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Affluent Christian Investor | April 19, 2021

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Biden Spending Leak Triggers Inflation Trade

On Monday, the New York Times ran a piece reporting that unnamed sources were indicating the Biden administration was about to release a gigantic spending proposal, one costing at least 3 trillion dollars.

“President Biden’s economic advisers are preparing to recommend spending as much as $3 trillion on a sweeping set of efforts aimed at boosting the economy, reducing carbon emissions and narrowing economic inequality, beginning with a giant infrastructure plan that may be financed in part through tax increases on corporations and the rich.”

I mention that the cost is at least $3 trillion because the $3 trillion in recommended spending does not count the “cost” of what are called “tax expenditures” such as targeted tax credits. Such programs often “refund” taxes to people who have not paid taxes. In other words, while done through the tax code, they are not really tax cuts, but rather expenditures.

The total new spending in the plans would likely be $3 trillion, a person familiar with them said. That figure does not include the cost of extending new temporary tax cuts meant to fight poverty, which could reach hundreds of billions of dollars, according to estimates prepared by administration officials.

Whether you call such programs tax expenditures or tax cuts, they are not likely to be supply-side in nature; that is, they are unlikely to change incentives towards long-run productivity. They will, however, cause decreases in revenues, which means that this new spending would likely be almost entirely new borrowing, especially if Senator McConnell is right that tax hikes on corporations and the wealthy are not expected to receive needed GOP support.

““I don’t think there’s going to be any enthusiasm on our side for a tax increase,” Senator Mitch McConnell of Kentucky, the Republican leader, told reporters last week. He predicted the administration’s infrastructure plan would be a “Trojan horse” for tax increases.”

So, if the base case is: massive new spending, no new taxes to pay for them, and tax expenditures which decrease revenues without offsetting growth effects, the inevitable result will be additional federal borrowing. Unless you think Americans are suddenly going to turn Japanese and shift towards becoming a saving society, and park their savings in very low-yield new treasury offerings, it is inevitable that the Fed remains the lender of last resort to the neediest borrower, the US government. Whoever said that if you want a friend in Washington you should buy a dog wasn’t an observer of modern central banking. Or maybe monetary lap dogs count, too. This all amounts to maybe $3 trillion of additional money creation, money which the Biden administration will not want to lie around moldering in money center bank vaults.

That’s probably why, right on cue, the dollar dropped, broad bond indices rallied, and (inflation-protective) TIPS rallied even more. So did commodities. Gold was down for the day, but that’s only when looked at from the baseline of midnight. It was up during the trading day. It seems like the market’s interpretation of the news led to a reflation trade.

 

 

Originally published on Townhall Finance.

 

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