After yesterday Goldman mocked Trump's budget (ironic as it was Trump's ex-Goldman Chief Economic Advisor who conceived it) and said it had zero chance of being implemented, today it was JPM's turn to share some purely philosophical thoughts on the shape of future US income and spending, which as we learned yesterday could balance only if the US grows for 10 years at a 3% growth rate, something it has never done, while slashing nearly $4 trillion in in spending, something else it has never done.
What caught our attention in the note by JPM's Jesse Edgerton was his discussion on the thorniest issue surrounding the US: its unprecedented debt addition, what America's debt/GDP will look like over the next 30 years, and whether there is any chance it could decline as conservatives in government hope will happen.
The answer to the final point according to JPMorgan, is a very resounding no, or as the bank politely puts it, "Despite this week’s budget proposal, legislative changes that would reverse debt growth look unlikely to us." Translated: US debt is never going down again.
As the US population ages in the coming decades, federal government spending on Social Security and Medicare are set to grow as a fraction of US GDP. Meanwhile, our current tax system is expected to collect a roughly constant fraction of GDP in revenues. Thus, deficits and debt will likely grow over time. The Congressional Budget Office (CBO) currently projects that the ratio of debt to GDP would reach an unprecedented 150% within 30 years under current law (Figure 1).
Figure 1 shows the CBO's central projection for the ratio of federal debt held by the public to GDP under current law. (Debt “held by the public” excludes government trust fund holdings, includes foreign and Federal Reserve holdings, and is currently about $14.4 trillion.) The 2016 level of 77% is the highest in history outside of the World War II era. This debt ratio is projected to reach a new all-time high of 107% by 2035 and 150% by the end of the 30-year forecast horizon in 2047.
An interesting aside from Edgerton: is it worth even worrying about debt:
It is debatable how much these projections should cause immediate concern. Many (though not all) economists would agree that it can be appropriate for borrowing and debt to increase when the economy is weak to provide offsetting fiscal stimulus. Once the debt is on the books, there may be no inherent reason it cannot be serviced in perpetuity and never paid back. Even the extent to which we should be concerned about the debt placing a burden on future generations is unclear— if the debt is largely internal to the US, servicing or repayment ultimately involves some future Americans writing checks to other future Americans. And if future generations will be richer than we are due to economic growth, perhaps it makes sense to try to get them to pay for our retirement.
Once this rhetorical musing is past however, JPM shares is a rare admission for a bank that a record debt load may actually be a bad thing.
To be sure, it is debatable how large a problem this debt growth represents, and long-run debt projections are highly uncertain. But, in our view, large deficits and debt likely place some burden on future generations, reduce capital formation, and create some small risk of financial crisis. Thus, there are solid arguments why we should aim to reduce debt ratios from current high levels when the economy is at full employment, as we believe it is now.
Such somber evaluation of the nation's debt crisis: our compliments. Unfortunately, it is what JPM says next that is worse, because it too is spot on: the reason why debt will never again decline.
Although the administration’s budget proposal purports to reduce debt growth, we currently see little appetite in Washington for the tax increases or spending cuts that could achieve this outcome. Our baseline forecast still includes a modest deficit-financed tax cut that would push in the opposite direction.
JPM's dour conclusion:
With the unemployment rate now at 4.4%, solidly below our 5% estimate of its natural rate, we see no reason for fiscal policy to try to boost the economy right now—in fact, it would make more sense to slow it down. And we do tend to think that high borrowing and debt levels have long run costs: they likely reduce national saving, burdening future generations with external debt, and compete with the private sector for funds, reducing capital formation. Plus, an ever-growing debt ratio brings at least some small risk that investors would eventually grow concerned about the safety and soundness of US debt, feasibly triggering a rapid and destabilizing repricing.
We don't know if JPM's gloomy assessment is right, but one thing we are certain of: the last bolded sentence is one which nobody will think twice about, until it is far too late to do anything to prevent it from happening. Here's why:
What could this look like in practice? Well, simple arithmetic shows that reducing deficits requires either higher revenues or lower spending. Higher revenues could come from either increasing tax rates or boosting incomes through channels like labor force participation, productivity growth, or immigration. (We note that we do not see any evidence that reducing tax rates would induce enough additional income growth to increase tax revenues.) And lower spending could similarly come from direct cuts or from other channels like reducing demand for safety net spending or slowing growth in medical costs. But as discussed above, the chance of changes like these being enacted in the coming years looks low to us.
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