Submitted by Peter Tchir of TF Market Advisors
Debt Service Is Growing Rapidly and Will Dwarf other Budget Line Items
Asides from the fact that I don’t see how people can believe the deficit doesn’t matter, let’s take a quick look at the facts that show it does matter. Massively!
Put most simply, in 2010, for every $1 of discretionary spending we spend $0.15 on interest. By 2020, for every $1 of discretionary spending we will be spending $0.50 on net interest payments.
No matter what your opinion you have on government spending, it has to be scary that the amount we pay on debt service is growing and risks overtaking the amount we spend on things we (allegedly) want. Or what we (allegedly) need since it’s a similar story when compared with Mandatory spending. The CBO expects both Mandatory and Discretionary spending to remain relatively stable, but that debt service will grow from just over 1% of GDP to over 3% by 2020.
Net interest payments will take up a disproportionate amount of the budget. Spending money on debt service is ultimately a waste and will severely limit what the government can do in the future as debt service swamps almost all other line items.
The CBO numbers are disturbing enough, but they are too optimistic!
The CBO makes it clear how we get there, and what scares me even more, is that their assumptions seem optimistic.
Here are the current Congressional Budget Office projections for the deficit:
So the CBO has the annual deficit gradually declining until 2014 and then rising steadily until 2020.
This is based on multiple assumptions, but at least a few stand out as optimistic, if not outright fantasy.
They assume that the tax cuts expire as scheduled. Possible, but I think last year’s tax cut ‘compromise’ showed us just how difficult it is to let tax cuts expire. So a big part of the drop off in the annual deficit is a result of revenue increases coming from the tax cuts expiring. This just seems unrealistic.
They also assume that all planned spending ends when it is scheduled to expire. I’d like to believe that there is enough concern over the budget in Washington that this assumption is reasonable, but again, history tells us that Washington has a lot of trouble letting spending expire as schedule. And it’s not ancient history, it’s the events of the past few weeks that confirm Washington is reluctant to cut anything or let spending expire.
They also have GDP growing at an average rate of 4.5%. This includes GDP growth of 6% in 2013 and 6.3% in 2014. Really? This is nominal GDP growth, so maybe they have high inflation expectations. The rate does match the longer term average rate. So maybe its reasonable? On the other hand, recent GDP is much lower and that is with massive stimulus, incredibly low rates, and QE2. Maybe they are right on the long term GDP growth, but it does seem more of an optimistic case, than a base case.
The CBO did not enforce the debt ceiling in their analysis. I guess even they know that is just a game and will never be enforced.
So we have 3 dubious assumptions all of which make the budget deficit projections look better than it is likely to. But that is not the point, the point is what is the impact of interest on our cumulative debt?
In fact, with GDP growing, tax revenues increasing, and spending only growing moderately, what is driving the budget deficit projections? It’s the interest payments!
By 2020 Interest Payments will be greater than the budget deficit!
In 2020 the CBO estimates net interest payments of $778 billion. They estimate the deficit to be $685 billion. Our whole deficit will be a result of the interest on accumulated debt. That seems crazy. Net Interest paid is $202 billion in 2010 and $778 billion in 2020. Sadly that is a growth rate I can believe.
The raw numbers are even worse, but we subtract from interest, the amounts going to Social Security and other trusts. That would make more sense if we believed that the expense side of social security was actually being properly accounted for. The raw numbers for 2020 are $375 billion higher. I think the net interest number is bad enough, and maybe the inter governmental interest is being accounted for appropriately, so I will ignore it, but in the back of my mind I can’t help but be a bit suspicious that there are some more additional tricks being played here to make future deficits looks better.
I was pleasantly surprised that the interest rate assumptions used by the CBO seemed somewhat realistic. They have t-bills going from under 1% today, to 5% by 2020. The 10 year goes from 5% to 5.9% over that same time frame. I don’t have a full breakout of what breakout they use between long and short term funding, but at least the levels seem reasonable and consistent with their nominal GDP growth assumptions.
On interest rates, they should include some stress tests. As it grows to be such a large line item, shifts in rates become exponentially more important. How bad does it get if rates are another 1% higher than this? 2%?
We have gone past the point of the deficit doesn’t matter thinking. Ignoring the impact of growing debt service is short sighted, irresponsible, and downright dangerous. The cumulative debt is a problem, and debt service will be the single biggest budget line item. That cannot be fair to future generations. We need to attack the deficit become the cost of carrying prior deficits is too high, and the in meantime we have to manage our exposure to interest rates and hedge as much as possible and future possible shocks until the problem is under control.