As 2023 draws to a close, this week’s Euros & Dollars articles will take inventory of how Europe and America are doing from an economic viewpoint, and then take a look at what we can expect in 2024.
Let us begin with the American economy in 2023. After all, it is easy to sum up: debt, debt, and more debt.
From the fourth quarter of last year through the third quarter of this year, the federal government spent $6,314 billion. Over that period of time, the federal debt increased by $2,238 billion.
Theoretically, this means that Congress and the president paid for 35% of their spending with borrowed money. In practice, it does not quite work that way; for ‘bookkeeping’ reasons, the federal government’s cash flow in the form of revenue and spending is not perfectly aligned with the growth in its debt.
However, the fiscal and financial technicalities are not the real story here. What really matters is that Congress, by virtue of its own inactivity, pledged allegiance to its decades-old tradition of endless debt growth.
I am now convinced beyond a reasonable doubt that this growth in the debt will only stop when the U.S. government is struck by a real fiscal crisis. Not a managed one, not a ‘tremor’ (which I will discuss below), but a raw, real, and unmitigated fiscal crisis.
The cost of this crisis will be so severe that a large majority in Congress will be ready to end deficit spending for good, and to do it in a way that convinces investors in the sovereign debt market that their reforms will actually work as intended.
One of the reasons I am convinced that a fiscal crisis is the only path to ending the deficits is the growing support for Congress to appoint a debt commission. As I will explain later, this idea is futile and a distraction from what really needs to be done to stop America’s fiscal bleeding.
As mentioned, the federal government doled out $6,314 billion last year. Total revenue over that time was only $4,771 billion; ignoring rounding errors and decimals, the budget deficit turned out to be $1,543.5 billion. This is a 42.5% increase in the deficit from the 2022 fiscal year.
The most appalling part of this massive growth in the deficit is that it happened while the economy that produces the tax revenue was doing relatively well. Unemployment stayed below 4%—it averaged 3.6% for the entire 2023 fiscal year—and although the rate per month since August has been about 0.1 percentage points higher than the same period in 2022, there is not a hint of a weakness in the labor market that would even begin to explain why the federal government is bleeding 42.5% more money now than it did a year ago.
The economy as a whole, i.e., GDP, is also doing well. Adjusted for inflation, GDP growth improved during the 2023 fiscal year. It started at 0.5% in the fourth quarter of 2022, picked up to 2.1% in the first quarter of 2023, and reached 2.5% in the second quarter.
In the third quarter, GDP growth accelerated to 2.8%, which is actually a good number by recent historical comparison.
To make a long story short: there are no macroeconomic reasons why the federal government should be running a bigger deficit. If anything, the deficit should be shrinking.
But wait; there is more. As the debt grows, so does the cost of the debt, i.e., the interest payments that Congress has to make to those who are kind enough to still lend them money.
Back in July, I predicted that the total cost of these payments for the 2023 fiscal year would reach $756-770 billion and that the $800 billion mark was not far off. However, I cautioned that this forecast was based on the good old ceteris paribus, i.e., ‘all other things equal’ assumption.
Well, all other things were not equal. Or, as Latin-illiterate economists often put it: ceteris turned out not to be paribus. American interest rates kept going up from July through September, and Congress doubled down on using deficits as a key source of funding. Therefore, my predictions from August were largely right on the money:
- I foresaw that the debt cost would exceed $900 billion for the fiscal year and exceed $1 trillion for the 2023 calendar year;
- According to the Bureau of Economic Analysis (Table 8.3 under its national accounts section), the federal government doled out $998.6 billion for interest payments over the 2023 fiscal year.
Right here is where the fiscal crisis comes into the picture again. The question on the mind of every economist analyzing the U.S. fiscal disaster in real time is: will this debt cost continue to rise? We all hope that it doesn’t, because the debt cost is an essential trigger for fiscal crises. When a ‘large enough’ share of a government’s revenue—and that would be real revenue, like taxes—is consumed by the debt cost, lenders eventually conclude that this government is no longer a fully reliable borrower.
Unfortunately, hope does not make economic policy. Realistically, the debt cost is going to rise to the point where some tremors in the market for U.S. debt suggest that a fiscal crisis is just around the corner. Those tremors, which will manifest themselves in the form of sharp, sudden, and painful increases in interest rates, will then result in some symbolic action by Congress ‘to calm the market and reassure investors.’
That Congressional reaction will decide whether or not a full-blown fiscal crisis emerges. There is only one such reaction that looks likely today: the formation of a bipartisan commission in Congress to come up with ideas to make the government debt manageable.
When this debt commission is formed, markets will calm down for a while. The commission will be asked to deliver its report within a short time frame, in the hope that its proposed reforms will be met by applause from the debt market.
All this may happen, except for the applause, but it will not end the growth in the U.S. debt.
Why not? Stay tuned for my 2024 outlook at the end of the week, where I will explain in detail why a debt commission, such as the one proposed by the Cato Institute, will not solve America’s existentially perilous addiction to government debt.
