ANALYSIS: US Government Testing Limits of Ballooning Debt, Deficits

The National Debt Clock is seen at a bus stop in Washington on July 31, 2023. (Madalina Vasiliu/The Epoch Times)

Federal Reserve Chair Jerome Powell recently told the Economic Club of New York that the U.S. government’s fiscal path is “unsustainable” and that Washington must “get off that path sooner rather than later.”

Mr. Powell’s clarion call came days before the Treasury Department released the Monthly Treasury Statement (MTS) that revealed the federal deficit was $1.695 trillion for fiscal year 2023, a 23 percent increase.

Before the official MTS was published on Oct. 12, the Congressional Budget Office (CBO) released its final Monthly Budget Review for fiscal year 2023, reporting that the budget deficit was $166 billion in September, resulting in a $1.7 trillion shortfall.

The budget gap was the largest since the pandemic-era $2.78 trillion shortfall in 2021 and represented enormous back-to-back deficits.

But while it is still about $1 trillion lower than a couple of years ago, a chorus of U.S. officials, market observers, and economists share the same sentiment as the Fed chair: this is unsustainable.

Figures are showing the U.S. government is heading in the wrong direction, says Maya MacGuineas, the president of the Committee for a Responsible Federal Budget (CRFB).

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“After declining in recent years due to the pandemic ending, the deficit is now back on the rise, totaling $1.7 trillion in 2023 and more than double last year’s when you exclude the President’s now-overturned student debt cancellation and timing shifts,” Ms. MacGuineas said in a statement. “With deficits doubling, interest rates surging, major trust funds on course to be exhausted in a decade, and new security threats emerging—everything is telling us it’s time to address the debt.”

The longer the U.S. debt is left to increase, the more difficult it will be to tackle, warns Carl Tannenbaum, the chief economist at Northern Trust. But the lack of political will could prove to be the biggest challenge for America’s finances, he added.

“To change its financial trajectory in any meaningful way, difficult decisions will have to be made,” Mr. Tannenbaum wrote in a research note. “Unfortunately, the political calculus is taking precedence over fiscal calculus in Washington. Representatives are loath to cast a vote that might help the nation’s finances in five years, but which might lose them their seat in the next election. But kicking the can further down the road is a losing strategy.”

How did the U.S. government get to this point?

Walking the Fiscal Primrose Path

Federal net outlays as a percentage of gross domestic product (GDP) are about 25 percent, up from 20 percent before the coronavirus pandemic. Since the end of the Second World War, this metric has been on a gradual upward trajectory, rising from below 11 percent in 1948.

With a $7 trillion budget, the U.S. government spends taxpayer dollars, borrowed funds, and freshly created money in various areas. But the meat and potatoes are concentrated in just several places.

In the last fiscal year, Washington spent $1.354 trillion on Social Security, $848 billion on Medicare, $821 billion on national defense, $774 billion on income security, and $302 billion on veterans’ benefits and services. One of the biggest budget items is the interest on Treasury debt securities, which was nearly $900 billion in fiscal year 2023.

Since the beginning of October, the national debt has experienced dramatic growth, climbing roughly $231 billion to nearly $33.7 trillion, Treasury data show. At one point over the past month, the national debt surged $275 billion in a single day. By comparison, the national debt was $316 billion in 1966.

The fiscal situation continues to deteriorate even after President Joe Biden signed the Fiscal Responsibility Act.

Following the debt agreement that was established with former House Speaker Kevin McCarthy (R-Calif.) in June, the national debt has soared by about $2 trillion.

Many fiscal and monetary policymakers have warned that this cannot be maintained, particularly as interest payments imbibe a greater share of the federal budget. Over the next decade, cumulative interest payments will exceed $10 trillion, the CBO projected this past spring.

The debt-to-GDP ratio is currently at about 100 percent. A recent report from the Penn Wharton Budget Model estimates that the U.S. debt held by the public cannot top 200 percent of GDP “even under today’s generally favorable market conditions.”

“Under current policy, the United States has about 20 years for corrective action after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt whether explicitly or implicitly (i.e., debt monetization producing significant inflation),” the report stated. “Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the U.S. and world economies.”

According to the 2024 White House budget, the national debt is expected to surpass $43 trillion by 2033.

Poor Demand

The next great challenge will be weakened investor demand for government debt.

In the third quarter, the Treasury Department issued $1 trillion in government bonds and plans to dump another $800 billion on the market in the fourth quarter. Despite the enormous issuance, Treasury Secretary Janet Yellen had warned there are liquidity issues across the Treasury market that need to be addressed.

Are these worries being realized?

Over the past month, there has been lackluster interest from domestic and foreign investors for a mix of short- and long-dated bonds at recent Treasury auctions.

For example, a sale of five-year notes drew a yield of 4.899 percent, short of dealers’ expectations. Or, in another example of poor demand, the seven-year note led to a yield of 4.908 percent, much higher than dealers’ projections.

Metrics monitoring bidder participation confirm sagging demand as dealers were given a bigger share of the Treasuries.

It is unclear how much government debt the Treasury will issue in 2024 and if there will be enough demand. As a result, Douglas Porter, the chief economist at BMO Capital Markets, urges caution for the U.S. government.

“You don’t want to test the limits of how much potential buyers are willing to buy your buyers,” Mr. Porter told The Epoch Times. “You don’t want to get to that stage where there are no buyers.”

In addition, Chinese investors have been gradually paring their holdings of Treasury securities, tumbling to about $805 billion.

This comes as the Federal Reserve has been reducing its bond holdings for more than a year, trimming the balance sheet by approximately $1 trillion since it initiated the quantitative tightening cycle.

Ultimately, the federal deficit “is far too large for comfort at this point,” Mr. Porter added.

While the U.S. economy has seen immense budget shortfalls before, they had typically been during financial crises, like the Great Recession or the coronavirus pandemic. But now that the economy is strong and experiencing full employment, policymakers need to rein in their spending to ensure interest does not “overwhelm the budgetary finances.”

Like Mr. Tannenbaum, the BMO economist is not convinced that there is the political will in Washington to reduce the deficit in a timely fashion.