Debt and deficit aren't the same thing. Here's the difference

Debt and deficit aren't the same thing. Here's the difference

January 23, 2021

New York (CNN Business)President Donald Trump is living up to his self-given nickname “King of Debt.” On his watch, the United States has borrowed aggressively — during the good times, and now the bad times.

Instead of whittling down the federal deficit when the economy was strong, Trump directed the federal government pile on even more debt to pay for massive tax cuts and spending surges.
That meant that the United States entered this crisis in rough financial shape. Debt-to-GDP stood at nearly 80% even before the coronavirus pandemic struck — a rate more than twice as high as the historical average and double the level before the Great Recession.

The breaking point is like an invisible dog fence. You don't know where it is, but if you actually hit it, it'll be a huge problem."

Maya MacGuineas, president of the Committee for a Responsible Federal Budget

Now, the national debt is exploding because Washington is being forced to rescue the US economy from its greatest shock ever. The Treasury Department said this week it will borrow $3 trillion this quarter alone. That’s nearly six times the previous record, which was set in 2008.
Still, while the national debt is scary — it now stands at nearly $25 trillion — now is not the time to cut back on the borrowing.

Economists agree that the United States must continue to rack up debt to prevent a full-blown depression. Otherwise, there won’t be much of an economy left to repay the debt once the health crisis is over.
Even deficit watchdogs are urging Uncle Sam to keep borrowing.
“We made a huge mistake being so in debt when the economy was strong,” Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget, told CNN Business. “But just because we were reckless and foolish going into the crisis, [that] doesn’t mean we shouldn’t borrow during it.”
Of course, there will be long-term consequences for the mountain of debt Washington is racking up. Eventually it will mean higher interest rates, hotter inflation and likely higher taxes.

‘Absolute necessity’

But for now, the focus is on keeping American businesses and households afloat. In March, Congress passed a $2.3 trillion stimulus package, the largest in US history. Half a trillion dollars of forgivable loans have been handed out to small businesses. Direct payments were made to low- and middle-income families.
The Congressional Budget Office expects the federal budget deficit will hit $3.7 trillion this year, up from an eye-popping $1 trillion in 2019.
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And more stimulus is likely coming, perhaps another $2 trillion later this year, to help out states and local governments battered by the crisis.
All of this will add yet more debt to the pile. But there’s no other viable option to stave off further crisis.
“The fiscal stimulus and resulting explosion of the deficit is an absolute necessity to combat the devastating impact from the economic shutdown and to avoid a second depression,” said Steven Oh, global head of credit and fixed income at PineBridge, an investment firm that manages $101 billion.
Spiking deficits are also the result of a dramatic loss of tax revenue caused by the shutdown of businesses and 30 million Americans out of jobs.
The federal deficit is expected to hit 18.4% of GDP in 2020 and decline only gradually over the next decade, according to Moody’s Investors Service.

Powell: ‘Not the time’ to worry about debt

Jerome Powell, the Federal Reserve chair, recently expressed regret about America’s failure to get its debt situation under control years ago.
“It tells you the importance of getting your fiscal house in order,” Powell said during a press conference last week. “Ideally, you would go into an unexpected shock like this with a much stronger fiscal posture.”
Yet Powell urged politicians not to worry about that now. “This is not the time to let that concern, which is a very serious concern, get in the way of us winning this battle,” he said.
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Worries about debt forced the United States to rein in spending shortly after the Great Recession a decade ago. Economists say that premature withdrawal of stimulus hobbled the economy.
“The anemic recovery was a direct result of not enough fiscal stimulus,” said Kristina Hooper, chief global market strategist at Invesco.
The national debt has been on an unsustainable path for decades, in large part because of high entitlement spending on Social Security and Medicare.
Before the pandemic, Moody’s forecast US debt would hit 100% of GDP in 2030. Now, it expects debt to stand at 128% of GDP by then.

Markets don’t seem to mind, at least not yet

The good news is that Uncle Sam is having no trouble, at least so far, with financing the deficit. The 10-year Treasury rate is near all-time low at just 0.7%. That signals investors don’t fear the US debt situation is even near a breaking point.
Markets aren’t freaking out about US debt for a few reasons.
First, this spending is temporary and emergency in nature.
Second, the US dollar remains the preeminent international reserve currency and US Treasury market is the deepest and largest in the world. Those are huge advantages that keep demand strong for US debt.
Third, it’s extremely cheap to borrow right now. The Fed slashed interest rates to near-zero –and economists think they may stay there into 2022.
“It doesn’t blow us up — because interest rates are so low,” said David Kelly, chief global strategist at JPMorgan Funds.

Rate hikes could set off a crisis

But that equation would change, of course, if rates rose sharply. Given the sheer magnitude of the debt, even a tiny increase in interest is costly. Interest payments were the fastest-growing expense for the federal government even before the crisis.
One risk is that a surprisingly strong rebound in the US economy forces the Fed to rapidly reverse course.
“If the economy comes back too hot, then you could have inflation, higher interest rates — and that could lead to a fiscal crisis,” said JPMorgan’s Kelly.
That’s exactly why some believe the Fed will be forced to keep rates at rock-bottom levels. “It will be that much harder this time to wean the economy off ultra-low rates because the debt is that much greater,” said Invesco’s Hooper.

Higher taxes, less spending

Still, it’s a mystery when and if the bond market will eventually balk at high US debt and demand much higher interest rates.
“The breaking point is like an invisible dog fence,” said MacGuineas, the president of CRFB. “You don’t know where it is, but if you actually hit it, it’ll be a huge problem.”
To avoid hitting it, politicians will eventually have to make difficult decisions to get the United States back towards a sustainable fiscal path — most likely less spending and higher taxes — both of which would translate to slower economic growth.
“If we live beyond our means today,” JPMorgan’s Kelly said, “we will have to live within our means in the future.”
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