BY JOHN MAULDIN
Dial your mind back to January 2001.
The world had survived Y2K; the stock market was topping out; George W. Bush had moved into the White House; and the US government had a balanced budget.
Wait, say that again? Yes, the budget was balanced, and indeed, we were running a surplus. This happy situation would not last long, but many intelligent people sure thought it would.
Five days after the Bush inauguration, then-Fed chair Alan Greenspan testified before the Senate Budget Committee. Congress was considering how to spend a rapidly accumulating budget surplus. Jerome Powell can only wish for the chance to say something like this:
“The most recent projections, granted their tentativeness, nonetheless make clear that the highly desirable goal of paying off the federal debt is in reach before the end of the decade. This is in marked contrast to the perspective of a year ago when the elimination of the debt did not appear likely until the next decade.”
Greenspan’s point was clear: Paying off the debt was both desirable and possible. He was so confident of it, he described at length the practical challenges of prepaying all the outstanding long-term Treasury bonds.
Now, 17 years later, the surplus is gone, and we could easily see a $2 trillion annual deficit soon. How did we get from there to here so fast?
The answer is assumptions.
If your average picture is worth a thousand words, the one below is worth many more.
It comes from former Treasury economist Ernie Tedeschi. Ernie pointed out that what seemed to be reasonable assumptions back at the time would have added up to a $15 trillion cumulative budget surplus through 2028.
That would have been nice, and probably allowed Greenspan to be right about paying off the debt. It didn’t happen. Instead, Ernie now foresees a $28 trillion cumulative deficit.
In other words, over a 27-year period the assumptions will have been about $43 trillion off, if Ernie is right. Maybe he’s not, but let’s go with his numbers for the sake of argument.
What accounts for that gaping difference? Lots of things, but they fall into three broad categories:
- Higher than expected government spending
- Lower than expected tax revenues
- Worse than expected economic growth
Ernie’s chart breaks down the effect of each wrong assumption. Note that the October 2000 long-term projections from the CBO anticipated $15 trillion in savings by 2028.
Source: CBO, CRFB, author’s calculations
At first, GDP had a relatively small effect, even though the original projections didn’t assume the 2007–2009 recession.
When all was said and done, the 10 years ending in 2010 saw an average of less than 2% GDP growth per year. And all that lost growth began to show up in the form of budget deficits this decade.
As time passes, the consequences of excessive GDP optimism grow more significant. Lower growth shrinks revenues. The effect compounds over time, and so the difference between 2% and 3% real GDP growth is enormous.
Just as those repeated years of 4% and better growth in the 1990s added up to a stunning surplus, our recent string of 2% and worse years add up to the opposite. And it will keep doing so, unless something sparks much higher growth.
But even if the CBO predicted GDP right, and even if tax policy stayed constant, spending is still a huge variable.
The services we want government to provide change over time. So does the composition of Congress, which decides which services to provide. Spending grows under either party, but not in the same ways.
Then there are occasional bolts from the blue like 9/11, which in short order led us to spend multiple trillions on wars in Iraq and Afghanistan and smaller involvements elsewhere.
We can’t blame the CBO for not knowing how much those wars would cost or how long they would last.
Growth Is the Cure
Even with wars and two recessions, we might have avoided today’s huge deficits if GDP growth hadn’t fallen that much.
The last calendar year with real GDP growth over 3% was 2005. Some people think 2018 will be the next one. I doubt it, but even if that happens it won’t make up for the years of missed growth opportunities.
All that said, this problem isn’t unsolvable. Growth really is the key. If real GDP can grow over 3% for more than three years, and we can reduce spending, we would go a long way toward solving our deficit problem.
We might not have a surplus, but we’d be much closer to balanced.
Unfortunately, I can’t presently imagine a scenario in which that happens. The tax cuts and deregulation are helping a little, but not enough.
Starting trade wars with China or tearing up NAFTA won’t help at all. Nor will continued gridlock over healthcare, or failure to solve the public pension problem, or to reform entitlement spending.
On the monetary side, it’s clear the Fed has no magic bullets.
Volatile Times Ahead
And just for the record, the $28 trillion debt projected for 2028 is going to be seen as too optimistic in hindsight.
We may be at $30 trillion of total debt by the middle of the decade, and by the end of the decade we could be seeing $40 trillion. We are beginning to see the drag on growth brought about by the inexorable rise of total (not just government) US debt.
We can’t pay that debt down through any realistic budget process. We, along with the rest of the countries in the developed world, are going to have to take extraordinary measures to control and reduce our debts and interest payments.
I’ve called it the Great Reset. There are several ways to reduce the debt, but they all amount to essentially changing the terms of the debt or some form of monetization.
All the while, technology is taking over more jobs, and politics is becoming harsh. The 2020s are going to be extraordinarily volatile in so many ways—which of course means that there will be lots of opportunities.