The day before signing the Fiscal Responsibility Act into law, President Biden said, “We’re cutting spending and bringing deficits down.”
House Speaker Kevin McCarthy and a number of his GOP colleagues were even more effusive in their praise of the legislation, issuing a statement that referred to the new law as “transformative change to how Washington operates.”
Republican Senate Minority Leader Mitch McConnell was every bit as enthusiastic, saying that the “agreement makes urgent progress toward preserving our nation’s full faith and credit and a much-needed step toward getting its financial house in order.”
It seems, however, all those lauding the deal that resolved the nation’s most recent debt-ceiling standoff may have been getting just a bit ahead of themselves.
In the merely three months since the Fiscal Responsibility Act became law, the gross national debt already has risen by another nearly $1.5 trillion, suggesting that perhaps the “transformative change” to which McCarthy and others referred to remains elusive (bear in mind that the projected deficit reduction which has earned the legislation so much praise totals $1.5 trillion over the next decade).
As for Mitch McConnell’s notion that the new law “makes urgent progress toward preserving our nation’s full faith and credit,” it turns out that Fitch Ratings, one of the world’s “Big Three” ratings agencies, doesn’t see it that way. At the beginning of August, Fitch downgraded America’s credit rating from AAA to AA+, in part because of what it said is “a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters.”
Because the downgrade came on President Biden’s watch, it may seem as though it’s a direct slap in the face of the administration. And while it certainly doesn’t reflect well on the White House, let’s be clear: Practically no one in Washington has clean hands on the matter of fiscal management…a fact underscored by Fitch’s detailing that the “deterioration in governance” they reference as a key reason for the downgrade has been ongoing for the previous two decades. Fiscal year 2001 is the last time the federal government ran an annual budget surplus, and deficits have climbed well into the trillions during both the current and previous presidential administrations.
In fact, the annual budget deficit had never before stretched above the $2 trillion mark until 2020, when it shot over $3 trillion in a year characterized largely by the pandemic. 2021, the first year of the Biden presidency, was close on its heels, however, which saw the government incur a whopping $2.7 trillion budget deficit. Although the 2022 deficit was more modest by comparison, it nevertheless reached nearly $1.4 trillion – the 4th-highest annual budget deficit in U.S. history.
In some respects, last year’s deficit might be even more eyebrow-raising than those racked up in 2020 and 2021. After all, during 2020 and 2021, the government was knee-deep in providing rescue money to both individuals and businesses on behalf of the significant economic fallout arising from the global health emergency.
That further suggests what’s going on this year might be most concerning of all: According to a recent update by the Congressional Budget Office CBO), so far in fiscal year 2023 – a year not characterized by a worldwide health crisis or severe economic downturn – the deficit through July has grown at twice the rate it did in 2022.
The possibility that budget deficits in 2022 and 2023 represent a “new normal” in fiscal recklessness raises the prospect of significant potential implications through both the near and longer terms. Ballooning deficits could mean persistently higher inflation and interest rates, and the cumulative impact – most starkly evidenced through a soaring national debt – might yield even graver consequences down the road.
We’re going to take a look at those potential implications a little later. Before we do, however, let’s examine what’s going on with annual deficits right now, and see if, in fact, it appears we may have “achieved” a new, albeit concerning, normal when it comes to U.S. fiscal policy.
You might have thought the contentious back and forth that characterized the negotiations over the debt-ceiling standoff, as well as the momentous decision by Fitch to downgrade America’s credit rating, would result in immediate changes to how the government handles its fiscal business.
Apparently not. In a piece of news many view as startling, the CBO recently reported that the federal deficit reached $1.6 trillion through the first 10 months of fiscal year 2023. That’s more than double the size that the deficit reached – $726 billion – through the first 10 months of fiscal year 2022.
What’s more, the CBO notes that October 1, 2022 – the first day of fiscal year 2023 – fell on a Saturday, mandating the shifting of $63 billion payments from what would have been 2023 into 2022. Had that not happened, the 2023 deficit through July would have topped $1.7 trillion.
Speaking of “$1.7 trillion,” that is also the CBO’s updated projection of where the deficit will land by the conclusion of fiscal year 2023. It’s a $200 billion jump over the previous forecast issued by the CBO just four months ago.
Reacting to the CBO’s revised forecast, Maya MacGuineas, president of the nonpartisan Committee for a Responsible Federal Budget, said, “With just two months left in the fiscal year, we’ve now borrowed $5.3 billion per day and have already surpassed all of last year’s deficits. The deficit this year and next year are on track to be 50 percent larger than before the pandemic, despite the fact that the pandemic is over and the economy seems to be growing at a steady clip.”
In a recent article on the CBO’s updated deficit projection, Bloomberg observed, “The outlook for the federal budget right now is essentially unprecedented—crisis-size deficits as far as the eye can see, even though the economy appears to be in good health.”
The CBO anticipates this year’s deficit will represent nearly 6% of GDP, with the trend broadly growing from there through 2053, when the CBO forecasts the deficit to represent a jaw-dropping 10% of GDP.
For some perspective, the deficit never reached 6% of GDP between 1947 and 2009, the year the U.S. faced the consequences of the global financial crisis head-on.
In nominal terms, the CBO projects the deficit will average – average – close to $2 trillion per year through 2033, and the gross federal debt will top $50 trillion by then, as well. As for the portion of the federal debt held by the public, the CBO projects that will equal 119% of GDP by 2033 and 181% of GDP by 2053.
According to Doug Holtz-Eakin, a former director of the CBO who now heads a policy think tank, political expediency lies at the root of this apparent new level of comfort with massive government indebtedness.
“During the 1980s and 1990s there was more of a focus on the long-term picture and making sure our fiscal house is in order,” Holtz-Eakin told Bloomberg. Not anymore, says the economist, who told Bloomberg that, in his view, fiscal policy now is being used as a tool to keep the economy rolling.
For all the fanfare that came with the resolution of the debt-ceiling standoff, the trend toward trillions-per-year deficits in years marked by neither crisis nor recession suggests nothing has changed when it comes to fiscal policy in Washington. Even worse, it raises the possibility that a “new normal” is now in place, one that practically exemplifies the recent characterizations of America’s fiscal outlook as “unsustainable” by several government agencies, including the Treasury Department.
But what does “unsustainable” mean, ultimately? The implication of an “unsustainable” fiscal outlook is that if nothing is done to change it, the economy could “break” in a potentially very-significant way. What might that actually look like?
The CBO has some thoughts.
“If federal debt continued to rise in relation to GDP at the pace that CBO projects it would under current law,” the agency said in its 2023 Long-Term Budget Outlook, “it would have far-reaching implications for the fiscal and economic outlook.”
An outright fiscal crisis is among those potential implications noted by the CBO. As enormous deficits continue to feed an even more enormous federal debt, the CBO says the prospects of a fiscal crisis would grow. The reason is that investors around the world eventually could lose confidence in the ability of the government to honor its obligations. Those investors in America’s debt – securitized in the form of Treasury instruments – may decide to dump their holdings and/or be disinclined to purchase any more.
Such an eventuality likely would cause interest rates on federal debt to climb as the effort is made to make yields more attractive to those investors, hoping they’ll keep buying Treasuries. That’s the point at which the fiscal crisis could morph into a financial crisis.
As rates climb, the value of previously issued Treasuries would fall. The countless mutual funds, pension funds, insurance companies and banks that maintain large portfolios of Treasuries would be at a heightened risk of failure in the higher-rate climate (remember that the failure of Silicon Valley Bank earlier this year was attributed largely to the unrealized losses incurred on its massive portfolio of government securities). As those failures spread, suggests the CBO, the scope of the crisis could become global in short order.
So often, the tone and tenor of discussions about fiscal unsustainability suggest the path traveled to a possible debt crisis would be gradual, giving legislators time to make appropriate adjustments before real trouble strikes. But that’s not necessarily true, according to the CBO.
“It is…possible that investors would lose confidence abruptly and interest rates on government debt would rise sharply,” the agency clarifies. “The exact point at which such a crisis might occur for the United States is unknown, in part because the ratio of federal debt to GDP is climbing into unfamiliar territory and in part because the risk of a crisis is influenced by a number of other factors, including the governments long-term budget outlook, its near-term borrowing needs, and the health of the economy.”
Similarly, Cato Institute sees it as very plausible that the onset of a debt crisis arising from fiscal unsustainability could be rapid, saying that “like recent banking crises, a U.S. debt crisis could arise suddenly because of how financial markets respond to revised information and changing economic and political conditions.”
The think tank adds, “Certain economic models, such as herd models and winner‐take‐all models, suggest that when investors suddenly doubt the government’s ability to pay back its debts, they may rush to sell U.S. bonds all at once. Such a sudden surge in sales could lead to a rapid rise in interest rates, making it more expensive for the government to borrow and potentially triggering a broader financial panic.”
It cannot be known, for certain, what the nation’s fiscal future holds for Americans. It seems there’s still plenty of time for political leaders on both sides of the aisle to come together and take truly meaningful steps to right the nation’s fiscal ship.
But the evidence suggests those steps will have to be much bigger than the ones taken to piece together the Fiscal Responsibility Act. Whether they’re taken in time to avoid the sort of potential outcomes envisioned by the CBO and Cato Institute remains to be seen. Given both this uncertainty and the relative powerlessness of average Americans to change it, some Americans have implemented measures they think could help mitigate any fallout from those possible outcomes.
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