Debt by a thousand blows

Specifically?

Musk and Ramaswamy have promised he will cut government spending by $2 tr over (I guess?) a one-year time frame. Only one problem: they are a bit short on details. Meanwhile concrete proposals to increase the debt continue to roll out—from both parties. Consider what we have seen in just the last few weeks.

More unfunded Social Security benefits

 One of the fastest growing parts of the budget is Social Security. However, Congress has now reversed one of the few attempts to manage the growth. The benefit rules were amended in the early 1980s to reduce “double dipping” -- payments to individuals that receive pension income from work in the public sector but were exempt from the social security tax during that part of their career.

The Social Security Fairness Act just repealed those cuts. Regardless of whether the new system is “fairer” or not, the notable thing is that the increased outlays were not offset by either higher revenues or cuts in other kinds of spending. This adds almost $200 bn to the budget deficit over the next decade.

Of course, the increased outlays are unfunded and hence mean a quicker draw down of the Social Security Trust Fund. Some critics argue that when the fund runs out it will force a sharp cut in benefits. I think that is highly unlikely. Instead, Congress will simply transfer more funds to the trust fund, covering its growing deficit.

A continuing resolution to increase the debt

Last week witnessed another fruitless budget showdown. Only a last-minute deal extended the budget into March, preventing a partial government shutdown through the holidays.

What did yet another brinkmanship battle accomplish? None of the big spending items were either removed or funded. These include:

·      $100 bn in funding for disaster aid

·      An extension of the farm bill along with an additional $10 bn for farmers

·      A bunch of other items with very small budget impacts were removed: 

What was also notable is what almost went into the bill. Trump’s main demand was for an additional two-year suspension of the debt ceiling. Suspension, as opposed to raising the ceiling, means that any sized budget deficit would be accommodated over the next two years. Now, I’m no fan of the debt ceiling: it has created repeated confidence shocks without any real progress in controlling the deficit. However, demanding the suspension shows that debt control is low on his priority list.

A bunch of minor stuff was cut from the bill. This included a cost of living pay raise for Congress that would have cost a couple million next year! Shrinking the bill from 1,500 to 100 pages also saved some printing costs!

Nothing is certain but death and debt

The bottom-line is that there has been a lot of talk about controlling the deficit, but very little action. Instead, we get periodic brinkmanship moments that sometimes add to the deficit—it costs money to plan for and implement shutdowns—and sometimes extract some minor concessions. Both presidential candidates ran on platforms that would tend to raise the deficit. (Here I’m talking about specific stuff, not vague promises like taxing rich people or cutting unspecified parts of the budget). Finally, supposedly one-off expenditures like disaster aid area repeatedly financed with borrowing (Chart)

For the economy, the growing budget deficit is a major headwind for growth. Deficits can be financed in three ways: (1) higher private saving, (2) lower private investment or (3) borrowing from abroad. Lower private investment undercuts the growth in the capital stock and hence weakens potential GDP growth. Higher foreign borrowing means more future income goes out of the country to service the debt (It also means both a stronger dollar and a bigger trade deficit). It is odd that most arguments for higher US trend growth ignore the offsetting impact of budget deficits.

For investors, this means is a big, very hard to predict, upside risk for bond yields. When will global markets become concerned about the unsustainable debt path? At what stage will the US go from threats to actual default? Will a successful politization of the Fed end the special status of the dollar?