Blood-Dimmed Tides

The Credit Strategist - November 2023

The United States reported a $1.7 trillion deficit for fiscal 2023 (the 12 months ended September 30, 2023), up $320 billion (+23.2%) from fiscal 2022 as revenues fell by $457 billion and expenses (miraculously) also fell by a lesser $137 billion.  Total outlays were $6.134 trillion so the deficit represented 27.6% of total spending which was slightly lower than fiscal 2022 ($6.131 trillion vs. $6.272 trillion) due to reduced pandemic-related spending (-$170 billion), expiration of the expanded child tax credit ($177 billion), and lower spending on food and nutritional programs ($21 billion).  Spending on social security (+$135 billion), Medicare (+$126 billion), Medicaid (+$24 billion) and interest on the national debt (+$177 billion) rose and will keep rising in the years ahead. 

The deficit is on course to hit $40 trillion by 2027. Even the folks in Congress (some of them at least) can do the math and see that it will soon cost more than one trillion dollars annually to service this debt even under the most optimistic interest rate assumptions.  The last time interest rates were at their current level in 2007, the federal deficit was equal to ~35% of GDP; today that ratio is ~98% and rising (I think it is much higher but am using the government’s numbers but even these numbers should render you physically ill if you are paying attention.  This alarming jump illustrates that the cost of servicing the debt is cannibalizing the budget at an accelerating rate.  If it hasn’t happened already, the Fed will soon lose its ability to fight inflation with higher rates because of their impact on the government’s ability to service the federal deficit, a handicap that will unleash further inflationary pressures and threaten financial stability.  This is why delaying action on the deficit is no longer an option.  We are already at Defcon 5.

The national debt hit $33.6 trillion in mid-October 2023, up $10 trillion in less than four years (since the first quarter of 2020) as pandemic spending supercharged our appalling fiscal.  The Congressional Budget Office projects the deficit will hit $54.5 trillion in 2033 as debt grows on an exponential rather than linear basis that is virtually impossible to reverse or slow.  In particular, the rising burden of servicing this huge debt is going to grow as long as interest rates remain elevated (meaning until the Fed is forced to lower them to prevent an economic collapse).  And even if interest rates drop, the rising quantum of debt will keep debt servicing costs elevated ad infinitum.  In fiscal 2023, $659 billion (more than 10% of total spending) was spent on interest, up sharply from $475 billion a year earlier.  In fiscal 2024 it will be higher because much of the government’s debt carries short maturities.  Whoever decided to borrow short-term to fund our deficit must have worked in Silicon Valley Bank’s Treasury Department.  Unlike SIVB, however, there won’t be anybody around to bail out the U.S. government or the U.S. dollar when these reckless spending habits hit the fan.

The Fed is now contributing to deficits by no longer returning capital to the Treasury as it did in previous years and by continuing to pay market rates on reserves.  The latter policy will produce something on the order of $1.6 trillion of losses to U.S. taxpayers according to bank analyst Chris Whalen.  Mr. Whalen further points out (along with others) that the U.S. economy looks deceivingly healthy due to the Fed’s reluctance to aggressively reduce its balance sheet and take other steps to unwind the massive pandemic liquidity infusion that is still inflating economic activity:  “The buoyant economy and job market are basically the result of the fact that the Fed has refused to drain liquidity from the economy causing, well, another liquidity crisis.”  The 4.9% 3Q23 GDP print is best understood as the economy continuing to ride the tsunami of government spending unleashed during the pandemic; there is no way growth would be anywhere that number if the deficit wasn’t closing in on two trillion dollars.  Rather than marvel at the so-called strength of the economy, observers should be noting that it is not organic but driven by massive government stimulus still working through the system.  Without that stimulus, growth would be much lower.