Rising debt and deficits pose a threat to the economy and markets

Government debt, which has ballooned by nearly 50% since the beginning of the coronavirus pandemic, is causing high levels of concern on both Wall Street and Washington.

Federal IOUs now stand at $34.5 trillion, an increase of approximately $11 trillion from March 2020. It now accounts for more than 120% of the total U.S. economy.

Concern over such eye-popping numbers was largely limited to partisan rancor on Capitol Hill, as well as watchdog agencies like the Committee for a Responsible Federal Budget. But in recent days, the topic has spread to government and financial executives, with one prominent Wall Street company saying it believes the costs of debt pose a significant risk to stock market gains. I have my doubts.

“We have a large structural deficit and we’re going to have to address it sooner or later,” Federal Reserve Chairman Jerome Powell told bankers in Amsterdam on Tuesday. “Sooner is much more attractive than later.” That’s the point,” he said. .

Mr. Powell has steadfastly avoided commenting on these issues, but he encouraged his audience to read the recent Congressional Budget Office report on the nation’s fiscal situation.

“Everyone should read what is being announced about the U.S. budget deficit and should be deeply concerned that this is an issue that requires urgent action from our elected officials,” he said. said.

Indeed, the CBO numbers are ominous because they show the likely path of debt and deficits.

The watchdog estimates that the debt held by the public, which currently totals $27.4 trillion, excluding government debt, will increase from 99% of GDP today to 116% over the next 10 years. This would be a “larger amount than at any point in the nation’s history,” the CBO said in its latest update.

Soaring budget deficits are increasing debt, and CBO expects the situation to worsen.

The agency projects a $1.6 trillion shortfall in fiscal year 2024, which has already reached $855 billion in the first seven months and will grow to $2.6 trillion by 2034. It will swell. The deficit as a percentage of GDP will widen to 5.6% from this year’s 5.6%. 6.1% in 10 years.

“Since the Great Depression, the only times budget deficits have exceeded that level are during and immediately after World War II, the 2007-2009 financial crisis, and the coronavirus pandemic,” the report said. It is said that

In other words, such high budget deficits are primarily common during economic downturns, and after a brief sharp decline after the pandemic was declared in March 2020, the relative decline that the United States has enjoyed for most of that period has increased. It’s not about prosperity. From a global perspective, European Union member states are required to keep their budget deficits at 3% of GDP.

The potential long-term impact of the debt came up in an interview JPMorgan Chase CEO Jamie Dimon gave to London-based Sky News on Wednesday.

“The United States should be very aware that it needs to focus a little more on the deficit issue, and that’s important for the world,” said the head of the largest U.S. bank by assets.

“Why wait if there’s going to be a problem at some point?” Dimon added. “The problem is caused by the market, and then you’re forced to deal with it, and you’ll probably end up dealing with it in a much more unpleasant way than if you had dealt with it in the first place.”

Similarly, Ray Dalio, founder of Bridgewater Associates, told the Financial Times a few days ago that rising U.S. debt levels have led to “particularly from foreign buyers concerned about the U.S. debt situation and potential sanctions.” He said he was concerned that U.S. Treasuries would become less attractive.

Foreign holdings of U.S. federal debt totaled $8.1 trillion in March, up 7% from a year earlier, according to data released Wednesday by the Treasury Department. Risk-free U.S. Treasuries are still seen as an attractive place to store cash, but that could change if the U.S. doesn’t keep its finances in check.

More directly, there are concerns that rising bond yields could spill over into the stock market.

“The clear big problem is that the U.S. federal debt is on a completely unsustainable long-term trajectory,” Wolf Research analysts said in a recent note. The company fears that “bond vigilantes” will go on strike unless the U.S. gets its finances in order as rising interest rates squeeze spending.

Wolf analysts say that policymakers (on both sides of the aisle) are unlikely to seriously address America’s long-term fiscal imbalances until markets begin to push back strongly against this unsustainable situation. That is our feeling.” “We believe that policymakers and markets are likely underestimating the expected future net interest costs.”

The debt situation is complicated by interest rate hikes by the Federal Reserve. From March 2022 to July 2023, the central bank raised short-term borrowing rates 11 times by a total of 5.25 percentage points, tightening policy in response to the sharp rise in U.S. bond yields.

Net interest on the debt, calculated by subtracting investment income from total government debt payments, totaled $516 billion this fiscal year. This is more than the government spends on defense and Medicare, and about four times the amount spent on education.

The presidential election may bring about some changes in the fiscal situation. The debt soared under President Joe Biden after an aggressive spending response to the pandemic, and grew even further under his Republican opponent, former President Donald Trump.

“The election could change the medium-term fiscal outlook, but the chances are smaller than we imagine,” Goldman Sachs economists Alec Phillips and Tim Krupa said in a note.

A landslide Republican victory could lead to an extension of the expired corporate tax cuts that President Trump forced through in 2017 — corporate tax revenues have nearly doubled since then — while a Democratic victory could While there may be some tax increases expected, “much of it is likely to go toward new spending,” Goldman economists said.

But the biggest problem with the budget is spending on Social Security and Medicare, and Goldman said reforms to either program are unlikely “under any scenario” surrounding the election.