Wall Street History

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Wall Street History

02/22/2013

The Deficit Picture

I’ve been writing in my “Week in Review” column recently of the dangers of the talk that the budget deficit is being normalized...that deficits are coming down and would be expected to fall if the economy grows at a respectable pace and spending is held in check. Below I show how the nonpartisan Congressional Budget Office (CBO) projects that the deficit will indeed fall to $430 billion by fiscal 2015 (after four years of $1 trillion+ deficits 2009-2012). While such projections can be way off, even just two years into the future, I also point out how the deficit then explodes all over again by the end of their latest 10-year forecast. This is because of entitlements and more normalized interest rates.

The point being it is going to be easy for Congress not to make the hard decisions needed on entitlements because they can tell their constituents, ‘Hey, the deficit is falling!’

CBO’s Baseline Budget Projections ($billions)

                              A2012     2013     2015      2022

Revenues              2,449     2,708     3,373     4,734

Outlays
 Mandatory            2,031       2,116      2,342     3,501
 Discretionary        1,285       1,213      1,189     1,396
 Net Interest             223          224         272        795
     Total                 3,538       3,553     3,803     5,691

Deficit (-)             -1,089        -845        -430       -957      

Notes:

The CBO assumes GDP growth of 1.4% fourth quarter to fourth quarter in 2013, then 3.4% in Q4 2014. From 2015-2018, GDP is est. at 3.6% annually, but 2.2% from 2019-2023. Regarding this last item, the CBO comments:

“For the second half of the coming decade, CBO does not attempt to predict the cyclical ups and downs of the economy; rather, CBO assumes that GDP will stay at its maximum sustainable level. On that basis, CBO projects that both actual and potential real GDO will grow at an average rate of 2 ¼ percent a year between 2019 and 2023. That pace is much slower than the average growth rate of potential GDP since 1950. The main reason is that the growth of the labor force will slow down because of the retirement of the baby boomers and an end to the long-standing increase in women’s participation in the labor force. CBO also projects that the unemployment rate will fall to 5.2 percent by 2023 and that inflation and interest rates will stay at about their 2018 levels throughout the 2019-2023 period.”

Core CPI is forecast to rise just 2.2-2.3 percent from 2015-2023.    

But in looking at the above, two things should obviously stand out; the explosion in Mandatory outlays and Net Interest expense.

Social Security, Medicare and Medicaid account for about 75% of current mandatory outlays and that percentage will just keep rising with the retirement of the Baby Boomers.

When it comes to interest expense, for 2012 the average rate on a 3-month T-bill was 0.10% and 1.8% for the ten-year T-note.

Of course these have been held down artificially by the Federal Reserve and the CBO projects a normalization of interest rates to the following:

Three-month T-bills 2.2%
Ten-year T-notes 4.5%

Three-month T-bills 4.0%
Ten-year T-notes 5.2%

And you see the result...net interest expense explodes to $795 billion by 2022 from the current $225 billion. That’s criminal...but it’s a direct result of the exploding national debt.

Wall Street History returns in two weeks.

Brian Trumbore    

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