If President Trump’s promise to increase defense spending comes
to fruition, it would sharply reverse the trend of the past five
years—and have important implications for the outlook on US
growth and inflation.
Trump’s National Defense Plan
President Trump has promised an ambitious program to rebuild the
US military. His plan includes modernizing US nuclear weapons
systems, investing more in cybersecurity, enlarging the US Navy’s
fleet and increasing the number of US Air Force fighter aircraft.
Military personnel levels would also grow: Trump envisions adding
more than 100,000, according to some estimates.
The details of Trump’s first Pentagon budget is part of the
overall budget he’ll submit to Congress in late February or early
March. The actual funding request for the current fiscal year
(which ends September 30) must be completed by April 30—that’s
when the current legislation funding the military budget is set
to expire. More important, Trump’s blueprint for the Pentagon
budget could set the baseline for defense spending for at least
the next four years.
The President’s military expenditures could be at the low end of
what some in Congress are proposing. For example, Senator John
McCain, who chairs the Senate Armed Services Committee, recently
released a white paper on defense spending, Restoring American
Power. McCain argues the US has underinvested in the military for
years, and that it’s now vital to substantially increase funding
for the Pentagon. His plan calls for a US$640 billion defense
budget for fiscal year 2018, which is US$58 billion above the
current budget baseline. Moreover, McCain’s defense plan urges an
additional US$430 billion in military spending over the next five
Defense Spending Patterns: Unlike the Rest
Defense spending patterns are unlike other federal programs in
that they’re neither cyclical nor countercyclical. They’re
usually based on military and political strategies, as well as
the country’s ongoing readiness to respond to or engage in global
encounters. In the past 50 years, we’ve seen three large defense
spending programs in the US (Display), according to
historical gross domestic product data.
Vietnam. The first buildup, tied to the
country’s military engagement in Vietnam and Southeast Asia,
occurred in the mid-1960s, during President Lyndon Johnson’s
term. It ran for five years.
Reagan Era. The second large defense spending
boom occurred during the first four years of Ronald Reagan’s
presidency. This buildup was part of Reagan’s political and
military strategy to rebuild the military apparatus after what he
characterized as years of neglect.
Iraq War. The third major increase started
during the first term of President George W. Bush and was linked
to 9/11 and the events that followed in the Middle East.
From a political and military standpoint, the Trump defense plan
parallels the goals and objectives of Reagan’s military push. And
with McCain’s more aggressive plan aligned on the same premise of
modernizing and improving the readiness of the US military, Trump
will likely have the influential senator’s backing to beef up the
Today’s Backdrop: Reminiscent of the 1960s
It’s important to look at the multiyear defense spending plans in
terms of the economic and financial backdrop of the time. From a
historical context, today’s conditions have more similarities
with the economic setting of the mid-1960s than with the defense
buildups of the early 1980s or early 2000s, which were in
recession or in the very early stages of recovery.
In contrast, in the mid-1960s, the US economy was already in its
fifth year of expansion, the jobless rate of 4.5% was relatively
low and inflation was tame (roughly 1.5%). The extra defense
spending boosted domestic-demand growth and added significant
pressure to labor costs, materials, supplies and product
prices—so much so that the acceleration in consumer price
inflation (from 1% in 1961 to near 6% in 1970) from the start to
the end of that business cycle was one of the largest of any
economic growth cycle during the postwar period.
Today’s economic backdrop looks similar in many ways. The economy
has been in recovery for seven years, the jobless rate is in the
mid-4% range and inflation is stable (at around 2%). While many
domestic and global factors are different now, we would still
expect a large multiyear defense spending program to boost growth
and put upward pressure on labor costs and inflation in the
coming years. It’s important to note that we’re coming off the
weakest five-year defense spending trend in the past 50 years, so
Trump’s defense spending need not match any of the prior three to
have a major impact.
When Trump unveils his budget, the defense spending request will
be a key focus. A large multiyear program would definitely lift
inflationary pressures. While we wouldn’t expect an acceleration
like that of the 1960s, a sustained rise of one to two percent in
general inflation would still seem reasonable—and much more than
the US Federal Reserve and financial markets are currently
The views expressed herein do not constitute research,
investment advice or trade recommendations and do not necessarily
represent the views of all AB portfolio-management teams.