Whoever wins the 2016 presidential election tomorrow night could be in for a rough 4 years in the White House courtesy of the gigantic debt burden amassed by Obama over the previous 8 years. While an accommodative monetary policy, including seemingly unlimited treasury buying by the Fed and foreign governments, has suppressed the budget impact of Obama’s ballooning federal debt balance, as Ed Yardeni told Bloomberg, “one shudders to think what would happen if rates actually ever did go back to normal.”
“We’ve really got ourselves into a pickle here,” said Edward Yardeni, president of Yardeni Research Inc. in New York, who’s been following the bond market since the 1970s. “All these years we’ve been kicking the can down the road, and suddenly we’re seeing a brick wall.”
“There’s been so much borrowing going on that’s been enabled by extremely low interest rates, one shudders to think what would happen if rates actually ever did go back to normal,” Yardeni said. “The impact on the interest expense would be significant, and could really bring deficit concerns back to the fore.”
As a report published by the Congressional Budget Office today points out, nearly 60% of the federal budget is spent on entitlements and interest payments on public debt. While the public debt balance has increased every single year of Obama’s Presidency, declining rates have largely offset the budget impact.
Outlays for the three largest entitlement programs—Social Security, Medicare, and Medicaid—rose by $29 billion (or 3 percent), $27 billion (or 5 percent), and $19 billion (or 5 percent), respectively. Spending for Medicaid grew largely because of new enrollees added through expansions of coverage authorized by the Affordable Care Act. With that growth, Medicaid spending has risen by almost 40 percent in the past three years. Combined outlays for the three programs were equal to 48 percent of federal spending and 10.0 percent of GDP in 2016, the highest shares ever recorded.
Outlays for net interest on the public debt increased by $23 billion (or 9 percent), largely because of higher inflation in 2016. (Each month, to account for the effects of inflation, the Treasury adjusts the principal of Treasury inflation-protected securities, using the change in the consumer price index for all urban consumers that was recorded two months earlier.) Outlays also increased because debt and average interest rates were higher in fiscal year 2016 than in fiscal year 2015.
That said, rates will have to “normalize” at some point and the CBO expects that the “winner” of the 2016 presidential election will be the beneficiary of that normalization.
If the CBO’s forecast is accurate, then outlays for the interest payments on public debt alone could rise over $300 billion over the next 8 years which would be more than a 50% increase in the current budget deficit.
And while headwinds are already baked into the federal budget from ballooning debt and entitlement spending, both Clinton and Trump have promised new expenditures for infrastructure projects and tax cuts.
“The Treasury has kind of gotten a free lunch over the last several years,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC in New York, and a former researcher at the Richmond Fed. “Deficits had been artificially suppressed by the nature of monetary policy. Now you have structural issues with spending on entitlements, and a policy impetus that seems to be moving toward fiscal stimulus.”
While there’s no guarantee that either major candidate will be able to get their proposals through Congress, economists predict the potential shift toward looser fiscal policy will expand the debt burden.
Proposals from Democratic nominee Clinton include a $275 billion infrastructure plan that she intends to pay for through corporate tax-law changes. She’s also suggested tax increases for the wealthy. The plans would inflate the debt by $200 billion over a decade, according to analysis from the non-partisan Committee for a Responsible Federal Budget.
Trump, the Republican candidate, has made pledges including cutting taxes and spending as much as $500 billion on infrastructure. The proposals would boost the debt by $5.3 trillion, the Committee for a Responsible Federal Budget estimates.
The deteriorating backdrop for the world’s biggest bond market risks spoiling the plans of Tuesday’s winner, whether it’s Hillary Clinton or Donald Trump. Both have promised measures to foster growth and create jobs. The prospect of the three-decade bull market in bonds approaching a turning point has implications for everything the candidates want to tackle, from infrastructure spending to national security to tax cuts.
With bond and equity markets bubbling up all over the world and accomodative Central Banking policies growing a little long in the tooth, there is a very real possibility that the next president will be blamed when Obama’s great “recovery” is unwound…which could very well mean that tomorrow’s “winner” is looking at a 4-year proposition.
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