Hi everyone, I’m Liz Ann Sonders and this is the June Market Snapshot. Many thanks, as always, for tuning in. On this month’s video, I’m going to focus on the topic associated with questions I get at every single speaking engagement, and that is deficits and debt. This video is a brief summary, but if you’re interested in the topic, we have a more comprehensive written report on deficits and debt posted on schwab.com, within the learn tab. Its title is: Deficits, Debt and Markets: Myths vs. Realities and was jointly penned with our own Kathy Jones on fixed income and Mike Townsend on the Washington perspective, so have a read.
[High/Low Chart for Debt on a tear post-GFC for total public debt as % of nominal GDP is displayed]
Obviously, U.S. federal government deficits and debt levels have risen sharply since the pandemic, raising concerns about the impact on the economy and financial markets. We share those concerns. As a reminder, the “deficit” refers to the budget deficit, which of course is the annual mismatch between what the government takes in and what it spends. It’s expected that the deficit will hit $1.6 trillion this year, which is 5.8% of U.S. GDP.
Government “debt” is the cumulative effect of running budget deficits. High and rising deficits mean more of the federal budget goes to financing costs, potentially crowding out other spending. Now without some constraint, the rate of increase could become unsustainable over time.
Now, the continued running of deficits each year has boosted U.S. federal government debt to more than $34 trillion, or about 120% of GDP as you can see here. That’s the equivalent, by the way. of more than $100k for every person in the United States.
The debate over deficits and debt is a never-ending one in the nation’s capital, and Washington is poised for another titanic battle next year when the debt ceiling returns. The debt ceiling is the Congressionally-mandated cap on the total amount of debt the United States can accumulate. In June of last year, Congress suspended the debt ceiling until January 1, 2025; and when the debt ceiling returns, no additional debt can be accumulated until Congress raises the ceiling.
The Treasury Department can buy Congress more time by taking a series of steps known as “extraordinary measures” to ensure there will not be a debt default. Those steps are finite and typically last a few months, which puts the true deadline as sometime in the spring. Of course, debt ceiling debates are not about REDUCING the debt or deficit … they are about permitting the United States to ACCUMULATE more debt.
By the way, when members of Congress argue over cutting a few billion from this agency’s budget or that federal program, it represents just a drop in the bucket compared to the $1.6 trillion deficit. The currently-divided Congress is not likely to make any dramatic changes to the federal budget in an election year, leaving 2025 as a potential year to watch in the debate over trying to get the deficit under control.
[High/Low Chart for Net interest payments top of leaderboard over next decade for projected growth in government spending is displayed]
Now over the next 10 years, the loftiest growth rates for spending, as you can see, are expected to be for Social Security and health care, and, of course, as well as net interest payments.
[High/Low Chart for Higher government spending = lower growth for government spending as % of nominal GDP is displayed]
As of the first quarter this year, government spending as a percentage of GDP was about 23%—currently elevated relative to history, but also well down from the pandemic peak of more than 40% as you can see.
[Table for annualized gain for government spending as % of nominal GDP is displayed]
Historically, high government spending has generally corresponded to lower economic growth. As shown here, across the spectrum of real GDP, payrolls, business capital spending, growth rates have been weaker when government spending was rising and/or high. Also notice that the highest zone of government spending does NOT correspond to the highest zone of inflation historically.
[High/Low Chart for Net interest payments on a tear over next decade for net interest payments as % of nominal GDP is displayed]
Of course, it’s not just the level of debt that matters, but the interest payments due on that debt, shown here.
[Projected net interest payments as % of nominal is displayed]
Per Congressional Budget Office estimates, interest payments are expected to continue to rise as a share of GDP, from 2.5% as of the end of 2023, to nearly 4% in 10 years.
[High/Low Chart for Debt growth > economic growth for y/y % change in total public debt is displayed]
Ideally, of course, the growth rate of debt is lower than the growth rate of the overall economy. Thanks to the removal of much of the pandemic-related direct fiscal stimulus, and the beneficial impact on tax receipts courtesy of the strong economic recovery coming out of the lockdowns, both worked in favor of bringing down the rate of debt growth. But since the plunge from more than 20% during the early part of the pandemic to only about 3% last year, the growth rate of debt has accelerated again to more than 8% … obviously well above GDP growth.
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The problems associated with the high and rising burden of debt are real and have historically had a deleterious impact on economic growth. Interestingly, though, the level of debt has had no correlation historically with the performance of either the bond or stock markets. In addition, although the supply of U.S. Treasury securities is increasing in order to fund the deficit, for now, demand for Treasuries has been strong enough to prevent a spike in interest rates. We don’t anticipate, by the way, that will change in the foreseeable future.
Perhaps it’s a pipe dream, but it would be great to see Congress tackle budget issues now—when the economy is growing—to prevent a further accumulation of debt relative to the size of the economy. However—and this is most important—we don’t believe investors should alter their long-term financial plans based on this issue. Again, take a look at our written report for a more comprehensive analysis; and thanks as always for tuning in.
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