Deficit Decline Buys Time for LawmakersChristopher Condon
Robust economic growth has helped push the U.S. budget deficit down to the lowest level since 2008, marking the sharpest turnaround in the government’s fiscal position in at least 46 years.
The shortfall of $483.4 billion in the 12 months ended Sept. 30 was 2.8 percent of the nation’s gross domestic product of $17.2 trillion over the same period, according to data compiled by Bloomberg using Commerce Department figures. The figure peaked at 10.1 percent of GDP in December 2009.
“That’s what happens when the government is holding itself back on spending and the economy is improving,” said George Goncalves, head of interest-rate strategy at Nomura Holdings Inc. in New York. “The question is, is that as good as it gets or will the deficit continue to shrink?”
The narrowing budget deficit has bought time for lawmakers to solve long-term threats to the economy such as the cost of retirement benefits. Gregory Valliere, chief political strategist for Potomac Research Group, said the fiscal relief may be short lived as austerity-weary lawmakers eventually boost spending on defense and other programs.
“I can see the beginnings of a pendulum shift away from fiscal restraint,” he said.
The Congressional Budget Office in August predicted the deficit will shrink further this fiscal year, to 2.6 percent of GDP, before rising to 2.9 percent in the presidential election year of 2016. Before the fourth quarter of 2008, the last time the deficit-to-GDP share reached 2.8 percent was in April 2005, the data show.
The reprieve is enabling the government to reduce the amount of debt sold in the short term.
The Treasury yesterday said its borrowing this quarter will decline to the least for the October-December period since 2007. The department made the projection in Washington ahead of its quarterly refunding announcement tomorrow.
Scott Brown, chief economist at Raymond James & Associates Inc., said the fiscal improvement has muted the political debate over the budget ahead of today’s midterm congressional elections. “The bigger problem with the budget is really the long-term pressure, and has to do with the retirement of the baby-boom generation,” Brown said.
The CBO’s baseline budget predicts spending on mandatory programs, including Social Security and Medicare, will expand by 72 percent to $3.63 trillion in 2024 from $2.11 trillion this year. That would raise the budget deficit as a proportion of GDP back to 3.6 percent, according to the CBO.
Concern over the long-term outlook for the deficit hasn’t hurt the government’s ability to borrow more cheaply than it has in the past. Yields on 30-year Treasuries have averaged 3.4 percent this year, compared with 6.09 percent over the past three decades.
Joe Davis, chief economist at Vanguard Group Inc. in Valley Forge, Pennsylvania, said neither the low current deficit nor the longer-term outlook for bigger shortfalls have had a big impact on Treasuries because those are outweighed by other influences, including the Federal Reserve’s loose monetary policies and the strength of the U.S. relative to other economies.
The Fed has held its benchmark interest rate at zero to 0.25 percent since December 2008. Expectations have increased that the Fed will raise rates in the middle of 2015 just as investors worry about slowing growth and potential deflation in Europe, pushing the European Central Bank in the opposite direction to the Fed.
That has helped the dollar strengthen about 11 percent against the euro in the past six months.
“Clearly the level of debt matters for fixed-income investors,” said Davis, whose firm is the largest mutual fund manager with about $2.64 trillion in assets. “The U.S. has been for years a special case because it’s the international reserve currency. But that right is neither permanent nor pre-ordained.”
Economists cautioned against doling out any credit in Washington for the improving budget numbers, given that political leaders failed to reach any broad compromise over long-term spending issues. Disagreement between Republican and Democratic leaders led to a government shutdown in October 2013.
“I see nothing to celebrate that we’ve wasted five years and didn’t deal with the problem we know is coming,” said Douglas Holtz-Eakin, an economist and former director of the Congressional Budget Office who advised Republican candidate John McCain during the 2008 presidential election.
Citing political gridlock over the country’s fiscal future, Standard & Poor’s lowered the country’s AAA credit rating one level to AA+ in August 2011, saying a deficit-cutting plan signed by President Barack Obama fell short of what was necessary “to stabilize the government’s medium-term debt dynamics.”
Investors ignored the downgrade as the yield on 10-year Treasuries ended 2011 at 1.88 percent, 68 basis points lower than on the day of the downgrade.
Surprisingly strong economic growth is helping to reduce the deficit by boosting tax revenue and reducing the cost of social programs such as food stamps and unemployment insurance.
The economy expanded at a 3.5 percent annualized rate in the third quarter, according to Commerce Department figures released last week, more than estimated by economists. That followed a 4.6 percent pace in the prior quarter, the strongest back-to-back readings since 2003.
The U.S. economy has added more than 200,000 jobs a month, on average, this year, driving down unemployment to a six-year low. The Fed last week focused on the labor market’s improvement as it announced an end to bond purchases designed to stimulate the economy by holding down long-term borrowing costs.
With voters heading to the polls in midterm congressional elections today, Valliere doubts a Republican takeover of the Senate will end budgetary gridlock because the political costs may be too punitive.
“The Republicans are talking a lot of trash now, but are you really going to go after senior citizens ahead of the 2016 elections?” he said. “The only way to get a grand compromise is a combination of entitlement cuts and revenue raises, and the House isn’t going to go along with that.”