You’re probably aware that the US budget deficit jumped to $590 billion for fiscal 2016. What you might not know is that US government debt rose by $1.4 trillion last fiscal year. That difference between the deficit and debt increases is a huge number.
What did we spend that additional $800 billion on?
My friends Dr. Lacy Hunt and Van Hoisington of Hoisington Asset Management can answer that question and more. Using current CBO projections and the trend in off-budget debt, Lacy and Van estimate that US government debt could grow by an additional $13 trillion in the next 10 years (by 2025). That would put total debt at $33 trillion and push to 150% debt-to-GDP.
Here’s the big problem: that’s the optimistic scenario. It assumes 2.5% to 3% growth and no recessions. As I have shown in a few of my own recent letters, the on-budget deficit would balloon to $1.3 trillion in a recession, easily pushing the increase in debt to $2 trillion per year. That total of $33 trillion of US government debt could be reached in the very early 2020s.
But wait, there’s more. In Thoughts from the Frontline, I’ve written about the significant increases in the cost of insurance premiums under the Affordable Care Act. The rising premiums aren’t figured into the CBO budget forecast.
Many of you might think that’s not a budget issue because individuals pay the premiums. But keep in mind, we are subsidizing, either partially or completely, 25 million people under the Affordable Care Act. And rising premiums for those people will indeed mean an increase in the deficit. Within a few years that could add $200 billion to the deficit unless we figure out how to control healthcare costs.
So what will rising government debt due to growth? That is when Lacy and Van roll out the big research guns, which I’ll let you absorb for yourself.
Hoisington Management Quarterly Review and Outlook, 3Q 2016
By Dr. Lacy Hunt and Van Hoisington
Deficit and Debt
The Congressional Budget Office has estimated that in the fiscal year ending September 30, 2016, the U.S. budget deficit jumped to $590 billion, compared with $438 billion in the prior fiscal year. However, over the same time period the change in total gross federal debt surged upward by $1.4 trillion, more than twice the annual budget deficit measure.
This difference between the increase in the deficit and debt is not a one-off fiscal policy event but instead part of an historical pattern. From 1956 until the mid-1980s, the change in gross federal debt was always very close to the deficit (Chart 1). However, over the past thirty years the change in debt has exceeded the deficit in 27 of those years, which served to conceal the degree to which the federal fiscal situation has actually deteriorated. The extremely large deviation between the deficit and debt in 2016 illustrates the complex nature of the government accounting.
To better understand why there is a gap between the increase in the deficit with the change in gross federal debt, we examine a recently available breakdown and analysis of data on the federal budget deficit from Louis Crandall of Wrightson ICAP, which consists of the year- over-year change ending June 30, 2016. The increase in debt for that period was over $1.2 trillion while the deficit was $524 billion, a near $700 billion difference. The discrepancy between these two can be broken down as follows (Table 1): (a) $109 billion (line 2) was due to the change in the treasury cash balance, a common and well understood variable item; (b) $270 billion (line 3) reflects various accounting gimmicks used in fiscal 2015 to limit the size of debt in order to postpone hitting the Debt Limit. Thus, debt was artificially suppressed relative to the deficit in 2015, and the $270 billion in line 3 is merely a reversal of those transactions, a one-off, non-recurring event; (c) $93 billion (line 4) was borrowed by the treasury to make student loans, and this is where it gets interesting. Student loans are considered an investment and therefore are not included in the deficit calculation. Nevertheless, money has to be borrowed to fund the loans, and total debt rises; (d) In the same vein, $70 billion (line 5) was money borrowed by the treasury to increase spending on highways and mass transit. It is not included in the deficit calculation even though the debt increases; (e) $75 billion (line 6) was borrowed because payments to Social Security, Medicare and Affordable Care Act recipients along with the government’s civilian and military retirees were greater during this time frame than the FICA and other tax collections, a demographic development destined to get worse; (f) Finally, the residual $82 billion (line 9) is made up of various unidentifiable expenditures including “funny money securities stuffed in various trust funds”.
As noted, these last four items discussed above (lines 4, 5, 6 and 9), which total $320 billion, fund activities and raise debt, but they are not in the deficit. Instead they are categorized as something else. Under the principles of economics, they are in fact cash expenditures that raise federal debt.
The future does not look any better. In January 2015, the nonpartisan Congressional Budget Office (CBO) said that the cumulative ten- year U.S. budget deficit (2015 to 2025) would total $8.1 trillion. In their August 2016 projection, the CBO places the current ten-year deficit at a much higher $9.2 trillion. If history is any indicator, the actual increase in debt is likely to be much greater than $9.2 trillion. In the past ten years, the cumulative budget deficit was “only” $7.9 trillion, but the increase in debt was $10.9 trillion, a 38% difference. Using the same math, by 2025 the debt increase will be in the neighborhood of $13 trillion, based on the $9.2 trillion deficit increase projected by the CBO. Additionally, the CBO’s economic projections rely on acceleration in economic growth from the pace thus far in this expansion, without adequate support for their forecast.
A Global Trend
The deteriorating U.S. fiscal situation is duplicated in Europe, the United Kingdom, Australia, Canada, Japan and China. Moreover, calls for more “fiscal stimulus” in the U.S., the EU and Japan have increased. In The Wall Street Journal article “Let’s Get Fiscal” published August 10, 2016, well-respected journalist and economics editor Mike Bird wrote, “After years of austerity, governments in the developed world are becoming more relaxed about loosening their purse-strings and engaging in a bit of fiscal stimulus.” And in an article entitled “Monetary Policy in a Low R-star World”, John C. Williams, President of the Federal Reserve Bank of San Francisco, published in the bank’s Economic Letter of August 15, 2016 wrote “… fiscal and other policies must also take on some of the burden to help sustain economic growth.”
The exceedingly ironic aspect is that such prominent figures think government spending has been constrained. According to the latest tabulations from the Organization for Economic Cooperation and Development (OECD), government debt-to-GDP ratios are at record highs in the U.S., the EU, the UK, Japan and a large number of other countries. No austerity has occurred, and consequently, even higher debt-to- GDP ratios will continue to be the norm in