Economic High Seas: The Perplexing Long Journey of the U.S. Fiscal and Trade Deficits
Domestic Funding: A New Lifeline? Maybe we're Numb to the Numbers
The fiscal deficit first,
Why This Rusty Ole Ship Will Keep On Sailing, for as long as the seas are “calm”
The U.S. fiscal deficit is like a rusty hull that has been patched up repeatedly. For decades, the government has spent more than it earns, leading to a growing national debt. Some of this was justified e.g. spending during the Global Financial Crisis and Covid. Nothing new, right? Each time the debt ceiling is raised, it’s akin to applying another layer of paint to cover the rust. Political negotiations between both houses often resemble the crew debating the best way to keep the ship afloat, even as the underlying issues remain unresolved. And yet, the ship keeps chugging along.
Why and how, I have often wondered. Let’s fact-check. Note: I have used various government databases and sources (linked below). I may round my numbers for ease of reference, but the source documents will have relevant details.
(1) The Big Numbers: At approximately $32 Trillion, the fiscal deficit represents a debt-to-GDP ratio of approximately 120%. Based on the Congressional Budget Office’s “The Budget and Economic Outlook: 2024 to 2034” (a non partisan analysis for the U.S. Congress), this number, unless checked by new policies, is estimated to increase by another $1.5 Trillion to $2 Trillion annually, for the next 10 years. This would take the fiscal deficit to approximately $47 Trillion to $52 Trillion, or approximately hitting a debt-to-GDP of 160%.
Note that a big chunk of that is due to the interest burden, carried because the deficit is debt-funded. The outlays go into the Social Security, Medicare, Medicaid, CHIP Act, and other government subsidies, while infrastructure and defense take somewhat of a back seat.
Note also that the debt ceiling which stands at approximately $32 Trillion will obviously have to be lifted again. Watch the show in Jan 2025.
Are we surprised to see infrastructure deterioration (yup, a complex topic in and of itself), and defense budgets affected? Productive investments beget productivity increases, but these have been somewhat choked. Never mind the trade barriers presently in place.
(2) Reliance on Foreign Funding and Lenders has risen over the few decades, BUT….
(3) Most foreign bondholders are deemed “friendly countries” (see below). The reliance on “trade barrier” type countries is not that significant. China bond holding over time has also been reducing, with some significant sales of U.S. bonds at the end of 2023 and the beginning of 2024. So far, no major negative impact on the USD (there are reasons for that, which I will not go into here). Yields, however, we need to watch. Further information here and here. Any change in FED rate policy moving forward, and market receptivity will need to be followed closely!
Important Author Note: Any example of a foreign investor buying U.S. securities, and say keeping them in custody in say a Belgium, Luxembourg or Switzerland Bank will typically have those assets reflected under Belgium, Luxembourg or Switzerland, itself. So the numbers reflected below, whilst is the best that we can do, needs to account for “custodial activities” commonly undertaken by Offshore banks etc (which I am not able to discern).
(4) Domestic Funding: A New Lifeline?
Per the chart from Peter G. Peterson Foundation (above), in recent years, the composition of debt holders has somewhat shifted, with more domestic investors stepping in to buy U.S. Treasuries. This trend is like a new lifeline, providing the much-needed support to keep the fiscal ship sailing. However, the question remains: can this continue indefinitely?
Just as a ship needs regular maintenance to prevent it from sinking, the U.S. economy requires sustainable fiscal policies to ensure long-term stability.
The FED Balance Sheet has also been shrinking. Any slack here will have to be taken up by the other domestic holders. Can they?
Now, a quick mention of the Trade Deficit (since I am running out of space here):
(5) The U.S. Trade Deficits almost pale in comparison at between $600 Billion to $700 Billion, annually. Remember the foreign holders of US Debt? Well, their holdings are tied to the U.S. Trade Deficit, because of the cashflows they receive from U.S. import payments. Logically, the easiest and safest thing for them to do is to by U.S. Treasuries. Other investments (e.g. infrastructure), can also be made, but you know how challenging that can sometimes be. Or just hold on to the USD for now, perhaps whilst you look into building a new World Bank (standard), with it’s payment network? I digress. Excuse me. Of note is that the US runs a service surplus vs the goods deficit. So far, tariffs and barriers appear to be hurting more than acting as a Panacea and widening. So, another solution is required. Better policies that impact the country positively. Progressive policies, not regressive policies. What and how - I am unsure. We will watch the space after November 2024.
(6) Country Ratings: Moody’s AAA Country Rating is presently on negative watch, while both Standard & Poors and Fitch have theirs at AA+. But does a downgrade significantly impact a major reserve country? I doubt it, based on facts only available now. I caution, however - Keep Watching Yields and Markets
And finally, this question, will a deterioration in both really negatively impact the country? What if Moody’s finally downgrades the U.S. country ratings to Aa1? Does it matter? Many countries with AA ratings function quite well - United Kingdom, France, Ireland, UAE, Austria, Belgium - all considered high investment grade, and most portfolios would continue holding any form of debt and/or equity.
Also, almost all this information is already baked in by economists, congress, rating agencies, and markets. We see the future. It doesn’t look bright. But, are things so bad?
Also, many other factors are considered e.g. rule of law, regulatory quality, government’s role and actions, sovereign political risks, natural resources, etc. Issues could arise with external vulnerability risks, shared macro risks, etc. And yet, for now, no major storms for this rusty old lady. Then again, what do i know? Watch the space, especially market receptivity and market yield changes.
References:
a) The Congressional Budget Office (Budget 2024 to 2034) https://www.cbo.gov/publication/59710
Pdf: https://www.cbo.gov/system/files/2024-02/59710-Outlook-2024.pdf
b) Peter G. Peterson Foundation https://www.pgpf.org/blog/2023/05/the-federal-government-has-borrowed-trillions-but-who-owns-all-that-debt
c) United States Census Bureau (comprehensive coverage on U.S. International Trade in Goods and Services) https://www.census.gov/foreign-trade/Press-Release/current_press_release/index.html
d) Understanding the roots of the Trade Deficit (St Louis FED) https://www.stlouisfed.org/publications/regional-economist/third-quarter-2018/understanding-roots-trade-deficit#:~:text=The%20long%2Drunning%20U.S.%20trade,a%20global%20form%20of%20liquidity
e) Pdf: The US Trade Deficit: An Overview https://crsreports.congress.gov/product/pdf/IF/IF10619
f) Moodys Country Ratings Overview: https://countryeconomy.com/ratings/moodys
g) Zero Hedge: https://www.zerohedge.com/markets/yields-spike-after-ugly-2y-auction-demand-foreign-buyers-slides and https://www.zerohedge.com/markets/ugly-5y-auction-sends-yields-2-week-high
h) Visual Capitalist: https://www.visualcapitalist.com/which-countries-hold-the-most-us-debt/
i) Foreign Holdings of Federal Debt: (a) General Updates: https://crsreports.congress.gov/product/details?prodcode=RS22331 (b) June 2024 Report: https://crsreports.congress.gov/product/pdf/RS/RS22331/49
Tariffs aren’t helping the US deficit because they are generally bad policy. The US trade deficit is an accounting issue. The US spends/consumes far more than it produces (hence why the fiscal deficit is so high). Other countries fill the gap by producing goods and selling them in the US.
It’s a structural issue that tariffs alone won’t “solve.”
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