Margin Lending

We've previously spoken about the problem of the US budget deficit, and we've also discussed how the increasing size of the deficit is forcing up the level of debt year after year. Now, we're going to revisit this issue and then look into what Elon Musk and Vivek Ramaswamy are attempting to do about it through their Department of Government Efficiency, or DOGE.

Up until about 2019, things were fairly stable in terms of the US budget. However, at the beginning of the pandemic, the US budget deficit exploded from 5% of US GDP in 2019 to just under 14% of GDP in 2020. It peaked at 13.94% in that year. The level of debt in the US, which was around 80% of GDP, began to rise. By 2020, the deficit was 13.94% of GDP, and though it slowed a little in 2022 to just under 4% of GDP, it grew again to 7.1% of GDP in 2023, and is projected to be 7.6% of GDP in 2024.

The problem isn't just these current deficits; it's that there are continuing deficits built into the legislation. These deficits are expected to continue: 7.3% in 2025, 6.7% in 2026, 6.2% in 2027, 6.2% in 2028, and 6% in 2029.

Looking at the level of US debt, it was stable at around 80% of GDP from 2012 to 2018. However, the expansion of budget deficits caused the level of debt to GDP to rise. This rising level of debt to GDP was something that Jay Powell referred to at the last Federal Reserve meeting as unsustainable. The International Monetary Fund tell us that net debt to GDP in the US rose from 83% in 2019 to 97% in 2020, when the deficit hit 14% of GDP. It then stabilised at 97% of GDP, slightly declining to 93% in 2022.

However, with continuing forward deficits, US debt to GDP is projected to rise dramatically. By 2025, it is expected to hit 98% of GDP, 101.7% in 2026, 104% in 2027, 105.8% in 2028, and 109% by 2029. This steady rise in debt as a percentage of GDP is what makes the debt unsustainable.

In recent weeks, two individuals have come forward with an initiative to reduce the US budget deficit, as part of the Trump administration’s efforts. Elon Musk and Vivek Ramaswamy have released a full statement outlining their plans. Their goal is to generate reductions in the number of people working in the US government, thereby reducing the size of the deficit that finances these positions. As the deficit falls, they hope it will also stabilise the US economy.

Musk and Ramaswamy have made it clear that they will not be employed by the government and will work without pay. They state they will serve as outside volunteers, not federal officials or employees. Unlike typical government commissions or advisory committees, they won’t just write reports or cut ribbons; they intend to cut costs. They are assisting the Trump transition team in identifying and hiring a lean team of small-government advocates, including some of the sharpest technical and legal minds in America. This team will work closely with the White House Office of Management and Budget.

They say that they aim to advise the Department of Government Efficiency on three key types of reform: regulatory rescissions (reducing regulations), administrative reductions, and cost savings. By reducing regulations, they argue, the number of employees required to enforce them will also be reduced, which in turn will lower government spending and lower the budget deficit. As regulations are cut, fewer employees will be needed, and as those employees retire or leave, federal spending will decline, which should reduce the size of the budget deficit.

Musk and Ramaswamy’s plan also focuses on driving change through executive action, based on existing legislation, rather than through new laws. They propose presenting a list of regulations to President Trump for executive action, which would immediately pause the enforcement of these regulations and begin the process of reviewing and rescinding them. They believe that removing such regulations will liberate individuals and businesses from burdensome rules never passed by Congress. This will stimulate the economy.

They further argue that the reduction of federal regulations will logically lead to mass headcount reductions across the federal bureaucracy. The Department of Government Efficiency (DOGE) plans to work with appointed officials in various agencies to identify the minimum number of employees necessary for agencies to perform their constitutionally permissible and statutorily mandated functions. The number of federal employees to be cut will be proportional to the regulations nullified. Fewer employees will be needed to enforce fewer regulations, and once the scope of authority is properly limited, the agencies will produce fewer regulations. This will result in further reductions in both personnel and spending.

Additionally, the DOGE aims to reduce federal overspending by targeting the $535 billion in annual federal expenditures that are unauthorised by Congress. These are funds spent by the administrative state on items like public broadcasting, grants to international organisations, and progressive groups like Planned Parenthood. Removing such spending is seen as another way to curb the budget deficit.

Their plan will focus on eliminating unnecessary regulations and the employees who enforce them, ultimately aiming to reduce the size of the Federal Government and its budget deficit. Their report on these efforts is expected to be completed by 4 July 2026, the 250th anniversary of the Declaration of Independence, marking the start of a national celebration of that milestone.

The process I follow begins with reviewing the outlook from the International Monetary Fund (IMF), then I run my models, and currently, I'm at the beginning of that process. I thought I'd share the IMF's base case outlook and where I might adjust it based on my models. I believe these nuances are important.

What is immediately clear when you examine the complete outlook is that there is no recession on the horizon. The US is experiencing growth at 2.2%.

Following a difficult period in the Euro area, despite a miserable past, recovery is underway with modest growth expected at 1.1% in 2024 and 1.6% in 2025. As for China, the IMF estimates growth at 4.8% this year, but I think it will be closer to 4.6%, with a slight recovery to 4.5% next year. However, I think 4.3% is more likely next year, primarily due to ongoing weak demand in the Chinese economy. That said, these are still excellent figures, especially considering the size of the Chinese economy, which is growing at a pace four times faster than Germany’s and nearly twice as fast as the US.

The standout performer in recent years has been India. It grew by 8.2% last year and 7% this year, with projections ranging from 6.5% to 7% next year. India's high growth is set to continue for the next two decades, driven by a rising working-age population. This is unlike China, where the working age population is shrinking.

In Australia, growth has been relatively soft this year, hovering around 1.2%, largely due to the decline from a record high commodities boom. The IMF forecasts 2.1% growth next year, but I think it will be closer to 2.5%. Still, this is modest growth compared to Australia's historical standards. On the inflation front, most places are experiencing low and falling inflation, except for Australia. The US's headline CPI is projected to decrease from 2.3% this year to 2% in 2025. The Euro Area is also seeing a slight reduction, from 2.4% this year to 2.2% next year. In China, inflation is low, with deflation last year and a forecast of around 0.9% to 1% this year, due to weak consumer demand. Usually, inflation in China is about 2%, and it should gradually increase as the economy recovers.

In India, inflation is targeted at 4%, and they are on track to meet that goal this year and next. In Australia, inflation this year could be around 2.7%, slightly lower than the 3% the IMF expects, with a slight increase to around 3.7% next year.

Overall, what we see is that the global economy is returning to reasonable growth. The fear of a recession has subsided, and the outlook is positive across most regions. Growth in the US is likely to exceed the Federal Reserve's estimate of 2%, with some models forecasting around 2.2%.

Thanks to the recovery in the Euro Area, India's strong performance, and Australia's rebound, the global outlook remains strong.

Still, it is possible that the market has already priced this in.

Last week, during a press conference following the Federal Reserve's decision to cut rates by 25 basis points, something we had forecast, J. Powell was asked about the US government debt. He stated that while the current level of US government debt is sustainable, the trajectory of that debt is not. This comment has sparked a discussion on how the Trump presidency, with its emphasis on cutting corporate taxes, will impact the US budget deficit.

Looking ahead, the US budget deficit for 2026 will be drafted in 2025 when both the presidency and Congress — the Senate and the House of Representatives — are all under Republican control. Interestingly, the Speaker of the House, Mike Johnson, who is part of the conservative Freedom Caucus, has made it clear that he wants to reduce the size of the US budget deficit. This will be a key issue moving forward.

The US budget deficit has been a frequent topic of conversation because it can serve as an indicator of trends in the commodity cycle. For instance, the most recent low in the deficit occurred in 2022, at 3.9% of GDP, signalling the bottom of the cycle for commodities. However, the budget deficit rose to 7.6% of GDP in 2023, and for the current year, it is expected to peak at 7.63% of GDP. This suggests that the peak in commodity prices may occur around 2026.

A significant part of the discussion centres on President Trump's promise to reduce US corporate tax rates to 15%. This is the same corporate tax rate as Germany. The potential cost of this tax cut is substantial, with estimates ranging from $460 billion to $673 billion. For the sake of discussion, if we assume the cost is around $500 billion, the impact on the US budget deficit will be significant. Currently, the US deficit is estimated to be $2.2 trillion, or 7.3% of GDP, and projections for next year remain the same.

Sustainability in terms of the US budget deficit is generally considered to be a level that matches GDP growth. Given that US GDP growth is expected to be around 2%, the deficit could realistically be about $600 billion, much lower than the current $2.2 trillion. This creates a significant challenge for policymakers, especially since cutting spending will likely be the key to reducing the deficit.

Mike Johnson, as part of the Freedom Caucus, will push for cuts in government spending, and President Trump has appointed Elon Musk to assist in finding opportunities to streamline government expenses. Musk, who is known for his ability to cut costs in companies like Tesla and X (formerly Twitter), will look for inefficiencies in government spending, even though the "Department of Government Efficiency" he is heading will exist only as an advisory body. Nevertheless, Musk’s skill and reputation for cost-cutting could play a crucial role in helping to bring down the deficit.

The push to reduce the budget deficit while implementing tax cuts will be a central focus in the lead-up to the 2026 US budget. The proposed corporate tax cuts to 15% will add roughly $500 billion to the deficit, but they are expected to increase after-tax corporate earnings, which should drive stock prices higher. This contrasts with the Democrats' proposal to increase corporate taxes, which would likely lead to a sell-off in the stock market and a potential recession in the following year.

If the Republican-led government can successfully reduce the budget deficit while implementing corporate tax cuts, it could be a significant boost to both the US economy and the stock market in 2026.