The accounts do not add up in the United States. The country has entered a spiral of deficit and debt that originated in the Great Recession, was aggravated by the pandemic and has not been resolved afterwards. In almost any other country, such a lack of fiscal discipline would be unsustainable. In the United States, some are beginning to fear that it is too. The public deficit doubled last year due to the fall in income; Debt in the hands of the public is on track to surpass its World War II high, and long-term interest rates, due to a mix of factors, have hit 5%. With the aging of the population and the political deadlock in Congress, in which Democrats and Republicans row in opposite directions, the problem will worsen.
The United States federal government closes its fiscal year on September 30 and has just published budget execution data. It had income of 4.4 trillion dollars and expenses of 6.1 trillion, with a deficit of 1.7 trillion, the equivalent of 6.3% of the gross domestic product (GDP), compared to 1.37 trillion of 2022. These figures, however, are distorted because in 2022 the Administration targeted as an expense a $379 billion student debt write-off that was never executed, since it was annulled last June by the Supreme Court. The reversal of 333,000 million has been recorded this year as lower spending in 2023.
Therefore, effectively, the deficit more than doubled, to $2 trillion (7.5% of GDP), a bar only surpassed in the two years of the pandemic. The main cause was the 9% drop in income, which the Treasury attributes to having been unusually high the previous year due to the recovery from the pandemic and capital gains. What has surprised analysts is that the deficit soars in a period of growth and job creation, when the opposite is normal.
Gross public debt stood at 121% of GDP, but that figure is misleading. There is about 7 trillion of intragovernmental debt, so the relevant data is the so-called debt in the hands of the public, which stood at 98%. With this criterion, the US public debt marked its historical maximum at 106% of GDP in 1946 due to the effort of World War II. The strong growth of the following decades reduced it to 23% of GDP in 1974, before the oil crisis. Although it rose in the following decades, it still stood at a healthy 35% in 2007, before the financial crisis.
With the Great Recession, new spending items and tax cuts, it increased to 79.4% in 2019. The pandemic raised it to 100.6% of GDP due to extra spending and the drop in economic activity. Despite the subsequent recovery, the debt has barely been reduced. A 98% debt to GDP ratio is by no means unsustainable, but the fiscal trajectory of the United States is, and even more so in an environment of high interest rates and persistent deficits.
Projections from the Congressional Budget Office, an independent organization, point out that the debt in the hands of the public will exceed its historical maximum in 2029, with 107% of GDP. It will rise to 115% in 2033; to 144%, in 2043, and to 181%, in 2053. “Such high and growing debt would slow economic growth, increase interest payments to foreign holders of US debt, and pose significant risks to the fiscal and economic outlook; It could also make legislators feel more limited in their political decisions,” he warns.
“The unsustainable fiscal path of the United States is nothing new. What is new are higher interest rates, which are now expected to stay high for longer. “The costs of interest rates have a direct impact on the spending that the US government needs to finance its debt and contribute to the global deficit,” warn economists at Bank of America, who expect a deficit of 1.8 trillion in the new fiscal year. , 1.9 trillion in 2025 and 2.0 trillion in 2026. “Higher interest rates increase deficit spending and lead to greater debt issuance, creating a spiral,” they add.
“A more significant fiscal adjustment will be necessary in the medium term to place public debt on a decidedly downward path,” noted the International Monetary Fund (IMF). in his latest report on the United States. “Achieving this adjustment will require a broad range of policies that include both tax increases and addressing structural imbalances in Social Security and Medicare. The sooner this adjustment is implemented, the better,” he recommended.
political blockade
There is little room for maneuver to reduce the deficit without traumatic decisions. Budget laws only enable discretionary spending, which represents a decreasing share. Not even the spending cuts demanded by Republicans would fix the problem. Regarding mandatory expenses, including pensions and public health care (Medicare), Democrats (and many Republicans) consider them untouchable. On the other hand, Republicans (and some Democrats) flatly reject tax increases. With a Republican Senate and a Democratic House of Representatives, the political blockade prevents reducing the deficit.
The division in Congress threatens to cause a partial shutdown of the Administration when the budget extension expires on November 17. Beyond the immediate disputes over spending, a first litmus test for fiscal policy will come when Donald Trump’s tax cuts included in the Tax Cuts and Jobs Act (TJCA) of 2017 expire, which in principle expire at the end of fiscal year 2025.
“Of course, if Trump wins the next election, and assuming that the Republicans can regain full control of Congress, the likelihood of the TCJA being extended would increase substantially,” says Gilles Moëc, chief economist at fund manager AXA Investment Managers. . “This could be offset by decisive action on the spending side, but given the new Republican demographics, backing off on federal age-related health care and pay-as-you-go pensions may not be an easy sell,” he explains. .
Moëc believes that the current president, Joe Biden, has “a comprehensive and internally coherent economic plan,” but that it does not involve fiscal consolidation as designed. “Where a Biden 2.0 Administration would probably be more interested in addressing America’s fundamental fiscal problem than a Trump 2.0 Administration is in the willingness to raise taxes,” he says, but that would require congressional control. The economist points out that the population’s preferences are “dissonant.” They want the spending on social security and healthcare that Democrats defend, but with the low taxes that Republicans advocate. He points out that the market is going to begin to follow US politics even more closely ahead of the 2024 elections. “The market wants a little peace and tranquility. It is unlikely that you will get it from American politics in the near future,” he concludes.
The interest burden
There is little room—political—for action on taxes and expenses. Likewise, the interest burden depends on the level of public debt and market rates, which are also not controllable by the Government. The rise in debt rates, which makes it more expensive to refinance maturing securities, has sparked a debate about its causes. Initially, it had to do with prolonging the tightening of monetary policy, but it has reached a paradoxical point where the market can at the same time moderate its expectations of future rate hikes by the Federal Reserve and demand higher yields at long term.
The debate is whether these high rates reflect the strength of the US economy, as Treasury Secretary Janet Yellen maintains, or whether the fiscal trajectory is being penalized with a kind of risk premium, even though US Treasury bonds are the risk-free asset by definition. “We suspect that an increasing number of investors are starting to look under the hood of the trajectory of the US deficit,” says Moëc, who emphasizes the large amount of debt to be issued. Tiffany Wilding, an economist at PIMCO, believes the bond selling that has driven up long-term rates “is largely driven by investor expectations of an increasingly strong U.S. economy” rather than concerns about more rate hikes: “We believe the sell-off is due to reduced recession expectations, which could ultimately lead to an increase in the supply of US Treasury bonds,” which stands at $3.5 trillion. She admits that it may seem “counterintuitive” because typically higher growth raises revenue and reduces the deficit. However, that is not happening currently, because in the absence of an imminent recession, central banks can reduce their bond holdings to a greater extent.
Garret Melson, portfolio strategist at fund manager Natixis, says the rate hike “has left many investors scratching their heads and searching for any justification for this move.” But she rejects the “easy narrative” that “bond vigilantes” are punishing deficits and debt. “The current fiscal situation in the United States is not problematic, but it is no surprise to anyone that the path is unsustainable,” she says. “The need to finance a growing fiscal deficit is not new news that investors have suddenly discovered during the summer months,” she explains. She also argues that if the sustainability of the fiscal path were the cause, the dollar should go down, when the opposite has happened.
“Yes, larger deficits translate into greater issuance of Treasury bonds which, in the absence of growing demand, would drive up yields,” he admits. “There is no doubt that this is part of the story, but the movement in bond rates appears to be due to a confluence of events that have caused a buyers’ strike, rather than a single factor such as fear of deficit.” Melson highlights as an explanation macroeconomic volatility, doubts about how growth and inflation will evolve, and uncertainties surrounding the Treasury’s issuance plans to finance this persistent deficit. “The marginal buyer of US Treasuries is increasingly price sensitive. If a base of buyers who are more sensitive to prices is combined with an environment of high volatility, the perfect conditions are created for a vicious circle that feeds on itself. High volatility generates lower marginal demand, which in turn generates higher volatility, and so on,” he explains.
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