A trillion-dollar government cut could shrink GDP by 3.4%. Here’s how that might play out for the economy and markets.
KEY TAKEAWAYS
MY HOT TAKES
To be clear. Are you confused yet? Sure, you are, but don’t worry, you are not alone. The Trump Administration is but 3 weeks old, and it has been a busy 3 weeks with countless executive orders, decrees, and memorandums. The Department of Government Efficiency, or DOGE, has come in hot, shuttering buildings, deleting agencies, and leaving everyone else in Washington DC shaking in their boots—strike that—everyone who works for an establishment that is reliant on the Federal Government as well as the constituents that they serve. Then there are the President’s public information sessions in which he shares his plans and his thoughts on the goings-on about the globe. One cannot argue that the President is making good on his campaign promises by shaking things up a bit.
Now, whether you were for him or not, whether you agree with his methods or not, you need to know what the economic implications are for all these efforts. They will affect your portfolio and the economy. I think now might be a good time to take that step back and get our bearings, because we are only at the beginning of the journey. Let’s dive in.
The US’s Gross Domestic Product (GDP) is calculated by the following equation:
GDP = C + I + G + (X – M)
Where:
C = Consumption (consumer spending on goods and services)
I = Investment (business investments in capital goods, residential construction, and inventories)
G = Government Expenditure (federal, state, and local government expenditure)
X – M = Net exports (balance of trade)
Now, using this model, let us see if we can fit some of the Administration’s recent activities into this model and determine their possible influences on the US economy. Let us begin with the hot topic of the day, tariffs. But first let me apologize if you are tired of hearing about this, but these realities must be understood concretely. Bear with me, I have your best interest in mind.
Ok, TARIFFS ARE PAID BY US-BASED IMPORTERS and NOT foreign governments or exporters. Politicians seems to be very vague about this, but trust me, it is not foreign governments. Tariffs essentially make imported products and services more expensive. Importers are likely to pass some or all of their costs on to the consumer to minimize margin compression. What happens when prices of goods and services go up? Well, we tend to buy less. Remember, that is why the demand curve is downward facing (negative slope) for most normal goods and services. So, tariffs will cause C and I to decline, and therefore GDP to decline.
Now, let’s switch over to the highly controversial DOGE, which is tasked with making the government more efficient. Let me be clear off the bat. A more efficient Federal Government is a good thing. It will certainly lead to a lower deficit, which I think we can all agree is desirable. Starting at the highest level, DOGE has set out to find trillions in savings for the Government. In 2024, the US Government spent just about $5 trillion on consumption. If DOGE is able to find $1 trillion in savings, please understand that G will decrease by 20%. The total GDP in 2024 was $29.7 trillion, so that savings will decrease overall GDP by 3.4%! It’s just math, stupid.
While we are on Government expenditures, we need to think about broader impacts. The Government employs roughly 3 million civilians. All those savings from the previous paragraph don’t just include the government buying less pizza for work get-togethers and $500 hammers. No, they represent payroll savings. What percentage of those 3 million employees do you think are worried about their jobs this morning? I would say… um, 2,999,989 of them—pretty much all of them except the President, Vice President, and Supreme Court members. All of those employees, outside of work, are also CONSUMERS. What do consumers do when they are worried about their jobs? They consume less! I won’t even try to come up with an exact figure, but consumption (the largest aggregate of GDP) will definitely be negatively impacted. This, of course, goes beyond government employees. Think about all the contractors, consultants, and recipients of government spending. Not only will consumption be negatively impacted, but also, in the private sector Business Investment (I).
I have to, again, make it clear that cutting fat in government expenses and seeking efficiencies, is not only a noble cause, but it is smart. However, one cannot avoid the reality that draconian cuts to expenditures will have short-term and medium-term negative impacts on economic growth. Remember that these cutbacks in consumption have broad implications which cannot easily be quantified. Virtually every stock in your portfolio will be impacted by these cuts.
Now let us look at some of the positive effects from these activities. Starting with tariffs, remember that those tariffs are paid to US Customs, so they become income to the government. More income collected by the government means a decrease in the deficit, something we all want. But wait! Who pays for those tariffs again? US COMPANIES, who will have two choices, pay the tariff and spend less (lower I) or CONSUMERS, if firms pass those cost increases on to them (which they will), ultimately decreasing consumption and GDP. Now, here is where it gets a little interesting. Before passing costs on to consumers, US importers will seek cheaper, non-tariffed goods, which are likely domestically produced—that is after all, a primary objective of tariffs. If there are domestically produced substitutes, that would increase net exports (X – M), and ultimately, GDP. A positive, though it will not likely be a one-for-one exchange, as not all goods are elastic (American made bourbon—though awesome—is not a good substitute for Mexican tequila), and supply chain shifts take time, so any benefits will not occur contemporaneously.
It is important to note that we are just at the beginning of this cycle, so we cannot jump to conclusions. There are still some very positive initiatives from the administration that will certainly be stimulative. Proposed tax cuts, for example, can offset extra costs borne by companies. Additionally, though less quantifiable, a laxer regulatory framework will provide significant savings for American companies as well as make them more competitive. In these cases, they can be stimulative to the economy if indeed these savings make their way into consumers’ pockets (they trickle down).
Finally, this is far from an exhaustive list of initiatives that need to be thoroughly vetted. However, as the administration’s bold strategy unfolds over coming days, months, and the next 4 years, we need to establish a framework for assessing their impact, objectively and quantitatively, and it would seem that the method used today is a good one. Remember this, because we will be referring back to quite a bit going forward.
What does this all mean? Well, if you have been following, it appears that we can expect some near- to mid-term pain in economic growth with hopeful future benefits. I am a long-term investor, so I know a thing or two about concept of invest now, reap rewards later. But, with investments, it is a methodical thoughtful approach which yields the highest returns.
YESTERDAY’S MARKETS
Stocks traded higher yesterday as investors shrugged off the Administration’s latest salvo in the trade war against steel and aluminum importers worldwide. Tech got a reprieve yesterday on no real news, leading the broader markets higher. US steel makers got a boost from expected onshore supply shifts and steel prices climbed, offering proof that economics is indeed a science.
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