Greatest risk to the Republican majority? Rising interest rates

I was having a drink the other night with a friend, who happens to have one of the most brilliant minds in structured finance. We got to talking about midterms and Donald Trump’s reelection bid. He politely laughed at my favorite question to those that detest the president: “What bothers you more, the peace or the prosperity?” But, then he advanced a thesis that has been nagging at me ever since: “The greatest threat to the Republican majority, and to Trump’s reelection, is rising interest rates.”

He advised, when you see government take an action, or fail to take an action, ask yourself who benefits. He said that in the case of rising interest rates, the only parties that benefit are those that would like to get rid of President Trump, which is basically the political establishment.

{mosads}I offered the explanations we have all heard from those who track interest rates: The Federal Reserve needs to control inflation before it takes hold, and after so long at the zero bound, it is prudent for the central bank to reel in the slack by raising short-term rates and selling off assets it bought through quantitative easing to gather capacity in the event we have another catastrophic shock to the financial system.

He countered that while those have been the reasons more commonly advanced and accepted, they do not bear scrutiny. Dropping rates and printing money are the primary tools to inject liquidity into the financial system. Raising rates now so they can drop them later is unnecessary. If rates are kept low so wages and profits can rise and a crisis hits, the Federal Reserve can respond by purchasing assets to print money.

First of all, inflation has been, and remains tame. Wages have only just started to move upward only so slightly. It should be all of our hopes that wages, which have been flat over the past 15 years, might finally rise to reward hard working and tax paying Americans for their effort with a better quality of life. Workers are not the ones benefiting from rising rates.

The largest borrower is the U.S. government. It has been able to carry the escalating national debt that now stands at over $21 trillion, in large part, because interest rates, which are the cost of carrying the debt, have been so low. But if rates continue to rise, it will put increasing pressure to both control spending and raise taxes. Both would be incredibly unpopular with voters, and that means tough choices.

Whatever they do at that point will disappoint the electorate. The government as an institution would be in a squeeze with lower tax revenues and more interest expenses, leaving less cash available to fund popular programs. The government will have to make do with less, so it is not the only one benefitting. Furthermore, a lot of households will see a reduction in free cash flow, or money to spend on discretionary expenses, because payments on credit cards, student loans, mortgages and cars will require more of their cash. Households will most definitely be hurt.

When consumers spend less, the economy slows. Businesses will respond by slowing down production, putting off hiring and purchases of capital equipment for expansion, and inevitably cutting workers. This gets exacerbated by banks imposing tougher underwriting standards, loaning less dollars and to fewer borrowers, and charging more for the loans they make. Net income will be lower, putting pressure on stock prices.

Savers, those that rely on income and appreciation earned by their funds, have enjoyed healthy returns in the rising stock and real estate markets of the Trump era. However, when credit dries up, asset prices fall, including those of stocks and real estate. When asset prices fall and free cash flow is compressed by the combination of lower revenues and higher interest costs, some businesses and some households will no longer be able to carry their debts and could be forced into foreclosures or bankruptcy. Businesses and savers thus will not be see any benefit.

The more interest rates rise, the more likely these phenomena will come into play, and the more likely voters will be motivated to make a change. In fact, if rates go high enough, these outcomes are inevitable. The only winners if rates continue to move upward are those who want to get rid of the very disruptive President Trump. It is worth noting that interest rates were kept at near zero for the establishment’s beloved President Obama, and he still could not get the economy to stop sputtering.

Trump came into office with a mandate to shake up the status quo on American priorities and policies. He has passed tax reform, is renegotiating trade deals, and stimulating the economy with reduced regulation and a pro-business agenda. Americans are starting to make more, and keep more of what they make. We have seen the lowest unemployment in history for blacks and Hispanics. Democrats and those in the Republican establishment are seeing the president’s approval numbers rising. If this keeps up, the electorate will return the Republican majority to Congress in 2018 and reelect Trump in 2020.

Thus far, his opponents in the Democratic Party and the establishment of his own party have failed to make their case on economic issues or political issues, and shrill media accounts aside, the special counsel investigation is also unlikely to get rid of Trump. The president and the GOP should see the greatest threat to the continued Republican majority, and to a second term for the Trump administration, is rising interest rates.

Dan Palmer is a Republican donor and conservative political strategist. He served as executive director of United We Stand, planned the potential transition of Ted Cruz, and supported the campaigns of Kevin McCarthy and Donald Trump. You can find him on Facebook @RealDanPalmer.