When Will the United States Budget Deficit Affect the Economy?

Photo of author

By CraigNewby

The simple answer is; that it always does, but the point of the question is when will action be taken to address the debt be such that it will significantly stop affecting the economy. Again, not to be difficult, but it will effect the economy when it affects the economy. Now before you stop reading (this is not an obtuse grammar exercise) there is logic to this explanation that will become clear.
There are two components that are closely followed but only one that really matters. The yearly budget deficit as a percentage of GDP is the most often reported. It makes for nice headlines, leads to some interesting discussion by pundits and then is largely forgotten. The most important component is the total debt as a percentage of GDP. This is the figure that is crucial in the thinking of economists, bankers and investors. The total US public Debt is presently in the $21.5 Trillion range which is almost 105 percent of U S nominal GDP. For some countries this would be a disaster but for the U S it is now only at the point of concern. It will eventually become an issue beyond a mere concern, the question is when?
We believe that it will be of major concern when interest rates return to historic norms in two to three years. Comparisons and case studies with other countries are only tangentially appropriate since none are the de facto world reserve currency. This creates an enormous latent demand for U S Dollars that make such comparisons pointless.
At this time the stock markets are signaling that an economic slowdown is expected in six to nine months. If this indicator is correct (and usually is) it will drag out the time frame for interest rates returning to historic norms but will not postpone the inevitable. Once interest rates return to the five to six percent range the interest component of the debt will be enormous. Depending on the budget deficit growth in the next few years it can be expected that interest servicing costs alone will approach the $1 Trillion mark! At this point a feedback loop or tipping point may occur where ever increasing rate hikes will be demanded by market participants to cover the risk of default and devaluation.
Faced with this type of scenario, and only then, will politicians be forced to raise taxes and/or cut expenditures to avert the tipping point. All along this slow moving potential train wreck, the economy will be affected, big time. Already, because of the increasing deficit caused by the Trump tax cuts there are limits to the most effective tool that the federal government has for economic stimulus, fiscal policy. Badly needed infrastructure spending is being talked about in a bi-partisan manner but the size of the deficit will limit the size of the stimulus package. This limitation will impact the mitigating effects that a strong stimulus will have on the expected economic slowdown next year. So if the economy takes a bit of a dive next year we cannot expect a huge boost from fiscal spending both in terms of immediate psychological confidence restoration or the long term economic benefits it would provide.
Richard J. Farcas, Research Director, SMS ASSOCIATES