Burgeoning debt and deficits are threatening to make the next recession deeper while tying the hands of policymakers, according to two leading economists. The Congressional Budget Office this week revised its estimates to paint an even bleaker version of the U.S. financial picture. In the updated look, the budget shortfall is projected to be about $2 trillion for 2024, swelling to $2.8 trillion in 10 years. Over this time, it will sometimes equal nearly 7% of gross domestic product, or close to double its trend over the past 50 years. As that happens, total debt held by the public is expected to hit a record 122% of gross domestic product, more than it was in the aftermath of World War II and easily eclipsing the level in 2020 when the government poured trillions of dollars into the economy to combat the Covid pandemic. Economist David Rosenberg said the cumulative effects will make it harder for both fiscal and monetary authorities to maneuver, threatening the longer-term economic picture. “The deficit this fiscal year is poised to come in at an alarming 7% of GDP, which is more than we have seen in prior recessions,” Rosenberg, the founder of Rosenberg Research, said in his daily note Thursday. “That we can have this type of fiscal expansion and yet also have the pace of economic activity weaken as it has is a bit of a shock but is now highlighting that there are limits to everything — the real problem is how the government is going to be able to combat the next recession with its fiscal maneuvering room so woefully constrained,” he added. Teetering on trouble In fact, Rosenberg thinks the economy already is nearing or in the early stages of recession. He noted that more than one-third of initial economic data readings are being revised lower. At the same time, the recent slow creep higher in unemployment is close to meeting the “Sahm Rule,” which states that a three-month average rise of half a percentage point in the jobless level over the past year is consistent with recessions. The situation has been complicated further by the inflation that has accompanied the aggressive fiscal and monetary expansion of the past four years. Though the rate of inflation has decreased substantially from its mid-2022 peak, Federal Reserve officials insist it is still too high and they are not ready to lower interest rates . In its fiscal revisions, the CBO noted that the rise in debt and deficits has come from “growth in spending on programs that benefit older people and rising net interest costs.” The government in fiscal 2024 has spent $601 billion on net interest — the difference between what it pays in financing costs against what it gets in investment — and the total has exceeded outlays for both health and national defense. Worries over a ‘tipping point’ To be sure, the U.S. economy has managed to avoid persistent fears over a looming recession, with consumers still spending, albeit it a slower pace, while the economy continues to create jobs. Treasury Secretary Janet Yellen recently said in a CNBC interview that the U.S. debt load, now totaling $34.7 trillion, is in “a reasonable place” so long as the economy continues growing. But Rosenberg is not the only one raising alarm over U.S. finances. Former White House economist Joseph LaVorgna noted that the the grim picture the CBO laid out could get even worse as its economic projections are “overly optimistic” and do not incorporate the likelihood of recession over the next 10 years. “If there is a downturn, unemployment will rise much more, and revenue growth will collapse,” wrote LaVorgna, who is chief economist at SMBC Nikko Securities and was a member of the National Economic Council under former President Donald Trump. “With budget deficits historically high relative to an economy operating at full employment, the government could be facing double-digit budget deficits when the next downturn hits.” While equity markets have largely shrugged off worries over the fiscal situation, LaVorgna and Rosenberg both insist that bond investors should pay attention. For instance, LaVorgna reiterated long-held — and as-yet unrealized — worries that the deteriorating fiscal situation could lead to a revolt in the fixed income space, sending borrowing costs higher and further aggravating the debt and deficits problem. “The economy and financial markets may be closer to this tipping point than some investors realize,” he wrote. “Whatever happens, the latest CBO projections speak to a longer-term fiscal outlook that we view as highly troubling and unsustainable. Bond investors should begin to take note.”
