How Worried Should You Be About the U.S. Debt and Deficit?
One of the most frequent questions we get from clients is: How worried should we be about the U.S. debt and deficit? The bottom line is that we don’t expect meaningful improvement in the trajectory for U.S. debt or deficits in the medium term. Below are the five most prevalent concerns.
1. Limited fiscal flexibility
The U.S. government’s wide deficit and elevated debt levels restrict its ability to respond effectively to future economic downturns. Governments boost spending to stimulate growth during recessions. However, the fiscal space for additional stimulus might be constrained by an already wide budget deficit which could slow economic recovery. That said, elevated yields provide ample monetary space to provide support should a downturn materialize.
2. Increased borrowing costs
As the federal deficit grows, so does the need to issue Treasury securities. While demand for Treasuries has remained robust, a continued increase in supply could lead to higher yields. This scenario would increase the government’s interest expenses, further exacerbating the fiscal burden.
3. Crowding out more productive spending
The Congressional Budget Office projects that by the mid-2030s, all federal revenues will be required to fund mandatory government spending alone: Medicare, Medicaid, Social Security and interest on debt. At that point, the only way to finance basic functions including defense, law enforcement, infrastructure and education would be to borrow more or to cut other discretionary spending.
4. Worries about dollar depreciation and excess inflation
If markets begin to question the credibility of U.S. sovereign debt, the dollar could depreciate and inflation could accelerate. Although historical data suggests this risk is low in the medium term, it cannot be entirely ruled out. The scenario in the United States could erode the dollar’s purchasing power and increase import prices, contributing to…
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