Deficit? What deficit?
From an entertainment point of view, the US presidential race is becoming steadily more interesting, even exciting, as we come into the final stages. The debates between the candidates generated a lot of hot air from the candidates, money for the networks, and material for the stand-up comedians, but they certainly seem to have made the contest more intense and the race much closer.
But the object of this exercise in democratic discussion is supposed to be to see which of the two candidates is better-suited and better-qualified to hold the most powerful position in the US and maybe the world. You can argue, plausibly, that if these two men are the choice being presented to the American people, then treating the race as entertainment is the preferred option – laughing instead of crying. But come November 7, or the inauguration if there is a new president, the show will be over whilst the grim reality that is the US economy will still be there, in all its pristine ugliness.
When you look at the overall picture of the American economy and get past all the hype and self-serving blather from brokers and investment banks about the ‘recovery’, there is one issue that dominates everything else. The deficit in the government budget is running at $100 billion a month. That’s $1.2 trillion a year, in an economy of some $15+ trillion – so in terms of deficit/ GDP, that’s about 8%.
Mind you, there has been an improvement in this area. The fiscal year that just ended (on October 1) saw the federal budget deficit fall to the said $1.2 trillion, from $1.3 trillion in the previous fiscal year. But this supposed achievement pales into insignificance when seen in the wider context: for four successive years the deficit has been well in excess of one trillion dollars – a number most people never knew existed, until the crash and crisis of 2007/2008. Worse still is that every realistic estimate of the deficit in the coming years, over the rest of this decade, envisages it remaining on this scale – and those estimates assume that the US economy continues to recover, rather than slip back into recession.
Even for Uncle Sam, it is very difficult to finance a deficit of this magnitude – and it might already have proven impossible without the repeated forays of the Federal Reserve into the markets. The Fed, via its ‘QE” programs, has bought very large amounts of government debt and thereby facilitated the financing of the deficit. To say that the Fed has monetized the government’s debt would mean that it had violated the law, but in practice that is what has been happening. Why the result has not been inflationary is another story, and whether it will eventually prove to be so is the focus of a major debate within the economic and financial community.
But unless the Fed really intends to hoover up ever-larger amounts of US Treasury bonds, it is not going to be possible to continue running trillion-dollar-plus deficits year after year. The investing public, which includes John Q. Public and the People’s Republic of China, will at some point refuse to keep buying – or will demand much higher interest rates to persuade them to keep doing so. In the simple, yet profound, formulation of economist Herb Stein, “if something cannot go on for ever, it will stop”. The US budget deficit is one of those many things that cannot go on for ever, and therefore it will stop.
The only relevant question facing the next president and congress is whether they will try and stop it in a considered and gradual way, by jointly formulating a medium/ long-term strategy to reduce the deficit and thereby win back the confidence of the financial markets. The alternative is that the markets will impose their will on the American politicians, by refusing to buy more bonds until their price has fallen considerably and the yield they offer has risen considerably. That event would represent a massive financial crisis and it would forcibly end the paralysis of the political system and the total unwillingness of political leaders to address the overriding issue in a meaningful and non-partisan way. Their avoidance of this subject is also one of those things that cannot go on for ever.