Back To Normal – But Worse

The Congressional Budget Office (CBO) has just published its projections for the US budget deficit and economic outlook for the next ten years. This annual document is a very important source of information for anyone who wants to understand how the economy is likely to evolve over the next decade. This year, “The Budget And Economic Outlook: 2014 to 2024” is 175 pages long. In this blog, I will highlight some of the most interesting and important aspects of this report.

The Budget Crisis Is Over

  • The budget deficit peaked at $1.4 trillion in 2009. By 2012, it was still $1.1 trillion. Last year, it fell very sharply to $680 billion. The CBO now forecasts it will be $514 billion this year and $478 billion in 2015.
  • When the economic crisis erupted in 2008, the government’s tax revenues collapsed and its spending (i.e. outlays) surged. Consequently, the budget deficit skyrocketed to 9.8% of GDP in 2009. This year the budget deficit is projected to be only 3.0% of GDP. The government’s revenues will amount to 17.5% of GDP. Government outlays will be equivalent to 20.5% of GDP. All three of these measures (the deficit, revenues and outlays) will be quite close to their average for the past 40 years. In other words, the government’s budget has returned to normal.
  • The CBO forecasts the deficit will be 3.0% of GDP this year and 2.6% of GDP next year. To put that in context, during the eight years of the Reagan Presidency, the US budget deficit averaged 4.1% of GDP a year.
  • Government spending fell by $83 billion in 2013 compared with 2012. Moreover, at $3,454 billion, it was $64 billion less than in 2009. Put differently, after a big jump at the peak of the crisis in 2009, government spending has remained quite flat since then.
  • The Fed handed over $76 billion of its profits to the government in 2013. It is expected to give the government roughly $90 billion more in both 2014 and 2015. That is the equivalent of 0.5% of GDP per year. It’s amazing how much money you can make when you make the money!
  • Fannie Mae and Freddie Mac contributed a profit of $97 billion to the government last year. Without the contributions from the Fed and from Fannie and Freddie, the budget deficit would have been 25% larger in 2013, $853 billion instead of $680 billion.

The Wars Are Over (Almost)

  • “Since September 2001, lawmakers have provided almost $1.6 trillion in budget authority for operations in Afghanistan and Iraq and for related activities.” (See page 64.) Just imagine the technological breakthroughs, medical miracles and wealth that would have been created if the government had invested $1.6 trillion in genetic engineering, biotech, nanotech and solar energy instead!
  • Defense spending fell by $46 billion or by 7% in 2013 to $625 billion or 3.8% of GDP. It is expected to decline to $604 billion or 3.5% of GDP this year and to $603 billion or 3.3% of GDP in 2015. Going back to 1974 (the year my data begins) and perhaps as far back as 1939, defense spending as a percentage of GDP has only been less than 3.3% during the six years between 1997 and 2002, when it ranged between 2.9% and 3.2% of GDP.
  • Based on current legislation, defense spending will decline steadily to 2.7% of GDP by 2023. That would be $707 billion spent that year, only a 13% increase over ten years. Let’s hope those spending restraints hold. However, in light of the pressure that the military (and the corporations that supply the military) will put on Congress, it is very unlikely that they will.

Much Slower Economic Growth Ahead

  • From 1950 to 2012, the US economy grew at an average annual rate of 3.3%. However, between 2009 and 2012, it only grew by 1.1% a year. The CBO expects the economy to expand by 3.1% to 3.4% between 2014 and 2016, but then to grow much more slowly after that, with an average growth rate of only 2.2% between 2018 and 2024.
  • The CBO now estimates that the economy’s real potential growth rate is only 2.1% per year between 2014 and 2024, compared with its potential growth rate of 3.3% per year between 1950 and 2013. That is a very sharp slowdown in the economy’s potential to grow.
  • The main reason for the slowdown in potential growth is that the growth in the labor force is expected to be much less than in the past, as the baby boom generation retires. During 2013, the number of people employed increased by an average of 190,000 per month. That number is projected to decline to only 67,000 per month between 2018 and 2024. If the CBO’s projections for the growth in the workforce are correct, I fear that such a slowdown will create an economic environment that is even more difficult than the CBO anticipates.
  • According to the CBO, US GDP will be $17.5 trillion at the end of 2014. It will then grow by roughly $1 trillion a year in nominal terms, reaching $27 trillion in 2024. The CBO forecasts that gross government debt will be $17.7 trillion at the end of 2014, or roughly 100% of GDP. That ratio is expected to remain at approximately 100% of GDP through 2024, putting gross debt at $27 trillion that year.

In closing, I would like to warn the reader that I believe this CBO report overstates the current health and future outlook for both the budget and the economy. Quantitative Easing became the driving force for the economy in 2013. QE pushed up asset prices and created a wealth effect that allowed Americans to spend more. That increase in consumption made the economy grow and generated higher tax revenues, making the budget deficit lower than it otherwise would have been. If QE ends this year, as the Fed has indicated, the economy could go back into recession. That would cause the budget deficit to be much larger than currently projected. So, keep that in mind. The CBO’s forecasts generally prove to be too optimistic.

Nevertheless, the Budget And Economic Outlook is a very useful document. I plan to discuss its implications in greater detail in the next issue of Macro Watch.

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