US Treasury Secretary Janet Yellen at an event in Beijing. Associated Press/LaPresse (APN)
In the USA the accounts are incorrect. The country has entered a deficit and debt spiral that originated in the Great Recession, was exacerbated by the pandemic and has not been resolved since. In almost any other country, such a lack of fiscal discipline would be untenable. In the United States, some are beginning to fear that this will also be the case. The public deficit doubled last year due to the decline in income; Debt in the hands of the public is on track to surpass its World War II peak, and long-term interest rates have reached 5% due to a variety of factors. As the population ages and political gridlock in Congress pits Democrats and Republicans at odds, the problem will worsen.
The U.S. federal government closes its fiscal year on September 30 and has just released budget execution data. It had revenues of 4.4 trillion dollars and expenses of 6.1 trillion, with a deficit of 1.7 trillion, which is 6.3% of gross domestic product (GDP), compared to 1.37 trillion in 2022. These numbers However, are distorted because in 2022 the government planned as an expense a write-off of student debt of $ 379 billion, which, however, was never implemented as it was canceled by the Supreme Court last June. The reversal of 333,000 million was recorded this year as lower spending in 2023.
As a result, the deficit has effectively more than doubled, to $2 trillion (7.5% of GDP), a mark only exceeded in the two years of the pandemic. The main reason was the 9% decline in revenue, which the Treasury attributed to being unusually high last year due to the recovery from the pandemic and capital gains. What has surprised analysts is that the deficit skyrockets during a period of growth and job creation, while the opposite is normal.
Gross government debt was 121% of GDP, but this figure is misleading. There is about 7 trillion in domestic debt, so the relevant data is the so-called debt in the hands of the public, which was at 98%. By this criterion, the U.S. national debt reached its historic high of 106% of GDP in 1946 due to the efforts 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 was still at a whopping 35% in 2007, before the financial crisis.
Due to the Great Recession, new spending items and tax cuts, it rose to 79.4% in 2019. The pandemic caused it to rise to 100.6% of GDP due to additional spending and the decline in economic activity. Despite the subsequent recovery, debts could hardly be reduced. A debt-to-GDP ratio of 98% is by no means unsustainable, but the United States’ fiscal performance is, even more so in an environment of high interest rates and persistent deficits.
Projections from the Congressional Budget Office, an independent body, suggest that debt in the hands of the public will surpass its all-time high in 2029 at 107% of GDP. In 2033 it will rise to 115%; to 144% in 2043 and to 181% in 2053. “Such high and growing debt levels would slow economic growth, increase interest payments to foreign holders of U.S. debt, and pose significant risks to the fiscal and economic outlook; It could also make lawmakers feel more limited in their policy decisions,” he warns.
“The unsustainable fiscal stance of the United States is nothing new. What is new are higher interest rates, which are now expected to remain high for longer. “Interest costs directly affect the spending 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 more debt issuance, creating a spiral,” they add.
“More significant fiscal adjustment will be required in the medium term to significantly reduce government debt,” the International Monetary Fund (IMF) noted in its latest report on the US. “Achieving this adjustment will require a broad range of policy measures, including 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 making traumatic decisions. Budget laws allow only discretionary spending, which represents a diminishing share. Not even the spending cuts demanded by Republicans would solve the problem. Democrats (and a large portion of Republicans) view mandatory spending, including pensions and public health care (Medicare), as sacrosanct. On the other hand, Republicans (and some Democrats) flatly reject tax increases. With a Republican Senate and a Democratic House of Representatives, political gridlock prevents deficit reduction.
The division in Congress threatens a partial government shutdown when the budget extension expires on November 17. Beyond the immediate spending disputes, the first litmus test for fiscal policy will come when Donald Trump’s tax cuts contained in the 2017 Tax Cuts and Jobs Act (TJCA), which generally expire at the end of fiscal year 2025, expire.
“Of course, the likelihood of an extension of the TCJA would increase significantly if Trump wins the next election and assuming Republicans can regain full control of Congress,” said 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 demographic, it may not be easy to forego federal age-based health care and pay-as-you-go pensions,” he explains.
Moëc believes that current President Joe Biden has “a comprehensive and coherent economic plan,” but it does not include fiscal consolidation as planned. “A Biden 2.0 administration would probably be more interested in addressing America’s fundamental financial problem than a Trump 2.0 administration would be in being willing to raise taxes,” he says, but that would require congressional oversight. The economist points out that the population’s preferences are “dissonant”. They want the Social Security and Health Care spending that Democrats defend, but with the low taxes that Republicans support. He points out that the market will begin to follow US politics even more closely before the 2024 elections. “The market wants a little peace and quiet.” “It is unlikely to get it from American politics in the near future,” he concludes.
The interest burden
There is little political space for action on taxes and spending. Likewise, the interest burden depends on the level of national debt and market interest rates, which also cannot be controlled by the government. The rise in debt interest rates, which is making it more expensive to refinance maturing securities, has sparked debate about its causes. The original idea was to extend the tightening of monetary policy, but a paradoxical point has now been reached where the market can simultaneously temper its expectations of future interest rate hikes by the Federal Reserve and demand higher long-term yields.
The debate is whether these high interest rates reflect the strength of the US economy, as Treasury Secretary Janet Yellen claims, or whether fiscal development is penalized with some kind of risk premium, even though US Treasuries are by definition the risk-free asset. “We suspect that more and more investors are starting to look behind the scenes of the evolution of the US deficit,” says Moëc, highlighting the large amount of debt to be issued. Tiffany Wilding, an economist at PIMCO, believes the bond selling that has pushed up long-term interest rates is “largely driven by investors’ expectations of an ever-strengthening U.S. economy” rather than worries about further rate hikes: ” We believe the selloff is due to lower recession expectations, which could ultimately lead to an increase in the supply of U.S. Treasury securities, which stands at $3.5 trillion. He acknowledges that this may seem “counter-intuitive” since greater growth typically increases revenue and reduces the deficit. However, this is not currently the case as central banks can reduce their bond holdings to a greater extent if there is no threat of recession.
Garret Melson, portfolio strategist at fund manager Natixis, says the rate hike “caused confusion among many investors looking for justification for the move.” But he rejects the “easy narrative” that “bond watchdogs” punish deficits and debt. “The current fiscal situation in the United States is not problematic, but it comes as no surprise to anyone that the path is unsustainable,” he says. “The need to finance a growing budget deficit is not new news that investors suddenly discovered in the summer months,” he explains. He also argues that if the sustainability of the fiscal path was the cause, the dollar would have to fall, although the opposite has occurred.
“Yes, larger deficits lead to more government bond issuance, which would drive up yields without growing demand,” he admits. “There is no doubt that this is part of history, but the move in bond rates appears to be due to a confluence of events that triggered a buyers’ strike, rather than a single factor such as fear of a deficit,” Melson says as an explanation macroeconomic volatility, doubts about the development of growth and inflation and uncertainties related to the Treasury’s issuance plans to finance this persistent deficit. “Marginal buyers of US government bonds are becoming increasingly price sensitive. When a more price-sensitive buyer base is combined with a high volatility environment, the perfect conditions are created for a vicious, self-reinforcing cycle. High volatility leads to lower marginal demand, which leads to higher volatility, etc.,” he explains.
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