Last week, the U.S. government breached the federal debt ceiling, the statutory limit on the amount of borrowing allowed the U.S. Treasury to finance previously authorized financial commitments of the Congress and the President. Without legislative action to raise the cap, America will eventually be unable to pay all of its bills and will in effect default on some of its bonds. This would, of course, be catastrophic for families and the economy, and inevitably the ceiling will be increased. But not before the inevitable brinksmanship and political posturing that has accompanied the process in recent years.
Christopher Hopkins
Understanding the terms in play and putting the fiscal position of the United States in perspective may help to follow the debate in the days ahead.
The official scorekeeper is the Congressional Budget Office, a non-partisan agency responsible for forecasting revenue and expenses over the next 10 years. These estimates inform members of Congress in their deliberations regarding budgetary, tax and borrowing decisions.
A deficit is simply a shortfall. Deficits occur when expenditures exceed revenues over a given period of time (one year for budget purposes). Consider a household with an income of $50,000 last year. With college tuition, a new roof and braces for Junior, expenses totaled $51,500. Our hypothetical family ran a deficit of $1,500 for the year, approximately equal in percentage terms to the Federal deficit. To finance the shortfall, they must either invade their savings or borrow the difference.
For fiscal 2017, the CBO projects a U.S. government deficit of $559 billion, roughly 3 percent of GDP on revenues of $3.4 trillion and spending of $3.9 trillion. Much bigger numbers, but same general principal as our hypothetical family.
Each year a new tally is made, so a budget deficit is the excess of spending over revenue for a single year.
We have experienced budget deficits every year since 1970, with the notable exception of 1998 to 2001. During those four years, revenue exceeded spending and the U.S. government ran a surplus as the result largely of exceptional economic growth. Regrettably, CBO's forecast is much less commodious, with the deficit reaching $1.4 trillion or 5 percent of GDP in 10 years.
While the deficit clock restarts each year, and since the government has no savings, we must borrow the difference every year. The accumulated total of previous deficits is the national debt, the sum of all outstanding borrowing by the Treasury. Total federal debt held by the public currently stands at $14 trillion, but CBO projects that total will soar to $25 trillion by 2027 (89 percent of GDP) thanks to ever-increasing annual deficits relentlessly piling up. Many economists believe that debt-to-GDP levels above 90 percent pose significant challenges to the economy, decreasing the available capital stock and leading to declining productivity, slower growth and lower wages.
Of course, the budget office must make certain assumptions regarding future growth, inflation and interest rates, but CBO also considers variations. For example, if interest rates rise one percentage point above expectations, the debt would expand by another $1.6 trillion in 2027.
CBO also spitballs 30 years ahead, and the picture is grim: national debt exceeding 145 percent of GDP, higher even than in the throes of WWII, assuming the current trajectory of spending and income. Of course, the current trajectory is unsustainable, and to paraphrase Herbert Stein, if something cannot continue indefinitely, it won't.
In the next few weeks, engulfed in drama, Congress will grudgingly raise the borrowing cap for the 82nd time since 1962 to pay the bills it has already racked up. And the cycle begins again.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.