$1 TRILLION DEFICITS FOR YEARS: Westpac explains why the US budget outlook is troubling

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  • The US government is spending more than earns, a trend that looks set to continue.
  • The Congressional Budget Office (CBO) sees US public sector debt-to-GDP rising to 96% within 10 years, up from 77% at present.
  • Westpac Bank describes this as a “troubling fiscal outlook”.

The US government is spending more than earns, a trend that looks set to continue if the latest projections from the bi-partisan Congressional Budget Office (CBO) are anything to go by.

According to the group’s baseline budget projections released earlier this week, the federal government deficit is expected to
rise from $665 billion last year to $981 billion by 2019.

From 2020, annual deficits are forecast to top $1 trillion, eventually rising to $1.5 trillion by 2028, the end of its forecast time horizon.

With cumulative deficits expected to grow faster than the US economy, public sector debt-to-GDP is seen rising to 96%, up from 77% at the end of 2017.

Source: Westpac Bank

To Elliot Clarke, Economist at Westpac Bank, this is a “troubling fiscal outlook”, pointing out that many of the economic assumptions made by the CBO are fairly optimistic, creating downside risks for GDP growth and, therefore, upside risks for future deficits.

“There are clear risks to [the CBBo’s] growth view,” Clarke says.

“The one that particularly stands out is wages growth.”

The CBO expect labour incomes to rise at a 3.5% annual pace from 2019–2022, then 3.2% to 2028.

“This would be a stronger result than that seen in the five years prior to the GFC, when compensation growth averaged 3.3% per annum, and almost twice the 2.1% pace seen between January 2008 to December 2017.”

In Clarke’s opinion, should wage growth fall short of the CBO’s lofty expectations, it could easily see GDP growth undershoot the group’s forecasts, especially as it expects the bulk of economic growth to be driven by the household sector.

“GDP growth is seen settling around potential — 1.75% — from 2020 onwards,” says Clarke.

“Of this, consumption is responsible for 1.4 percentage points. That compares to annual contributions from business investment and government spending of 0.3ppts and 0.1ppts respectively, once the initial benefits of reform fade.

“Simply, if wages growth disappoints, then consumption will follow, restraining GDP growth to a sub-trend pace. Such an outcome would have flow-on consequences for business investment as well, creating a further impediment to growth.”

Clarke says that could easily see the US public debt-to-GDP ratio blow out beyond 100% given the government would have difficulty in cutting spending at a time when the US economy is already operating below its potential level.

“Should growth disappoint it would be very difficult make cuts to spending,” he says.

“This is because mandatory spending and interest costs are locked into strong up trends, and also given discretionary spending is already at a low level compared to history.

“If it occurs, weak growth is therefore likely to feed straight through to higher debt levels.”

Bigger deficits and ever-larger debts, in other words.

Along with growth risks attached to the CBO’s wage growth forecasts, Clarke says the US economy will have to create history in order to achieve the group’s baseline forecasts.

“On the probability of a downside surprise on growth, note that the current expansion is already the second longest in United States’ history, back to 1945.

“Growth over the entire decade to 2028 would make this expansion almost twice the length of the previous longest episode.

“This seems all the less likely given the leveraged state of the economy and the ageing household sectors’ historically weak savings.”

The bond market vigilantes will be watching closely.