The financial media has understandably and predictably been abuzz over Fitch Ratings downgrading the US from its triple-A rating. Fitch is wrong about the near term outlook, but it has a longer-term point. Whether right or wrong, the entire US political system is culpable for needlessly and senselessly putting America in this unenviable position.
There can be no question: US fiscal arithmetic is strongly sustainable for well into the foreseeable future.
Net debt held by the public is around 93% of gross domestic product. Of that, nearly 20% of GDP of Treasuries is held by the Federal Reserve and the US government holds around 10% of GDP in financial assets net of liabilities. The Congressional Budget Office projects that, in 2033, net debt held by the public will amount to 115% of GDP.
These are manageable debt ratios. Japan and many European countries carry far higher debt loads. These countries lack the dynamism and growth potential of the US. They also lack the depth, liquidity and attractiveness of US capital markets and America’s ability to issue Treasury safe assets for which there is enormous widespread global demand.
There is little new in Fitch’s analysis. US fiscal policy data are well documented, as are the political fiscal follies. The Office of Management and Budget, CBO, International Monetary Fund and private sector institutions all publish extensive fiscal data.
But do not disregard Fitch’s judgment. Even if Fitch offers few new insights, US fiscal policy faces enormous longer-term challenges and weaknesses, well known to all, and America is showing few signs of addressing them.
These weaknesses emanate largely from America’s polarised politics.
The constant threat of debt ceiling crises and the game of chicken over defaults and government shutdowns are failing to discipline fiscal policy or advance stabilisation. Rather, these practices sow financial market instability. Unfortunately, the US may be on track for another fiscal showdown and shutdown at the end of September. These developments also harm the world’s perception of America as able to carry out its special responsibility for the smooth management of the international monetary system.
There is little political appetite to touch mandatory entitlement spending – nearly two-thirds of total US spending in the order of 24% of GDP – given the electoral clout of older Americans. Defence spending accounts for nearly half of the remaining discretionary spending and is largely untouchable. There is only so much blood that can be squeezed from the rest of the discretionary budget, especially as the interest bill rises.
Meanwhile, there is no consensus for raising revenue, which is roughly 18% of GDP. One party argues ‘no new taxes’ and the other wants to increase taxes on the rich while protecting the middle class – defined as earning more than $400,000 per year, even though that figure encompasses less than the top 2% of households. While many politicians speak loudly about cutting spending, when push comes to shove, they don’t.
Even assuming significant debt loads can be sustained over the longer term, they will place an unfair and onerous burden on America’s younger generations to finance the growing number of older citizens, while the rising interest bill further squeezes social safety nets. They further raise the spectre of fiscal dominance and the loss of Fed independence.
Figure 1. US fiscal deficits will stay high over the next 30 years
US fiscal deficit as a share of GDP, %
Source: Congressional Budget Office
Long-term CBO projections point to high US fiscal deficits continuing in the coming years, again influenced heavily by rising entitlement spending and higher interest bills amid a largely flat revenue dynamic (Figure 1).
Net debt held by the public will begin to explode in the 2030s, reaching 180% of GDP by the early 2050s (Figure 2).
Figure 2. Net debt held by the public will skyrocket
Federal debt held by the public as a share of GDP, %
Source: Congressional Budget Office
Further, US fiscal processes have largely failed. Rather than the US specifying a stabilisation path to discipline fiscal outcomes, US 10-year deficit/debt projections are a derivative of the spending and revenue stalemates. According to its own processes, Congress is supposed to pass 12 appropriation bills before the start of a fiscal year to implement the budget. But it hasn’t done so this century, resulting in shutdown threats, continuing resolutions and – often after several months – humongous, untransparent packages.
In short, America’s fiscal arithmetic is sustainable for the next 10 years, if not next few decades. But there is no political will to take steps to alter the unfavourable, if not ultimately unsustainable, longer-term trajectory of debt and deficits. The problem will become more intractable the longer the US waits.
It is folly to think the US can grow its way out of the situation, nor is it wise to count on an eventual market crisis to spur action.
Fitch is wrong about the near-term arithmetic, but right that the US political system is failing to act responsibly in tackling its looming deficit and debt problems and that the costs of inaction could become inexorable.
Mark Sobel is US Chair of OMFIF.