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Fiscal Outlook: Latest Warnings Highlight Potentially Unsound Trajectory

Isaac Nuriani    |
Oct 20, 2023
  • IMF official says U.S. fiscal outlook is the “most worrying.”
  • Analysts: Public debt to GDP at 175% could mean debt default.
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The federal government’s fiscal year drew to a close at the end of the day on September 30. And while the precise final number for the 2023 deficit remains unknown, it appears the figure will be extraordinary.

In a year marked by no emergency pandemic assistance, no national crisis of any kind…and characterized by low unemployment rate as well as an expanding economy (at least as indicated by headline GDP growth measures), the annual budget deficit nevertheless is projected to land at $1.7 trillion according to the Congressional Budget Office.[1] That will be the third-highest deficit in U.S. history…in a year that analysts say was absent any justifiable reason for that level of deficit spending.[2]

The impressive (for all the wrong reasons) 2023 budget deficit seems to imply “business as usual” when it comes to American fiscal imprudence. And this despite a year that already has been embarrassing for the U.S. in terms of fiscal missteps.

There was the contentious, months-long debt-ceiling standoff, which was “resolved” at the beginning of June with an agreement to suspend the ceiling for about a year and a half in exchange for modest spending cuts that observers say don’t change the nation’s fundamental fiscal outlook.[3]

Just two months later, Fitch Ratings decided it was sufficiently unimpressed by the debt-ceiling debacle such that it decided to slash the nation’s credit rating from AAA to AA+ – the second time in a little over a decade Uncle Sam’s credit rating has been cut.[4]

One of the principal reasons cited by Fitch for its downgrade decision is “ a steady deterioration in standards of governance over the last 20 years,” with the ratings agency declaring that “the repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”[5]

Next, in what could only be seen as direct validation of Fitch’s “deterioration in standards of governance” criticism as well as its frustration with “last-minute resolutions,” Congress had to scramble on the last day of fiscal year 2023 to piece together stopgap legislation that temporarily (until November 17) avoids a government shutdown.[6] The shutdown threat was triggered by significant differences between Republicans and Democrats about funding priorities for fiscal year 2024 – differences that led to the removal of Kevin McCarthy as House speaker and which have yet to be resolved.[7]

That lack of resolution is why the threat of a government shutdown continues to loom, with some analysts suggesting that if it comes to pass, it could last much longer than a handful of days.[8]

Heard enough? “But wait,” as they say on your favorite infomercial, “there’s more.”

Against the backdrop of all I’ve touched on so far, two key figures at the International Monetary Fund recently called out, in a very public way, the U.S. over its currently uncertain fiscal outlook. The comments came at the same time the Penn Wharton Budget Model, a prestigious applied research organization that focuses on the fiscal impacts of public policy, projected that if the nation remains on its current fiscal path, the government will be forced to default on its debt within two decades.

The damning remarks of IMF officials and the ominous projection of Penn Wharton – both of which we’ll examine more closely – further underscore just how precarious the nation’s fiscal future is, presently. And they serve as just the latest in what has been a steady stream of reminders this year that unless and until truly significant changes are made in U.S. fiscal policy, uncertainty – and the volatility that so often accompanies it – remain potential features of the economic landscape.

IMF: U.S. Debt Dynamics “Are Very Unfavorable”

In case the array of fiscal misfires in 2023 weren’t enough of a clue already, Vitor Gaspar, director of the International Monetary Fund’s Fiscal Affairs Department, has a message for America:

“US deficits are elevated and they’re projected to be persistent. Under unchanged policies, debt dynamics in the US are very unfavorable.”[9]

Gaspar’s message is essentially the same as those that have come before it: We may not be on the verge of fiscal disaster right now. But if the nation’s oft-referenced “fiscal trajectory” is not changed in time, things could get particularly ugly.

“The perpetuation of current policies entails an unsustainable fiscal path,” Gaspar said.[10]

In other words, the potential for fiscal calamity goes hand in hand with fiscal irresponsibility. It doesn’t seem as though that should be a revelation…but it might as well be, given how disinclined to changing course so many in Washington appear to be.

You’re likely aware that Treasury yields – the interest paid by the government to investors in America’s debt – have been soaring recently.[11] It’s believed one of the reasons that yields are climbing is because those investors, many of which are foreign countries, are becoming increasingly aware of the possible implications of national-debt “unsustainability.” At the same time America’s 2023 deficit finished the year at the CBO-projected $1.7 trillion, foreign investors have been making fewer purchases. Growing investor disinterest in buying Treasurys, combined with the need for the government to auction off even more of that debt to cover the surging deficit, is necessarily forcing higher rates to attract buyers.[12]

It doesn’t help, either, that the sizable deficit lodged this year is projected to be the first of many substantial deficits expected to be racked up despite prevailing economic conditions that don’t appear to justify such massively excessive spending.

In his comments, Pierre-Olivier Gourinchas, IMF research director, went straight at the odd visual of soaring deficits against a backdrop of economic functionality, seeming to imply that U.S. fiscal policy is irresponsible:

“Most worrying is the case of the United States, where fiscal deficits have deteriorated substantially in 2023. Fiscal policy in the U.S. should not be procyclical, even less so at this stage of the inflation cycle.”[13]

“Procyclical” fiscal policy refers to an increase in government spending occurring at a time when the economy appears to be thriving – and when there is ostensibly less need for that spending.

But the spending continues. We saw it in fiscal year 2023, and the CBO projects it will continue at the stunning average rate of roughly $2 trillion per year through the next decade.[14] And as it does, it seems reasonable to speculate that we’ll hear even more about the nation’s “unsustainable” fiscal outlook going forward.

Particularly if projections such as the one made very recently by the Penn Wharton Budget Model begin to mount. Penn Wharton analysts appear to have underscored just how unviable America’s long-term fiscal outlook potentially is by doing something others seem to have been reluctant to do: discuss the oft-referenced “unsustainability” in terms of the consequences they suggest are sure to follow if that unsustainability is not addressed in a timely fashion.

Let’s talk about that next.

Penn Wharton: U.S. Could Default on Its Debt in as Soon as 20 Years

Here’s the most recent, “bottom-line” message from the Penn Wharton report America’s fiscal outlook: The U.S. has roughly 20 more years to rein in its debt or a genuine default will occur.

“Under current policy, the United States has about 20 years for corrective action after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt whether explicitly or implicitly (i.e., debt monetization producing significant inflation),” the report said.[15]

Part of what makes Penn Wharton’s assessment significant is that it “officially” establishes a timeline for the point of no return implied by repeated, nonspecific declarations that the nation’s long term fiscal outlook is “unsustainable.”

And there has been no shortage of those declarations in 2023. At a press conference earlier this year, Congressional Budget Office Director Phillip Swagel indicated his belief that the nation’s current “fiscal trajectory is unsustainable.”[16] In May, the Government Accountability Office’s annual report to Congress began with the sentence, “The federal government faces an unsustainable long-term fiscal future.”[17] Even the Treasury Department’s “Fiscal Year 2022 Financial Report of U.S. Government” published in April referred to the nation’s “unsustainable fiscal path.”[18]

Right now, the ratio of public debt to GDP is 98%. According to Penn Wharton, “unsustainable” becomes an absolute tipping point for default when that percentage reaches 200%.

And it might be even less.

Public-Debt-to-GDP of 175% Could Potentially Trigger Default, Say Penn Wharton Analysts

“This 200 percent value is computed as an outer bound using various favorable assumptions: a more plausible value is closer to 175 percent, and, even then, it assumes that financial markets believe that the government will eventually implement an efficient closure rule,” Penn Wharton researchers said.[19]

“Once financial markets believe otherwise,” they added, “financial markets can unravel at smaller debt-GDP ratios.”[20]

Notably, Penn Wharton makes clear that the highly concerning outcome it says is possible wouldn’t be an example of a “technical default where payments are merely delayed.” Rather, “this default would be much larger and would reverberate across the US and world economies.”[21]

In describing the currently inexorable growth of the debt, Penn Wharton notes that some of it is “well understood,” attributable to recovery efforts in the wake of such economically significant events as the financial crisis and the more recent global health crisis. But whether the reasons make sense or not, Penn Wharton reminds us all that “U.S. debt is on secular upward path and past projections have, if anything, underestimated that increase, regardless of the reason.”[22]

There was a time U.S. leaders might have taken offense at the harsh criticisms recently lodged by IMF officials over the government’s inability to keep an orderly fiscal house. But in order for such a reaction to be justified, there would have to be at least a defensible fiscal position to assume.

And there doesn’t seem to be. It’s been an extraordinary year of fiscal missteps and warnings, to include Penn Wharton’s stark projection that a highly consequential default could lay ahead if Washington doesn’t get on the stick once and for all and do the heavy lifting required to keep prospective default firmly at bay.

Will that heavy lifting get done…eventually, at least? You’d like to think so. But that it hasn’t happened so far suggests it can’t be taken for granted that it’s going to. Which means those concerned about the potential impacts of worsening fiscal uncertainty might find it prudent to consider what steps they could take to mitigate those impacts in the event they ultimately do come to pass.

 

[1] CBO.gov, “Monthly Budget Review: September 2023” (October 10, 2023, accessed 10/19/23).
[2] Committee for a Responsible Federal Budget, “Deficit Tops $1.7 Trillion As Interest Rates Surge” (October 10, 2023, accessed 10/19/23).
[3] David Lawder and Andy Sullivan, Reuters.com, “Analysis: Debt ceiling deal ignores US debt time bomb” (June 5, 2023, accessed 10/19/23).
[4] Fitch Ratings, “Fitch Downgrades the United States’ Long-Term Ratings to ‘AA+’ from ‘AAA’; Outlook Stable” (August 1, 2023, accessed 10/19/23); Damian Paletta and Matt Phillips, Wall Street Journal, “S&P Strips U.S. of Top Credit Rating” (August 6, 2011, accessed 10/19/23).
[5] Fitch Ratings, “Fitch Downgrades the United States’ Long-Term Ratings.”
[6] Lisa Mascaro, Kevin Freking and Stephen Groves, AP News, “Government shutdown averted with little time to spare as Biden signs funding before midnight” (October 1, 2023, accessed 10/19/23).
[7] Josh Schafer, Yahoo Finance, “Ousting of House Speaker Kevin McCarthy raises chances of government shutdown, Goldman says” (October 4, 2023, accessed 10/19/23).
[8] Atul Bhatia, RBC Wealth Management, “A U.S. government shutdown looms large, and it may not end quickly” (October 12, 2023, accessed 10/19/23).
[9] Rich Miller, Bloomberg.com, “US Treasury Debt Dynamics ‘Very Unfavorable,’ IMF Official Says” (October 11, 2023, accessed 10/19/23).
[10] Ibid.
[11] Christopher Rugaber, AP News, “Rising long-term interest rates are posing the latest threat to a US economic ‘soft landing’” (October 5, 2023, accessed 10/19/23).
[12] Ibid.
[13] IMF.org, “Transcript of October 2023 World Economic Outlook Press Briefing” (October 10, 2023, accessed 10/19/23).
[14] CBO.gov, “The Budget and Economic Outlook: 2023 to 2033” (February 2023, accessed 10/19/23).
[15] Penn Wharton Budget Model, “When Does Federal Debt Reach Unsustainable Levels?” (October 6, 2023, accessed 10/19/23).
[16] Victor Nava, New York Post, “CBO projects US will add $19 trillion to the national debt in the next decade” (February 16, 2023, accessed 10/19/23).
[17] GAO.gov, “The Nation’s Fiscal Health: Road Map Needed to Address Projected Unsustainable Debt Levels” (May 2023, accessed 10/19/23).
[18] Fiscal.Treasury.gov, “Executive Summary to the Fiscal Year 2022 Financial Report of U.S. Government: An Unsustainable Fiscal Path” (April 6, 2023, accessed 10/19/23).
[19] Penn Wharton Budget Model, “When Does Federal Debt Reach Unsustainable Levels?”
[20] Ibid.
[21] Ibid.
[22] Ibid.
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