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CNB Economic Commentary: Oct 7

October 7, 2013
To: Everyone
From: Gregory S. MacKay, Senior Vice President & Chief Economist
Date: 10/04/13

We’re four days into the Federal Government’s 18th shutdown since the Ford Administration. That’s right – 18th. I guess we should be used to this kind of behavior from our elected representatives. All of the shut downs beginning with the Reagan Administration have had a budget deficit as the primary issue. Most lasted 1-3 days, with two in the Clinton years lasting 5 and 21 days. It’s uncertain at this point how long this shutdown will go on, but it looks similar to the 1995-1996 situation where a single issue (seven year budget with Congressional Budget Office figures) stymied both sides for 21 days. In shorter shutdowns, continuing resolutions were often passed and then vetoed by the sitting President, and compromise was quickly reached due to the multiple issues under consideration.

This time we’re being told it’s all about the Patient Protection and Affordable Care Act (“PPACA”, “Obamacare”). Both sides have stated that no compromise is acceptable. Democrats want it, Republicans want it changed. Lurking behind this seemingly one issue event is the ongoing discord between the tax and spend policies of both parties. To balance the budget, Democrats look to some tax increases and cuts in defense spending, while Republicans look to cut spending on social programs and hold down tax increases. Such simple analysis seems to support the overused “rich versus poor” taglines, but this budget impasse is only the tip of the iceberg. Looming about three weeks from now is the fact that this country will run out of money to pay its bills if the debt ceiling isn’t raised.

Thus, the budget debate and the debt ceiling debate are truly philosophically linked. While the budget debate is all about this fiscal year (which began October 1), the debt ceiling crisis is all about past and future fiscal indiscretions. We like to look at Congressional Budget Office (CBO) data, as it seems relatively straightforward and non-political. The CBO points out that the deficit this year of 4% of GDP is the smallest since 2008, proof that the economy has recovered nicely. It goes on to state that under its current projections, the deficit will continue to drop to 2% of GDP by 2015, and in 2018, federal debt held by the public will fall from its current 73% of GDP to 68%. These numbers should have Congress dancing in the aisles, but longer term projections paint a somber picture. As our population ages, the CBO projects that federal debt held by the public could reach 108% of GDP by 2038. It projects federal spending will increase to 26% of GDP from the current 22% (the last 40 year average is 20.5%). Federal spending in 2038 for major health care programs and Social Security will increase to 14% of GDP from the current 40 year average of 7%. Federal spending on everything but Social Security, health care, and interest payments could fall to 7% of GDP, well below the 40 year average of 11%. Now add in the possible “crowding out” of private investment by government needs, possibly higher interest rates and payments caused by large borrowings, and possible less flexibility in both fiscal and monetary policy as U.S. debt grows, and the need for fiscal reform becomes obvious.

Of course, long term projections can be uncertain. The CBO has factored in possible changes to tax law, productivity, interest rates, deficit reduction, and health care expense and has come to the conclusion that federal debt held by the public in 2038 could range from a low of 31% of GDP to a high of 190%. That’s a pretty big spread. In the summary of the CBO’s September 2013 “Long Term Budget Outlook”, it states its case quite simply: “Because federal debt is already unusually high relative to GDP, further increases in debt could be especially harmful. To put the federal budget on a sustainable path for the long term, lawmakers would have to make significant changes to tax and spending policies – letting revenues rise more than they would under current law, reducing spending for large benefit programs below the projected levels, or adopting some combination of those approaches”. We hope all our representatives will read the report.

A sidebar to this information is President Obama’s letter to all federal employees dated October 1, 2013. We found it interesting that there are 3.4 million people who work for the federal government… it’s the country’s largest employer… that’s about 2.4% of all employed people… doesn’t seem like much until you learn that the total is more than the combined workforces of Walmart, I.B.M., McDonald’s, and Target… or another way – there are more people working for the federal government that the combined workforces of I.B.M., McDonald’s. Target, Kroger, Home Depot, Hewlett Packard, Sears, UPS, and General Electric… Hmm.

The good news this week is that the markets have stabilized… for now. Equity prices for the Dow Industrials are down 3.9% from September 19 highs, the S&P 500 is off 2% for the same period, and NASDAQ is actually up .4% since September 19. Treasury bond yields in 10 years have stabilized at around 2.65%, up from 2.4% earlier in the year, but down from the 3% level seen in late summer. We need to see some meaningful progress in budget and debt ceiling talks so that we don’t risk another U.S. credit rating shock to our markets.