Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
The mounting fiscal deficit is becoming a louder topic. A deficit can be economically problematic on many levels and its financial hemorrhaging can reach far into the future. It is not as simple as it seems especially given the controversial view concerning its peril and potential solutions. How do repeated deficits and consequential growing debt affect investors? Are there hidden agendas that seek to solve an immediate requisite regardless of future costs? Let’s look at the influences and components of a deficit through the lens of the data and debates that may allow you to gauge the gravity of the situation.
Fiscal Policy versus Monetary Policy
The growing debt, covered by media outlets, typically refers to our national debt. Fiscal policy denotes the actions of the federal government. This is primarily the collection of taxes (the revenue side) and the government’s spending (the liability side). Spending is intended to be on behalf of U.S. citizens' health, welfare and security. The government spends money in many areas which include: defense, Medicare, Social Security, and interest on the debt.
Monetary policy is set by the Federal Reserve System (Fed) which is the central bank of the United States. The Fed has two primary mandates: 1) to maintain stable pricing and 2) to maximize employment. These mandates are carried out through a variety of actions which include setting the Fed Funds rate (the rate at which depository institutions lend reserves to other depository institutions – usually overnight) and influencing the supply of money in circulation.
A deficit is created when spending exceeds revenue. A comparison often made illustrates an individual putting purchases on a credit card but not paying it off each month. When the government’s spending exceeds its revenue, it borrows money to make up the difference. This is where the comparison ends though. If an individual’s debt gets too high, it eventually concludes with creditors’ unwillingness to lend more money, and perhaps even leading to a declaration of bankruptcy. The U.S. government borrows money by issuing new Treasury bonds, collecting the proceeds and using the money to pay what it owes. As long as investors are willing to purchase Treasuries, the U.S. government has a willing lender. The problem is that the issuance of new Treasury securities adds to the nation’s debt. A debate exists as some pundits insist that this process can lead the nation to bankruptcy while others argue that printing new money may not have limits.
The pandemic brought about record-breaking borrowing levels pushing the nation’s deficit to over ($2.7) trillion in 2020 and 2021. With one month left this year, the deficit is near ($1.7) trillion. The last decade of consistently high deficits has increased the nation’s overall debt as new securities have been issued to pay the deficits. These Treasury-issued securities are the equivalent of the U.S. government racking up credit card debt. Let’s look at how the nation’s debt has risen.