Shrinking US deficit matters to your portfolio

Beneath the veneer of good economic news, trouble lurks. Here's what it could mean for you.

By StreetAuthority Aug 16, 2013 4:32PM
Image: Measuring Finances (© Corbis)By David Sterman

It's the feel-good story of 2013 that nobody is talking about.

The nation's budget deficit, which had been spiraling out of control, is finally returning to manageable levels. Thanks to higher government revenues and lower government spending, this year's shortfall (for the fiscal year ended Sept. 30) will likely be around 40% lower than a year ago.

In fact, the Congressional Budget Office (CBO) predicts the budget deficit will fall below $400 billion by fiscal 2015. Good news, indeed.

Or is it?

Should we be pleased the budget deficit will still be larger than the entire economy of many mid-sized countries? And for investors, does that falling budget portend good news for stocks and bonds? Before we answer those questions, let's take a closer look at the road ahead for the U.S. government's finances.

A fast-shrinking deficit ($billions)Source: Congressional Budget Office

Despite the current good news, demographic forces threaten to push the deficit higher later this decade. Until 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.

How much higher? The CBO notes that Congress is currently spending around $2 trillion every year on mandatory spending such as Social Security and Medicare, though that figure is expected to swell 75% to $3.5 trillion by 2022.

No matter how large or small, the deficit is still troublesome to the rising $16.7 trillion national debt. 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.

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. 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 trillions 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 the 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 Department of Agriculture, Department of Education and Department of State -- all combined. By next year, interest payments will exceed what the United States spends annually on Medicaid.

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 means falling bond prices, which will lead to a drop in value for that bond fund you may own. Net/net bonds are vulnerable to the ongoing budget deficit, regardless if 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 the economy as government spending shrinks. Uncle Sam provides a lot of juice to the U.S. economy -- with expenditures in defense, technology, infrastructure and the like. Economists suggest the smaller amount of government spending is already shaving a full percentage point of growth from the U.S. economy's GDP.

And with the massive debt and deficit pressure still in place, government spending is bound to fall yet further, which 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.

Action to take:
Can Congress ever eliminate the nation's budget deficit? Where there's a will, there's a way, but Washington has lacked the will to do so. In 2012, I suggested ways the government could balance its books. But thus far, only defense spending has been tackled. The other five suggestions have gone unheeded.

Yet until you see Washington finally come to agreements that cut spending and raise revenue, you need to be concerned about bonds and stocks. The recent drop in the annual deficit is great news, but the fact that the national debt is fast-approaching $17 trillion means a debt-triggered crisis can't be ruled out.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

More from StreetAuthority
Aug 16, 2013 7:16PM

I just looked at David Sterman's 2012 article about balancing the federal budget.  He basically wants to raise taxes left and right, on both the rich and the middle class, while cutting only defense and capping Medicare and Medicaid.


Many bloggers on this website including myself could have done a better job than Sterman.  What makes him qualified to collect a handsome fee or perhaps, salary for writing inferior information that amateurs could better?  What about eliminating departments that are full of bureaucrats?  Commerce, Education, Energy, Agriculture... Disperse the duties of Homeland Security back to Justice and Defense where they were before.  Put Vet Admin back in Defense.  Have less activity and fewer employees in Labor and HHS.  The Treasury Dept has way too much activity.  And yes, all the other departments must be reduced in size, too, even the State Dept., which specializes in meddling in the affairs of other countries.

Aug 16, 2013 7:34PM

David Sterman doesn't seem to realize that the sequester DID NOT LOWER GOVERNMENT SPENDING compared with 2012.  The sequester merely reduced the rate of spending increase!


Government spending is GOING UP in 2013!

Aug 16, 2013 7:21PM

Shrinking deficit?! What the hell is this guy talking about?? A couple of economists came out earlier this week and stated that the government was fudging the true deficit numbers!  The $16.7 trillion debt is closer to $70 trillion when you add in Medicare, Medicaid, government pensions, etc.


In short, the government is fudging the deficit number the same way they fudge the unemployment numbers. I should be surprised by this, but I'm not.

Aug 17, 2013 1:54AM

Shrinking deficit? Don't know who to believe? Believe this, the Fed can't keep buying bonds, which keeps interest rates artificially low. They will have to eventually taper it off, which will increase interest rates. Will this help the US economy? No. Let's keep it real. Were not in a goldilocks economy. The majority of people here have temporary jobs at minimum wage as far as I'm concerned. The Feds printing $85 billion a month. They will print around +1 trillion this year if they keep it up at this rate. By the way, they're buying mortgage-backed and government treasury loans. In doing so, this inflates the stock market to fake all-time highs. What about the +16 trillion dollar national debt? Who has to pay this off? We do and our children. Believe that.  

Aug 16, 2013 10:58PM
Good to see Federal income is higher.  Government will just spend more.  What if this Federal tax burden would be spent on business growth, saved and spent, and improved demand?  More private sector jobs! 
Aug 16, 2013 9:39PM
Aug 16, 2013 6:40PM
The lesson to be learned.

Smaller (or in our case, Absentee government) does seem to generate savings.
Maybe this is the way to 'go'. 

Aug 16, 2013 11:23PM

"What makes it doubly bad is that trillions will be spent principally in Asia because that's where our debt is," he added.


He doesn't know what he's talking about. The $16 in debt is held by institutions, individuals and government agencies. Foreign countries hold about 25%. The FED and SS Trust fund hold about 40%. US investors and institutions hold about 35%.

Aug 16, 2013 7:32PM

Although the deficit is numerically smaller than it was a year ago, this is the result of smart-aleck tactics, not of fiscal policy growing more sound.  Much of the revenue comes from this path:  Federal Reserve --> Fannie Mae/Freddie Mac --> Internal Revenue Service.  The Fed's purchase of mortgage-backed securities at prices far higher than what the private sector would pay is a clever and sneaky way to fund the federal budget.  It differs from having the Fed buy bonds (which is also does in enormous amounts) in that the nominal federal deficit is conveniently reduced.


You, the reader, need to know that the MONEY SUPPLY EXPANSION (technical inflation) is about the same whether the Fed feeds the federal budget through the tax system or through the Treasury bond system.


The corporations and rich have had their own cleverness with regards to paying taxes.  Since they could pay 2012 taxes up until 4/15/13, income tax collected was at the 2012 marginal rates even though the payments were made in 2013.  The higher rates from letting the Bush tax cuts expire on the rich apply for 2013 taxes.  The corporations and rich avoided the higher 2013 rates as much as they could.  The aggregate revenue in Jan-April thus spiked.  The tax collected in the latter months of 2013 shall likely be far less than officials expect.

Aug 17, 2013 10:15AM
Mr.Sterman must live in Colorado or Washington State....He's been smoking something for sure....
Aug 17, 2013 10:04AM
What is always not mentioned, the United States population isn't shrinking nor or the Cost of doing Business, Government or Private sector shrinking. In Fact, the IRS cut it's workforce by 5,000 in 2012 compared to 2011. And yes, there will be other Real Cuts in other areas, not just a reduction in growth of spending. There certainly are areas of Government, Federal, State and Local where cuts are needed and Wages are out of line with Reality. Just as in the Private Sector.

Low Rates, for now, have given the Global Powers times to get their house in Order. Problem is, they have no idea of how to do it. You see, there is a problem with cutting another person's salary when you aren't willing to cut your own.

Aug 16, 2013 11:59PM
Of course the deficite is shrinking... What do you think happens when you have zero % interest rates, and pump 85 billion dollars into the economy.  Inflation is shrinking the value of the deficite, and interest rates are making the payments non existant.  HOWEVER, this can't last forever, or for that matter another year.  How long do you think it takes for the 85 billion QE's to actually get into the market, and actually start influencing it?  Months... So if you thought inflation was bad now, wait a few months.  Even if the fed scales back the QE's, the damage is already done.  The other problem is... the stock market reacts instantly to the QE's.  So all the profit and good news from the QE's has been had, while the damage is still lurking.   Put those 2 together and you paint a bad pictuer with "Zang" watercolors.  So as they scale back the QE's, inflation continues to rise.  Which means interest rates will rise to counter that inflation.  Which means the Deficite will, soon, no longer be shrinking but growing and with interest.  Tack that onto the fact that it's 16.7 trillion, well.... you get the idea.
Aug 17, 2013 12:44AM

These articles are all reactionary to the effects rather than the underlying cause.  George Bush Sr. screwed this country with NAFTA and the American Competitiveness in the Twenty-First Century Act; they were finished under Bill Clinton and he was erroneously credited for starting these global killers.  America has lost around 50,000,000 jobs and imported millions of foreign workers and terrorists on H-1B, L1, Green Card and Student Visas from the aforementioned debacles based on corporate fear Baby Boomers leaving the job market in droves would cause a severe labor shortage.  

60% of Baby Boomers may never retire now and young workers are severely at a disadvantage while the American Dream is for the rich.  Obama approved importing hundreds of thousands of foreign workers into America every year he's been in office even though we have a job shortage and the second depression in history mislabeled as The Great Recession.  This lead to severely underfunded hedge funds which insures against bad mortgages and a dramatic drop in derivatives which almost totally collapsed the global economy.  Those in poverty may die there before this is corrected, if ever.

Obama was pumping 135,000 foreign workers every year into the US during the worst downturn since 1929.  The number was just recently reduced to 60,000 a year but the damage is still mounting as Americans are starving and being driven into poverty.  When anyone attempts to get a job in America, they are in direct competition with Congress' foreign workers and it has stagnated cities across America with no end in sight.  The only thing the Feds can do now is continue to print money but hyperinflation is a severe risk if they don't pull those funds back into the Fed within 5 years.

Aug 17, 2013 12:57AM
Many of you are not capable of distinguilshing "the deficit" from the national debt, counting future unfunded liabilities.  Either by choice or worse yet because you just can't grasp the difference, many just parrot what they hear from the media and political sound bites.  Believe it or not, there are some of us out there who don't obsess over pointless political blame games but instead focus a large part of our energies into providing for our families futures based on the weight of the evidence.
Aug 16, 2013 11:07PM
Aug 17, 2013 1:06PM
Everyone is on government welfare including auto makers, banks, defense workers, educators, energy producers, farmers, investors, realtors and on and on.  The US government prints tons of currency so that we all can trade products and services that would be otherwise worthless. Sooner or later somebody is going to call the US bluff and label us the world's currency manipulators par none.  If China wants to scare the crap out of US investors all they need to do is start dumping US Treasury bills and watch the US interest rates go sky high. The FED can't print another $4-8 trillion to offset that effect.
Aug 16, 2013 9:34PM
wait 6 months and the deficit will slowly start back up
Aug 17, 2013 11:04AM

Lower deficit???? Didn't we all know when Obama introduced the Trillion dollar deficit and then lowered it by a small percentage that the libtard media would praise him? The way to lower deficits and begin salvaging the next generation's standard of living is to stop spending more, across the board, than the government takes in with revenue. REAL CUTS and not just reductions in the amount of increases will solve the problem.


Begin with across the board cuts and let's see some of the able bodied entitlement seekers cut off. Maybe we'd see some work ethic return to the country rather than these leeches sucking our tax dollars down the gutter while being lazy.

Aug 17, 2013 2:25PM

Here is the problem with this article.


1. Social Security and Medicare unfunded liabilities.

2. Federal Pensions unfunded liability.

3. Funky unacceptable accounting practices

4. Below market interest rates thanks to Federal Reserve QE financing distorts real interest cost on federal debt.

5. % of people actually contributing to tax coffers is shrinking by the month -

6. Middle class America is disappearing

7. Affordable Care Act - AKA - Obamacare will bankrupt the country.


Dumbed down country thanks to Federal Department of "Brainwashing" Education.

Aug 17, 2013 4:42PM
so let me get this right..we need the economy to keep tanking in order to keep my portfolio from not tanking?   Makes perfect sense.
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