‘The losses we make on minting pennies are this big’
‘Let’s rip the waste out of our great nation’s budget, even if it’s a penny at a time,’ posted Donald Trump on his way home from the Superbowl Sunday.
In the same post, Trump announced that the US government would discontinue the production of pennies. Minting each of these 1-cent coins now costs the government 3.69 cents, leading to a net loss on every penny struck.
This is one of many cost-saving steps suggested by Elon Musk (pictured above) and his new Department of Government Efficiency (DOGE). But it is only a baby step. The government’s penny business lost $85.3m in 2024. Stanching this loss is sensible, but it won’t put much of a dent in the government’s $1.9tn deficit.
The question for investors is whether Trump, Musk, and Treasury Secretary Scott Bessent can save enough pennies to materially shrink the US fiscal hole.
That was then…
The US government has cleaned its fiscal house before. Between 1993 and 2000 under President Bill Clinton, Robert Rubin (as Clinton’s chief economic advisor, then as treasury secretary) and House Speaker Newt Gingrich led a successful effort to reduce government outlays as a share of GDP.
At the same time, government revenues benefited from a booming economy and soaring stock market. Both forces contributed to a swing in the budget balance, from a deficit of 4.5% of GDP in 1992 to a surplus equal to 2.3% of GDP in 2000.
Can today’s leaders pull off something similar? Perhaps. But DOGE has its work cut out. A range of adverse conditions will make it much harder to balance the US budget – or even to shrink the deficit – than it was in the 1990s.
…And this is now
First, relative to GDP, discretionary spending is already near historic lows. Doubtless, there is still plenty of wasteful government spending to trim. The production of pennies (and nickels) is just one example.
Perhaps their strategy will work. But the numbers are against them. Trump has said he does not want to cut Social Security, Medicare and other ‘mandatory’ outlays. This means DOGE has to make its cuts from discretionary outlays. But discretionary outlays are already near a historic low relative to GDP, at just over 6% of GDP in 2024. That is roughly the level of discretionary spending at the end of the belt-tightening operation in the 1990s.
But the smaller discretionary spending becomes relative to GDP, the harder cuts become politically. After picking the low-hanging fruit the administration will be left facing cuts in ‘sensitive’ areas – notably defence.
Demographic headwinds
Added to this is the fact that an ageing population is adding to mandatory outlays. In the 1990s, policymakers benefited from a demographic tailwind. At the time, the working-age population aged 20-64 was growing faster than the retirement-age population of 65 and above. The working-age population has a labour force participation rate above 50% and so contributes to income tax revenues and GDP growth, while being ineligible for Social Security and Medicare. Older folk participate less and draw more heavily on public welfare programmes.
Today, the situation has reversed, with the number of old folk rising faster than the size of the working population, which tends to weigh on revenues relative to GDP and push up mandatory outlays.
Demography and yields
The third problem is that structural forces are putting upward pressure on bond yields. The demographic tailwind of the 1990s helped to support tax revenues and contain mandatory outlays relative to GDP. It also contributed to a structural downtrend in bond yields. This put downward pressure on real yields around the world, including in the US. Low inflation contributed to the fall in nominal yields and as US treasury yields fell, so did the US government’s net interest costs (see second chart).
Since then, demographic trends in the US and around the globe have shifted. The population of retirees and net capital consumers is now growing relative to the population of workers and capital providers. All else being equal, this should see time preferences rebound structurally – implying higher interest rates.
Other forces are at work too. Covid and Trump’s pushback against globalisation have encouraged companies to shorten their supply chains and build in redundancies. This will require capital. The push for more data centres to run AI will also require lots of capital.
In turn, this will require heavier investment in energy production and distribution infrastructure. And the trend in these turbulent times is likely to shift towards higher defence spending, especially in Europe.
Finally, in the US Trump is looking to cut corporate tax rates and reinstate 100% immediate expensing of capital investments to encourage capital spending and growth, which will put upward pressure on bond yields.
Back in the 1990s, Rubin benefited as Treasury secretary from structurally falling bond yields. Today, Bessent wants yields to fall during his tenure as well, but from demographics through AI and geopolitics to tax-rate trends, the structural winds point toward higher – not lower – yields.
Tax-cuttin’ man
In addition to all of the above, Trump wants to cut taxes. In the 1990s, US government tax revenues rose on the back of booming growth and handsome capital gains on US stocks. The same could happen again. But in the 1990s, the Clinton administration made no major tax cuts.
Today, Trump wants to extend his 2017 tax cuts on individual income (an extension which is not factored into the Congressional Budget Office projections in the first and second charts). He also plans to remove the cap on state and local tax deductions, abolish taxes on tips, cut corporate tax rates and reinstate 100% expensing of capital investments.
It seems probable that domestic tax cuts will reduce US government revenues as a share of GDP. Imposing tariffs on imports might offset some losses but are unlikely to fully offset domestic tax cuts.
Conclusion
It is likely that Trump, Musk and Bessent will cut US discretionary spending on the margin. This could free up resources for more productive use in the private sector but there are formidable forces working against it.
If Trump and co can cut spending enough to materially reduce US deficits, their action could weigh on US bond yields through two channels. First, there would be less treasury issuance for the market to digest. Second, a reduction in deficit spending would likely weigh on growth and inflation over the short term, which would tend to weigh on yields. If bond yields do decline, it would reduce the US government’s net interest costs, further improving the fiscal outlook.
All else being equal, lower yields and less demand for foreign capital to finance the US government would also tend to weigh on the dollar which could help support US manufacturers.
On balance, the US fiscal deficit is likely to remain large through Trump’s second term and could even grow.
If it does, it will have the opposite market implications: upward pressure on growth, inflation, and bond yields, as well as on the dollar.
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