It's the feel-good story of 2013 that nobody is talking
The nation's budgetdeficit , which had been spiraling out of
control, is finally returning to manageable levels. Thanks to
higher governmentrevenues and lower government spending, thisyear
's shortfall (for thefiscal year ended Sept. 30)will likely be
around 40% lower than a year ago.
In fact, the Congressional Budget Office (CBO ) predicts the
budget deficit will fall below $400 billion by fiscal 2015. Good
Or is it?
Should we be pleased the budget deficit will still be larger
than the entireeconomy of many mid-sized countries? And for
investors, does that falling budget portend good news forstocks
andbonds ? Before we answer those questions, let's take a closer
look at the road ahead for the U.S. government's finances.
A Fast-Shrinking Deficit ($billions)
Source: Congressional Budget Office
Despite the current good news, demographic forces threaten to
push the deficit higher later this decade. Until policy makers
adopt additional measures to raise revenues (likely through tax
increases) and cut government spending, the CBO forecasts a $650
billion deficit by fiscal 2019 and an $800 billion deficit by
2022, as a growing pool of retirees absorb a higher amount of
retirement and health care benefits.
How much higher? The CBOnotes that Congress is currently
spending around $2 trillion every year on mandatory spending such
asSocial Security andMedicare , though that figure is expected to
swell 75% to $3.5 trillion by 2022.
No matter how large or small, the deficit is still troublesome
to the rising $16.7 trillion nationaldebt . And all that debt
means the government doles out more than $300 billion a year in
interest payments on that debt, which plays a role in keeping the
budget from coming into balance.
To be sure, the current interest payments actually benefit
from the current era of low interest rates. When interest rates
start to rise, the government will likely pay much higher sums.
Erskine Bowles, who has been leading a government council that
seeks to tackle the persistent deficits, paints matters in
"We'll be spending over $1 trillion a year on interest by
2020. That's $1 trillion we can't spend to educate our kids or to
replace our badly worn-out infrastructure," said Bowles at a
November 2012 forum hosted by IHS Global Insight.
"What makes it doubly bad is that trillion will be spent
principally in Asia because that's where our debt is," he
No matter how you look at it, it remains hard to see how the
national debt will stop growing and start shrinking. Even with
current low interest rates, the annual interest payments consume
more of the federal budget than the Department of Agriculture,
Deptartment of Education and Department of State -- combined. By
next year, interest payments will exceed what the United States
spends annually onMedicaid .
Bad For Bonds?
Thus far, the huge tide of deficits and debt has not had much of
an impact onbond markets. The global economy has been so weak
that investors have gladly bought relatively safe government
bonds . But as the global economy strengthens, massive sums of
money will pull out of bond funds in pursuit of higher returns,
such as stocks.
The drop in demand for bonds means that bond issuers (such as
the government, states, municipalities and corporations) will
have tooffer higher yields. And rising bond yields means falling
bond prices, which will lead to a drop in value for thatbond fund
you may own. Net/net bonds are vulnerable to the ongoing budget
deficit, regardless if it's $1 trillion or $400 billion.
Good For Stocks?
So if investors can be expected to pull money out of bonds and
into stocks as the global economy firms, should we read that
tomean that budget deficits are good for stocks?
Not at all. In fact, we're already seeing real headwinds in
the economy as government spending shrinks.Uncle Sam provides
alot of juice to the U.S. economy with expenditures in defense,
technology, infrastructure and the like.Economists suggest the
smaller amount of government spending is already shaving a full
percentage point of growth from the U.S. economy'sGDP .
And with the massive debt and deficit pressure still in place,
government spending is bound to fall yet further, which means
Uncle Sam will be providing an ever-smaller boost to the economy.
Net/net stocks have rallied in recent years, despite still-large
deficits, but the road ahead will become bumpier as the
government shrinks in size.
Action to Take -->
Can Congress ever eliminate the nation's budget deficit? Where
there's a will, there's a way, but Washington has lacked the will
to do so. In 2012, I suggested ways the government could balance
its books. But thus far, only defense spending has been
tackled. The other five suggestions have gone unheeded.
Yet until you see Washington finally come to agreements that
cut spending and raiserevenue , you need to be concerned about
bonds and stocks. The recent drop in the annual deficit is great
news, but the fact that the national debt is fast-approaching $17
trillion means a debt-triggered crisis can't be ruled out.
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