Who Will Balance the Budgets?

It’s not today’s problem, but it’s a question investors will start asking more often as the Republican Party confronts its identity crisis.

When I first studied economics and politics, professors painted a stylized picture of a cycle and a pendulum. Economic cycles began with ample support from government spending and cheaper loans until inflation kicked in and forced tighter belts and higher interest rates. Growth slowed, prices stabilized and the cycle would begin again. Meanwhile, a pendulum swung back and forth between a political left that welcomed more government largesse and a political right focused on stable prices and balanced budgets.

They were never perfect metaphors, but as guidance for today’s markets, all those lectures seem pretty useless. Investors should be wary of anything that seems like a simple explanation for the path ahead.

We’ve examined how the fraying connection between growth and inflation has distorted traditional economic cycles here, here and here, but there’s obviously something wrong with America’s political pendulum, too. Precisely because the inflation outlook seems tame, the current blast of fiscal stimulus bodes well for the recovery and risk markets this year. But as Donald Trump’s Republican Party remakes itself, investors will soon start to ask who will make the case for balanced budgets when the time comes.

Political parties naturally evolve as they build workable coalitions from election to election. Republicans swung from protectionism to free trade over the course of the 20th century, while Democrats moved from South to North. The current battle for the Republican soul looks likely to play out between Trump supporters and traditionalists across a long list of hot button issues, from immigration to climate policy to civil rights. The balance of forces will be measured by the fundraising potency of both camps.

“Political parties naturally evolve as they build workable coalitions from election to election. Republicans swung from protectionism to free trade over the course of the 20th century, while Democrats moved from South to North.”

On economic policy, the Trump voter strikes an unusual contrast to the traditional party views in a recent survey. At least three-quarters of those who voted to re-elect the president last November claim predictable views that government is too big and taxes are too high. But they divide sharply on policy prescriptions, with 45% saying that “government should guarantee all people a minimum standard of living if they work to the best of their ability.” 

Nearly two-thirds believe Social Security benefits should be protected even if it means raising taxes, while only about half endorse the basic principle of supply-side economics that cutting taxes on the rich helps grow the economy for everyone.

As this new Trump voter has emerged, the traditional alliance between corporate America and the Republican Party is unraveling. Businesses benefited directly from the Tax Cuts and Jobs Act of 2017 but bridled over the Trump administration’s restrictions on skilled immigration, its trade war with China and even its approach to climate policy. CEOs also hated being caught in the middle of the culture wars, especially amid last summer’s protests over racial equality and gun violence.

The break widened after the election, perhaps because it was easier to disassociate yourself with a politician who was already headed out the door. The Business Roundtable denounced Trump’s talk of a stolen election. The head of the National Association of Manufacturers’ statement called the Capitol invasion “seditious” and suggested invoking the 25th amendment to remove Trump. Business leaders announced bans on future political donations.

While there is clearly much nervousness about the Biden administration’s tax and regulatory agenda, the U.S. Chamber of Commerce currently backs his stimulus plan and some increase in the minimum wage. If that is not disorienting enough, Trump Republicans seem open to more populist spending, too. In fact, Trump himself blamed the loss of two Georgia Senate seats on then-Senate Majority Leader Mitch McConnell’s insistence to cut $2,000 payments to $600 in December.

The stories are already being written about the Republican lineup for the 2024 presidential election, and the potential candidates are clearly treading carefully amid the intra-party turmoil. The core Republican commitment to low deficits has been under some question for years, but balancing budgets and hawkish appointments to the Federal Reserve Board were never high on President Trump’s list. They may disappear altogether from future Republican platforms.

That’s not to say there aren’t plenty of Republicans—and Democrats—who worry about fiscal projections from the Congressional Budget Office. Nor is it to suggest that the Democratic Party doesn’t have plenty of policy turmoil of its own, which will likely be on full display as Biden’s honeymoon fades. 

But losing a political party that makes fiscal discipline a central aspiration instantly reframes the debate. For an investor, this means America’s political future will look less like the past than ever before. Easy predictions about which party will back which policy may prove as worthless as economic models that tried to link lower unemployment to higher inflation. Sharp analysis will require better understanding of the coalitions within parties—and perhaps even across party lines. 

Meanwhile, I have some old textbooks for sale.

Christopher Smart, PhD, CFA

• Chief Global Strategist & Head of the Barings Investment Institute

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