VOL. 128 | NO. 192 | Wednesday, October 2, 2013
The Worldly Investor
A Dose of Fiscal Truth: Important, Not Urgent
By David S. Waddell
I recently received an email from a client asking how in the world the U.S. would overcome its bulging debt pile. There are three parts to this answer.
First, the annual deficits we run (tax receipts – spending) tend to correlate more with economic activity than policy. Through August, bolstered by an expanding economy, government revenues have increased 13 percent, contributing to a 35 percent reduction in the deficit. We will likely finish the fiscal year with a deficit of 4.5 percent, still high by historic standards, but much lower than the 10 percent hit during the crisis. Deficit figures are overwhelmingly a function of economic activity.
Second, our gross federal debt (accumulated deficits) today roughly equals $17 trillion. This number has nearly doubled over the last decade. The two ways to extinguish our trailing debts are either to pay them down (unlikely), or inflate them away. At a 4 percent inflation rate, our current debt pile would shrink by half in 15 years or so. Inflation significantly reduces federal debts.
Lastly, according to the CBO, by 2038 federal government spending will approximate 26 percent of U.S. GDP, compared to the long-run average of 20.5 percent. Health care spending will account for more than half of that amount, twice the historic average. Therefore, the escalating interplay between rising health care expenses and rising interest expenses (due to rising health care expenses) accounts for nearly all future debt accumulation. More health care subsidies equals more debt, fewer health care subsidies equals less debt. The trajectory of our future national debt depends directly on the trajectory of health care legislation.
With the economy addressing the deficit, and inflation addressing accumulated debt, legislation becomes the wildcard in calculating our long-term solvency. There are only two ways to address the issue; proactively or reactively. The Affordable Care Act postured toward taking proactive measure. Unfortunately, according to the CBO, the ACA does not reduce long-term health spending. Using current law, over the next 25 years 35 percent of the increase in government health care spending can be attributed to aging, 40 percent from increasing costs, and 25 percent due to increased subsidies. Adopting universal health care certainly serves a humanitarian purpose, but it does not serve a fiscal one. This proactive attempt to limit health care debt accumulation actually increased it. Oops. The reactive path emanates from crisis. Consider the events in Europe. Bond market participants decide one day that risks outweigh security, and demand for debt issuance evaporates. This leads to a spike in interest rates, economic upheaval, and a dose of very unpopular national entitlement reforms. Fortunately, or unfortunately depending on your perspective, the U.S. receives much greater fiscal latitude due to its sheer size and status as the world’s reserve currency. As a result, the bond market will give us extended time and the benefit of the doubt. This enables legislative buffoonery without immediate consequence, as we are witnessing today. The fiscal cancer of health care spending is clearly metastasizing, but while the treatment is definitely important, according to the bond market, it’s not urgent.
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.