Debt ceiling! Fiscal Cliff! Sequester! After a few years of news focusing on little else than our nation’s political dysfunction, investors can be forgiven if they have a case of “Washington fatigue.” The latest round of political posturing is around the “sequester” – $1.2 trillion in cuts (over 10 years) that are set to hit in less than a month unless Congress strikes a deal to avoid it. If you cut through the noise, however, you may be surprised to learn that our supposedly dysfunctional Congress already has accomplished a great deal regarding the nation’s fiscal future.
This week’s OppChart shows forecasts for U.S. debt as a percentage of GDP under three scenarios: 1) no government action, 2) government action to date, and 3) government action to date plus the potential sequester cuts (based on Congressional Budget Office assumptions). As the chart shows, the tax hikes and spending cuts in the Budget Control Act of 2011 (the debt ceiling agreement made in summer 2011) and the American Taxpayer Relief Act (the fiscal cliff compromise made at the beginning of 2013) add up to more than $2.3 trillion in deficit reduction over the next decade. That’s enough to nearly stabilize the public debt at about 78% of GDP in 2022. Without those measures, the ratio would have been more like 87%, approaching the level beyond which some prominent studies conclude that debt starts harming economic growth.1 Should sequestration take place, debt-to-GDP could fall to just over 73% by 2022. That 73% isn’t ideal, since it likely would result in about a 1%/year drag on the U.S. economy, but we believe it’s a level the nation can sustain without disastrous results. The picture worsens after 2022, a result of the aging population and the nation’s entitlement promises. But, for now, our politicians have bought some time – a decade – to continue with the incremental, give-and-take approach that’s given us the progress we’ve made so far.
What does this mean for markets and investors? Broadly speaking, the prospect of more stable debt levels and less political brinksmanship, could lead to increased confidence on the part of consumers and businesses. And increased confidence is generally a positive thing for markets.
- “A Decade of Debt,” Carmen Reinhart and Kenneth Rogoff, April 2011.