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Long Story Short: The Budget Deficit Growth Shows No Signs of Slowing Down

Do Budget Deficits Matter? U.S. Deficit Tops $1 Trillion in First 11 Months of Fiscal Year

(Note: companies that could be impacted by the content of this article are listed at the base of the story [desktop version]. This article uses third-party references to provide a bullish, bearish, and balanced point of view; sources are listed after the Balanced section.)

The U.S. budget deficit topped $1 trillion in calendar 2019 according to Treasury Department figures released on Monday. The $1.02 trillion deficit was an increase of 17.1% from the previous year. The U.S. deficit has expanded for four consecutive years. This is the first time this has happened since the early 1980s. With the latest figures, the national debt has now grown to $23.2 trillion. Budget plans for the fiscal year ending September 30, 2020, anticipate a deficit of $1.1 trillion. This is based on government spending of $4.75 trillion and revenue of $3.65 trillion. Kimberly Amadeo, of The Balance, cites three reasons for the increase in the budget deficit in recent years. First, she points to increased defense spending ($989 billion) in response to an expanded war on terrorism. Second, tax cuts have added $3 trillion to the national debt greatly increasing debt servicing costs ($479 billion). Finally, she points to a growth in unfunded mandatory spending for programs such as Medicaid ($419 billion) and Medicare ($645 billion). Put succinctly, more than half of government spending is going toward programs that would be very difficult to cut. So, is the federal deficit a runaway train about to derail (Bear case), or is the increase a manageable outcome of an expanding economy (Bull case)?

The economy is also growing. If the government were a corporation, lenders would look at ratios such as debt coverage to determine the entity’s ability to service the debt. And, while deficit and debt levels are growing, so is the economy. The federal deficit represents approximately 5% of gross domestic product. That percentage has been as low as 3% and as high as 10%. From that point of view, the federal deficit is not alarming. Lenders also look at total debt levels as cash flow. U.S. debt as a percentage of GDP is 79%. This is the highest level since World War II, perhaps a more concerning measurement.

Interest rates are low. The reason debt servicing ratios are low relative to historic levels despite record levels is that the cost of servicing debt (Treasury yields) are historically low. With inflation relatively tame and interest rates for other nations also low, there are no immediate concerns that U.S. Treasury rates will rise. Proponents of modern monetary theory would argue that governments should expand deficits while keeping interest levels low to the point of zero unemployment or signs of inflationary pressure.

Voter interest in the deficit is declining. Gallop polling shows that only half of the population worries about the budget deficit “a great deal” in a March 2019 poll, down from 64% of the population eight years ago. While polling is probably not a good argument for government policy, it is perhaps an explanation of government policy.

What if interest rates rise? As discussed in the Bull arguments, the government’s ability to service debt is manageable due to low interest rates. But what if interest rates were to rise? Debt servicing costs would suddenly become the largest government expenditures, surpassing Medicare, Medicaid and defense spending. If the rise in rates comes along inflationary pressure, it may come at a time when the Federal Reserve feels the need to slam on the brakes which would slow future tax receipts. The argument made by Keynesian economists is that the deficit should rise during periods of economic weakness but should decrease during periods of strength so that the government reloads its economic response weapons.

Are we comfortable with foreign governments owning our debt? Of the $23 trillion in debt outstanding, $17.1 trillion is public debt. Of this, $6.7 trillion is held by foreign governments lead by Japan ($1.2 trillion) and China ($1.1 trillion). China has periodically made threats about selling Treasury bonds. However, both Japan and China want to keep the value of the dollar high relative to their currencies to support growth in their countries. Selling treasuries and converting the proceeds to yen or yuan would be counterproductive to their goal.

Rising debt levels requires Congress to raise the debt ceiling. Article I Section 8 of the U.S. Constitution gives Congress the authority to borrow money. This was modified in 1917 during World War I to allow the Treasury to issue debt subject to a debt ceiling set by Congress. The government regularly surpasses Congress’s set debt ceiling. In recent budget discussions, Congress has threatened to not raise the ceiling to influence government spending. The current debt ceiling is $22 trillion, which had been surpassed in fiscal 2019.

Government spending is going to increase, so we should be prepared. Rising health costs will mean higher expenditures for Medicare and Medicaid. Political instability in other countries makes cutting defense spending difficult. Rising debt levels means debt servicing costs rise even if interest rates hold steady. And, Social Security, which currently is self-funding but expected to become insolvent in the next twenty years, could begin to require government spending.

Whether or not one thinks the budget deficit is a problem depends upon one’s view of the future. Continued economic growth would make the deficit less significant. On the other hand, an economic slowdown would make the deficit more problematic.

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Long Story Short: The Budget Deficit Growth Shows No Signs of Slowing Down

Do Budget Deficits Matter? U.S. Deficit Tops $1 Trillion in First 11 Months of Fiscal Year

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