One key issue facing US financial markets is the fiscal condition of the federal government in the next decade. As deep throat suggested, to understand what is going you need to “follow the money”. So closer look is warranted to quantify and qualify the risks the US government is facing going forward.
To do this, we need rely heavily on the Congressional Budget Office’s projections.
The following table illustrates one of the major risks facing the US government: entitlement programs i.e. mandatory outlays.
This is the baseline forecast from the Congressional Budget Office. These are in fact, low-end (conservative) estimates of US fiscal spending, reality could be much worse. Look at the trajectory of mandatory outlays (which includes interest expense on debt). It shows a steady increase in mandatory outlays, due to the baby boomer effect, and increasing healthcare costs.
Now compare this with the expected tax revenues.
To get an understanding US’s fiscal outlook trends, we need to determine if tax revenue will be enough to fund these mandatory commitments and interest expense; i.e. can the US afford to pay for its promises and servicing its debt. The following chart shows a conservative forecast for the next 10 years:
Basically, the data from the CBO shows that the US will not be able to fund its mandatory commitments with tax revenue from 2021 onwards. The deficit will continue to grow in the next 10 years, reaching almost $300bn by 2028. This assumes a suppressed interest rate environment. Note also that discretionary spending is suppressed in CBO’s outlook. It assumes no new spending program will be approved in the next decade.
There is a proposal for a $2 trillion dollar infrastructure fund which would impact these figures significantly. Also, this does not consider planned US’ defense spending which looks likely to increase as well.
To understand how much the deficit can overshoot, take 2018 for example. The CBO model and requested deficit was $440bn. The real deficit came in at $779bn. Under Donald Trump, the deficit has consistently come up higher than expected. This year is no different:
It appears that the US budget deficit in 2019 will be at least 25% higher than planned.
However, I have adopted a conservative, if unrealistic, view (i.e. a best-case scenario).
When a government cannot cover mandatory expenditure with tax revenue, it has effectively entered a debt trap. Unless it defaults on obligations (be it social or financial), the debt level will continue to increase. From 2021, this will be the scenario facing the US government. What does this mean?
US government debt is now on the path to eventual implosion. Barring default, unless there is a dramatic increase in nominal revenues, the debt burden will continue to rise ad infinitum. This will be the case even if there is no discretionary expenditure, which of course is impossible. This just implies that the pace of US debt expansion will continue to rise. Given a current moratorium of foreign buying, the US must rely on domestic sources for funding.
This has already been evident in the recent data from the US:
The US can no longer rely on the savings of reserve holders and the rest of the world to fund its liquidity requirements. As a result, since 2016, the domestic market has been forced to step up to the plate.
This is the classic crowding out effect. The US government will be competing with the domestic private sector for funds. Without significant monetary largesse, it will lead to higher interest rates (to attract funds from other segments of the economy). Given the level of leverage in the corporate sector, as well as the household sector, any rise in interest rate will have a very negative impact on spending and investment. This will impact balance sheet solvency (especially with respect to the high yield and LBO markets).
Outside a dramatic rise in fiscal revenues, there is one other possible solution to US’ budget issues: quantitative easing / debt monetization. Of course, that is why there is a sudden resurgence in interest in Modern Monetary Theory, also known as MMT, as well as Federal Reserve talk of yield curve targeting, which is effectively QE without limits.
It is apparent that the US government and the Fed are aware of this situation and are trying to get ahead of it to justify the next round of quantitative easing. This is also the reason that the Fed decided to stop raising rates and end quantitative tightening before it has even truly begun.
The timing of when the US will hit this fiscal wall is critical to forecasting both the global economic outlook as well as its geopolitical one. Rising tensions in Venezuela and Iran, along with the cold war with China, are driven by the need to reduce external deficits, and find new sources of funding (in the case of Venezuela and Iran, oil revenues).
Furthermore, this provides a timeframe in which the US can acquire these revenues through military interventions. Why? Because after a certain point, the fiscal balance would not be able to sustain a war without extremely negative consequences for the domestic economy. Given the trajectory of mandatory expenses and tax revenue, it appears that if the US were to try to annex Venezuela and Iran, it would have to do it in within the next 2 years.
Without these actions, the size of quantitative easing needed to keep the US economy stable and financial markets calm will easily dwarf the amount monetized during the Great Financial Crisis. And the status of the US dollar as the sole reserve asset and America’s exorbitant privilege will likely be gone. This is an unthinkable outcome for US elites.
In other words, turbulent times await us in the next two years, whether it will be the collapse of the dollar based financial and trade system or a dramatic spike in geopolitical tensions.
If you don’t accept this analytical approach look at how Britain addressed a similar crisis in the 70’s, as revenues revenues (and deposits) from former ‘commonwealth’ clients diminished without a significant increase from other clients. The Brits engineered the exploitation of ‘expensive’ North Sea and Alaskan Oil, a rise in oil prices to support the profitable exploitation of these fields, and a simultaneous ‘shutting off’ of both Iranian and Iraqi oil production (via revolutions and wars) – to keep prices high and provide market opportunities for ‘expensive’ oil! The elites sit back and manipulate ‘the world’ for their benefit.
Later when North Sea and Alaskan Oil production dropped, somehow (miraculously) the Soviet Union was broken up, and the very same oil companies are now active in Central Asia exploiting new fields.
But the big prize – now – is Iran and Venezuela! Whoever grabs this oil and gas will survive the next few decades of economic warfare. There is NO question the US has its sights on all this wealth. And, there is no question, the US needs all this wealth to simply balance its books.