Stocks rose yesterday as optimism swooshed through the markets ahead of key earnings and economic data. The market has turned spectator to presidential elections, just a week – 1 week from TODAY.
Pennywise. Have you heard that the US has a huge Federal Deficit? Sure, you have. You end up with a deficit when you spend more money than you make. Sound familiar? I hope not. But maybe… there was that time back when you got your first credit card – well, hopefully that is in the past. Let’s focus on the US Government for today’s discussion. And, YES, the US has a hefty deficit. But what does that really mean?
The word became a bit of a thing back in the 1980s as it ballooned to new heights. The word, itself, actually took on a life of its own, becoming a rally cry for fiscal conservatives, and today it is part of the American zeitgeist, eliciting fear amongst anyone born before 1980 – as intended. If you were born before 1980 and you hear the word, you think of excess, big government, inflation, high interest rates – and doomsday (remember that?). To be clear, that period of high deficit that began around 1970 and lasted through Bill Clinton’s Presidency in the late 1990s, was not the first time the US ran a budget deficit, but it was the largest. Clinton’s efforts didn’t last very long as the country soon fell back into a deficit, where it has been since about 2002. The post-Global Financial Crisis period saw it vastly expand as digging out of that crisis cost money. Things improved slightly until the pandemic, which witnessed its ascent to nosebleed levels. By 2023, a slight improvement could not stick. Today, the US sports a $1.83 trillion deficit, which kind of makes that Reagan-era deficit height of $220 billion almost a joke.
So, here we are, a mere week ahead of a Presidential election. and both sides are barreling into the close making their final arguments – and handing out prizes to voters – in order to secure the Top Job. All those prizes, if actually fulfilled, cost money. Money, that the Government most likely does not have lying around. No, those promises of tax cuts and incentives will cost money that the Treasury needs to find. That is where the worry starts. You see, if the Government cuts taxes, the Treasury makes less income. If the Government starts handing out incentive checks, it will be spending more out of any already shrunken income. That is deficit 101 folks. How will the Treasury stay afloat? The old platinum card, of course. The Government will have to borrow money by selling more debt. When it sells more debt, that is, it floats more bonds, the increase in debt supply will cause bond prices to go down and increase… wait for it … wait for it… interest rates!
It is clear that no one likes higher interest rates, except for, maybe banks and loan sharks. Taking it a step further, many believe that higher deficits and interest rates will lead to higher inflation again. Are you nervous yet? You are supposed to be. Let’s take a step back for a minute. Indeed, the total outstanding government debt has ratcheted higher with the bulging deficit that grew unrelentingly beginning in 2002. It actually grew by some 500%! The high point – or, low point, depending on how you look at it was in 2020, when the deficit hit $3.1 trillion. Can I show you a chart of 10-year Treasury Note yields from that period of 2002 through 2020. Take a quick look then follow me to the finish.
That’s right 10-year yields actually went down through the largest deficit expansion in US history. How can that happen? Well, we have forgotten a part of the equation. That is Gross Domestic Product, or GDP! It grew by 112% through that period, and an additional 28% since. It was $10 trillion in 2002 and is now around $29 trillion. So, yes, the Government did spend more money it didn’t have and financed it with a mountain of debt, but it did so, presumably to grow the economy. If we look at deficit as a percent of GDP, we see a different, perhaps more enlightening view. Right now, the deficit as a percent of GDP is around 6.4%. It had some ups and downs since Reagan’s time in office, but for the most part it was between 3% and 4%, which makes the current level larger than normal, though it has been worse.
Well, as you might suspect, there are two ways to improve that number. You can decrease the deficit OR… you can increase GDP 💡! What if by spending more, a candidate promises to grow the economy? That, my friends, is the way to assess the allegedly ugly beast of the deficit. So, will interest rates go up in the future if the next President cuts taxes for corporations or for targeted demographics? Based on history… well, you be the judge of that. And with respect to inflation. Let’s remember how that last bit of nasty inflation came about. It is not because of the deficit, that I can assure you. Remember supply chain problems, lack of housing supply, and… INCENTIVE CHECKS driving demand? The latter of the three certainly contributed to the deficit but also contributed to inflation. Looking at the period of 2002 through the pandemic, we note that CPI was 1.6% at the start of 2002 and was at… 1.4% at the start of 2021. Can you see a threatening pattern here? I didn’t think so. Let’s be clear. Very generally, a larger deficit and increased debt should be avoided. Very generally. But just like great returns you have gotten in your life, it took investment. At least you got incentives from your credit card company.
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