could justify why a hedge fund manager making a million dollars per year should pay 15%, but a full time CEO at a corporation making half that would be subject to the highest marginal rate of 35%? It’s absurd. Now I’m not a big fan of the “progressive” tax system, whereby the tax rate goes up with income. I think a “flat” tax system, in which everyone paid the same rate, would be better. (Ideally I would like to see income taxes replaced by far less onerous and intrusive consumption taxes). But I certainly don’t believe in a “regressive” tax system in which lower-earning citizens pay higher rates than those at the top. But that’s exactly what Trump is trying to do.
     
    Given this wide disparity in tax rates, we can assume that the employment landscape will adjust dramatically. We should expect that legions of highly-paid full-time employees will start to form Limited Liability Corporations (LLCs) to work freelance rather than as employees. There are few barriers that would prevent such a shift, and the growth of internet-based work scenarios will continue to break down the traditional barrier between employee and freelancer. Yes, there are some labor rules that seek to separate employees from freelancers, but those rules may be easily circumvented, especially when the reward is so great. Rather than envy the lawyer earning more and paying less, the CEOs of the country will likely incorporate and sell their services freelance to their former employers.
     
    This shift will mean that a great many of the country’s highest earners will be paying taxes at the lowest rate. As a result, the reductions in tax revenue would likely be far greater than what is predicted in the standard modeling.  
     
    But unlike most prior tax cuts, the Trump version does not even make any attempt to balance the cuts with corresponding cuts in government spending. If Trump’s tax cuts don’t immediately generate sustained 4% growth or more, we may be staring down the barrel of $2 annual deficits. Is this an experiment that we really want to try?
     
    But even if the reforms can kick the economy into higher gear, thereby creating higher revenues with lower rates (The Laffer Curve), our current low interest rate environment provides significant obstacles to permit that growth to be sustained. If growth kicks up to the 4% range, the Federal Reserve will have to accelerate its rate increase schedule to keep interest rates in line with GDP growth and to prevent inflation, already above its official 2% target, from running out of control. Plus the markets will also act to adjust interest rates higher due to greater demand for credit and rising inflation. These higher rates will act as a stiff headwind to an economy that has grown increasingly dependent on ultra low rates.
     
    But increases in rates would also cost the economy in another way. Our current bonded national debt is ready to surge past the $20 trillion mark. The Trump tax cuts will push it beyond that very quickly. If the Fed raises rates to keep pace with higher growth, then the Government will have to pay much more to finance the outstanding debt. At $20 trillion, every point of increase in interest rates will cost the government $200 billion annually. At that level, if interest rates were at 3.75%, instead of the current .75%, then the Federal Government would have to come up with about another $600 billion per year in interest payments. (That number will be much higher when the debt grows past $20 Trillion).
     
    But it's not just Uncle Sam that is over-loaded with debt. Corporations and households would see their interest costs surge as well with rising interest rates. So what lower taxes giveth, higher interest rates will taketh away.  
     
    Consider the housing market. Not only will higher interest rates substantially increase the cost of home ownership (through higher mortgage rates), but Trump’s tax proposals will dramatically increase the cost of ownership for those living in high tax states. Under the proposal, homeowners will no longer be able to deduct property taxes, and a doubling of the standard deduction means a much larger percentage of homeowners will not be able to deduct mortgage interest from their federal income tax. Plus, with the top tax rate reduced from 39.6% to 15%, the mortgage interest deduction will be far less valuable to those higher earners who can still take advantage of it. Higher mortgage rates and lower tax subsidies will increase the cost and decrease the appeal of home ownership. This could lead to a crash in real estate prices, especially in the high end of the market. Falling prices could wipe out what little home equity many Americas have left, and lead to another wave of foreclosures. The losses to Fannie Mae and Freddie Mac could be significant, with the costs falling directly on the Federal government, further driving up annual deficits.  
     
    The reality is that years of massive deficits, runaway government spending, artificially low interest rates, and three rounds of quantitative easing, have left the economy so sick that any tax cut large enough to revive it may actually kill it instead. If the Fed tries to keep it on life-support a bit longer by suppressing interest rates with a massive QE4 program, we risk run-a-way inflation and a dollar crisis with economic consequences far more profound than those of the financial crisis of 2008. The only silver lining to this cloud may be that the coming fiscal train wreck leaves lawmakers no choice but to slash government spending. If the real Republican agenda is to starve the beast, its success is assured.
     
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  5. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Friday, March 10, 2017
    With his widely followed, and positively reviewed, address to Congress last week, President Trump showed how easy it could be to unite Washington around a big-budget centrist agenda on health care, immigration, taxes, infrastructure and the military. But the continued accusations surrounding his campaign’s alleged Russian connections, and the President’s conspiratorial responses, have insured that the battle lines have only hardened. However, anyone with even a casual concern with ballooning government debt should take notice just how easily both parties in Washington would agree to vastly expand the gushing red ink if a political truce can be brokered. Those fears should galvanize around the newly-issued Republican replacement for Obamacare.  If such a monstrous bill could successfully navigate Congress, we would find ourselves stuck deeper in a deficit deluge than we can possibly imagine.  
     
    Obamacare attempted to rewrite the laws of economics by preventing insurance companies from charging high-risk customers more than low-risk customers. But to make this work without bankrupting the companies, all agreed that the young and healthy would need to be forced to buy insurance.  The flaw that doomed the law was that the penalties for not buying were too low to actually motivate healthy people to buy.  Consumers were charged just a few hundred dollars per year to forego insurance that would have cost many thousands. Given that they could always decide to get insurance in the future, at no added cost, the choice was a no-brainer. Without these healthy people keeping costs down, insurance premiums have risen alarmingly. 
     
    Ironically, the Supreme Court noticed this flaw as well. In sustaining the Law’s constitutionality, Justice Roberts argued that the relative lightness of the penalties was insufficient to compel anyone to buy insurance and, as a result, he considered them to be a “tax” that could be voluntarily avoided rather than a coercive penalty to force commercial activity. (Presumably had the tax been high enough to actually work, it would have rendered Obamacare unconstitutional – see my 2012 commentary).
     
    However, the Republican replacement plan, which removes all taxes on individuals who don’t buy insurance, and all penalties on employers who do not provide insurance to their employees, will actually make the problem far worse.
     
    The only reason healthy people buy health insurance is that they know that if they wait until they get really sick no insurance company will sell them a policy.  The same principal holds true for all insurance products.  You can’t buy auto insurance after you get into an accident. You can’t buy life insurance at a reasonable cost after your doctor has given you six months to live. The fact that your car is already wrecked, or your arteries already clogged, are pre-existing conditions that no insurance company would be expected to ignore. 
     
    Allowing voters the low-cost option to buy health insurance after they actually need it is very popular. It’s like promising motorists they can stop paying their monthly auto insurance premium and just buy a policy after they have an accident.  If the government were to require this, all auto insurance companies would quickly go out of business (unless they were bailed out by the government).
     
    Obama’s solution was to use the penalties to force healthy people to buy insurance before they actually needed it.  As the years wore on, the relatively low cost of the subsidized exchange plans and the availability of those plans to anyone proved popular.  However, the mandates and penalties, as well as skyrocketing premiums for non-subsidized policies, were clearly unpopular.  
     
    The Republicans have taken the “brave” political approach of keeping the parts that are popular (subsidized access, pre-existing conditions waivers, expansion of children’s coverage until age 26) and jettisoning those that are not (the mandates and the penalties).  The new plan pretends to offer a replacement to the Obamacare penalties by allowing insurance companies to charge a 30% increase to the premium for those who come back into the system after having previously allowed their coverage to lapse. But the problem here is that the premium increase is far too small to force anyone healthy to buy insurance. In fact, it is so low that any healthy person currently insured may decide to drop coverage.
     
    The effect of this law, were it actually enacted, would be the death of the health insurance industry.  As the law removes the requirement that larger employers provide insurance, I believe that big companies would look to self-insure employees for routine care.  For example, employer and employees could pay into a common risk pool that would set their own deductibles and co-pays. For employees who incur medical charges in excess of the cost of an actual policy, the pool could provide funds to pay for outside insurance at the increased 30% premium. As a result insurance costs would be encountered only if there is a need.
     
    Self-employed individuals would only buy insurance if the total cost was less than the tax credit provided by the new plan.  If they can’t find such coverage, they would likely buy a new form of insurance that this law may create: A policy that would pay for health insurance premiums if the user ever got sick enough to need them.  Such insurance would be very cheap, as the maximum exposure to the insurance company is only 130% of the premium for a standard health insurance policy.   
     
    In the end, the only people buying health insurance would be those who can buy it for free using their tax credits and really sick people for whom insurance premiums are cheaper than their medical bills.   But as insurance companies lose money on the latter group, they will be forced to raise their premiums on the former.  This puts us right back in the box we are stuck in with Obamacare.
     
    As premiums soar well above the amount of the tax credits, more people will drop out.  Unless the amount of the tax credits rises substantially, which will cost a fortune, all health insurance companies will eventually go out of business.  The end result will be socialized medicine, only it will be Trump not Obama that gets the blame.  It seems to me that this would be a political loser for the conservative cause. I would rather we go down in flames with Obamacare as then, at least, we will have a chance at a free market solution that could actually work.
     
    The government has a very poor track record with containing the cost of a service when it gives consumers money to buy it. Think student aid and college tuition.   Plus the plan is constructed in a way that makes it ripe for potential abuse.  Whenever the government is giving away money, people always game the system to get it.  Think about the wide-spread fraud in welfare, food stamps, disability, and even cell phone credits. Trumpcare will be no different. Many people will buy catastrophic plans with extremely high deductibles just so they can pocket the difference between the tax credits and the costs of the plans.  If they actually incur a medical condition that results in a high out-of-pocket expense, they can just switch their coverage to one with a much lower deductible.  Such a switch may even be possible without the 30% premium for lapsed coverage. 
     
    If Trump and the Republican leadership can push this monstrosity through, despite the obvious mathematical shortcomings, look for them to make similar efforts on infrastructure and defense spending. All this adds up to uncounted trillions in new debt, and a giant step closer to the utter bankruptcy of the nation. But the real danger lies in the possibility that the law is voted down by conservative Republicans and Trump turns instead to Democrats.
     
    In contrast to the former mission statement of the Republican Party, Trump believes that government solutions can work as long as they are “smart.”  The opening weeks of the Trump presidency were dominated by combative rhetoric, conservative and pro-business appointments, and nationalistic executive orders. And while this approach sent Democrats and the media into convulsions, it solidified the loyalty of Trump’s political base, and allows him to pivot toward the center if he wants. If he could peel off some “Red State” Democrats, he would be in a position to enact some of the biggest spending increases that the country has ever seen, even if fiscally conservative Republicans bolt.
     
    If those conservatives defeat the new health care bill, Trump could look to partner with Democrats in a heartbeat. Of course, to get that support, he would have to make the current bill even more generous. Let’s hope that his self-inflicted wounds continue to prevent such an unholy alliance.
     
    Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday!
     


    To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy - How to Save Yourself and Your Country, click here.

    For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.