-- Tim, Gainesville, Fla.
Before we answer those questions, let’s take a closer look at the road ahead for our government’s finances…
Despite the current good news, demographic forces threaten to push the deficit higher later this decade. Until and unless policy makers adopt additional measures to raise revenues
(likely through tax increases) and cut government spending, the CBO forecasts a $650 billion deficit by fiscal 2019 and an $800 billion deficit by 2022 as a growing pool of retirees absorb a higher amount of retirement and health care benefits.
What kind of numbers are we talking about? The CBO notes
that we are currently spending around $2 trillion every year
on mandatory spending such as Social Security
, though that figure is expected to swell 75% to $3.5 trillion by 2022.
Yet a deficit is still troublesome, no matter how large or small. It means that our national debt
, which now stands at $16.7 trillion, keeps rising. And all that debt means the government doles out more than $300 billion a year in interest payments on that debt, which plays a role in keeping the budget from coming into balance.
Erskine Bowles, who has been leading a government council that seeks to tackle the persistent deficits, paints matters in starker terms: "We'll be spending over $1 trillion a year on interest by 2020. That's $1 trillion we can't spend to educate our kids or to replace our badly worn-out infrastructure," said Bowles at a November 2012 forum hosted by IHS Global Insight. "What makes it doubly bad is that trillion will be spent principally in Asia, because that's where our debt is," he added.
No matter how you look at it, it remains hard to see how our national debt will
stop growing and start shrinking. Even with current low interest rates, the annual interest payments consume more of the federal budget than the U.S. Department of Agriculture, Department of Education and State Department -- combined. By next year, interest payments will
exceed what we annually spend on Medicaid
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To be sure, the current interest payments actually benefit from the current era of low interest rates. When interest rates start to rise, the government will likely pay much higher sums.
Bad for bonds?
Thus far, the huge tide of deficits and debt has not had much of an impact on bond
markets. The global economy
has been so weak that investors have gladly bought relatively safe government bonds
. But as the global economy strengthens, massive sums of money will
pull out of bond funds in pursuit of higher returns, such as stocks.
The drop in demand for bonds means that bond issuers (such as the government, states, municipalities and corporations) will
have to offer
higher yields. And rising bond yields mean
falling bond prices, which will
lead to a drop in value for that bond fund
you may own. Net/net, bonds are vulnerable to our ongoing budget deficit, no matter whether it's $1 trillion or $400 billion.
Good for stocks?
So if investors can be expected to pull money
out of bonds and into stocks as the global economy firms, should we read that to mean
that budget deficits are good for stocks?
Not at all.
In fact, we're already seeing real headwinds in our economy as government spending shrinks. Uncle Sam
provides a lot
of juice to the U.S. economy, through defense spending, technology investments
, infrastructure spending and the like. Economists
suggest the smaller level of government spending is already shaving a full percentage point of growth from our economy.
And with the massive debt and deficit pressures still in place, government spending is bound to fall yet further. This means Uncle Sam will
be providing an ever-smaller boost to the economy. Net/net, stocks have rallied in recent years, despite still-large deficits, but the road ahead will
become bumpier as the government shrinks in size. (Speaking of the road ahead, my colleague Elliott Gue -- editor of StreetAuthority's Top 10 Stocks
newsletter, has just released his picks for the Top 10 Stocks Of 2014. Click here to learn more
Can we ever eliminate our nation’s budget deficit? When there’s a will
, there’s a way, but Washington thus far has lacked the will
to do so. In 2012, I suggested ways that the government could balance its books
but thus far, only defense spending has been tackled. The other five suggestions have thus far gone unheeded.
Yet until you see Washington finally come to agreements that both cut spending and raise revenue
, you need to be concerned about bonds and stocks. The recent drop in the annual deficit is indeed great news, but the fact that the national debt is fast-approaching $17 trillion means that a debt-triggered crisis can’t be ruled out.