Investors continue to be rewarded for holding higher risk assets as economic growth remains strong, consumer spending remains strong, and corporate profit growth is robust. Both U.S. and international equities posted strong gains in the quarter and riskier parts of the bond market led the way. Despite the enthusiasm, there are a few clouds on the horizon. Inflation has remained more persistent than expected and consumer confidence is moderating in the face of higher interest rates and an upcoming election. Over the long-term, the growing federal debt will likely slow economic growth and annual budget deficits will need to be brought to sustainable levels.
The ability of the United States Federal Government to run and manage debt dates to the late 18th century when then Secretary of the Treasury Alexander Hamilton proposed a plan to consolidate, and manage debt incurred from financing the Revolutionary War. The concept was to maintain fiscal responsibility and the flexibility to spend and run debt during periods of crisis such as a war or economic pressures and generate budget surpluses when times were good. Just as an individual would consider the ability to maintain a sustainable level of debt relative to their income, a sovereign nation’s ability to maintain debt is measured as a percentage of GDP (Gross Domestic Product).
For much of history, this held mostly true as times of crisis in the 19th century such as the Civil War, the War of 1812 and territorial expansion incurred debt, but overall levels were relatively low as a percentage of GDP and were reduced through surpluses and economic growth. World War II was a massive undertaking, and despite significant tax increases, a large amount of debt was incurred to cover the costs of mobilizing troops, producing weapons, and supporting the war, bringing the national debt to over 100% of GDP. This war debt was brought under control and debt to GDP fell into the 20% range for most of the 1970s.
As recently as 2001 the federal government ran a surplus of $133 billion, a third straight year of surpluses following tax increases in the early 1990s, a booming economy and reduced spending following the end of the Cold War. This brought debt down to 32% of GDP, the lowest level since the early 1980s, and led the Congressional Budget Office (CBO) to project that the national debt would be fully paid off by the end of FY 2009. Since then, responses to the global financial crisis, the pandemic, several major tax cuts, and increases in discretionary spending have brought the federal debt back to World War II levels of roughly 100% of GDP. The CBO estimates that with current legislation in place that includes the 2017 tax cuts expiring in 2027, the budget deficit will reach 116% of GDP by 2034.
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