About five years ago I gave a presentation to our Investment Committee with a simple, yet provocative title – “Do Deficits Really Matter?”
Some context is important. The U.S. government had just run trillion dollar deficits for the previous four fiscal years. It was a challenging time for markets and the economy. The Great Financial Crisis was in the rear view mirror, but many people were still scarred by it. Financial markets had rebounded significantly, but they were not responding to deficits in the manner that many had expected. Interest rates were still very low by historical standards and inflation was tame. Then things changed quickly. Stronger economic growth combined with the sequester immediately led to lower deficits. Almost as quickly as we were confronted with the problem, it disappeared.
Fast forward to now and the Congressional Budget Office projects a return to trillion dollar deficits for fiscal years 2020 through 2028. We’ve had large tax cuts for corporations and individuals and some new Democrats in the House are promising a Green New Deal that would be very costly. How will we pay for all of this and more importantly, what will the impact be on the markets and our clients?
One thing is obvious to me. The fear we have been taught to feel about deficits has not manifested itself in the markets. Let’s take a deeper look at how fiscal policy works and see if we can find some answers.
The U.S. government is not like a household. The analogy of U.S. government spending being run up on China’s credit card is simply incorrect. As the sovereign issuer of our own currency, we can never run out of dollars to pay for things. If you don’t believe me, google “monetizing the debt” or better yet, think about this quote from Alan Greenspan: “The United States can pay any debt it has because we can always print money to do that.”
Why not just print a million dollars and send it to every citizen? Therein lies the rub. Even the proponents of deficit spending recognize that there are still limits in place. The problem is disagreement about what those limits are and how we should measure them. And more importantly, do we trust politicians to act responsibly with the information?
As we move forward into the next decade, I believe there will be less conversations about what we can “afford” and more discussions about what we want our society to look like. What should government prioritize and how should we shape our decisions around entitlements, defense spending and taxes?
As investors, it may be difficult to adjust to this new framework. I am thankful that we have a flexible process that will allow us to adapt to whatever happens.
From the desk of Jonathan Liles, CFP®, CIMA®
This article was featured in the Winter 2018 Quarterly Newsletter available here:
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