The word “trillion” is thrown around quite casually these days in Washington. Hearing members of Congress go back and forth using such massive denominations is enough to make any fiscal conservative nauseous. But almost all, including myself, agree that more assistance is needed for businesses and individuals struggling in the COVID era. The question is not if, but how much. Dealing with the fallout is something to be addressed tomorrow once the suffering has subsided. But that doesn’t mean we can’t keep track of the hole we are digging for ourselves.
As we await a presidential election and the next round of fiscal stimulus, which based on press reports could be anywhere from $500 billion to as high as $2.5 trillion, I started to wonder if our current experience is the “new normal.” The following chart shows cumulative budget deficits for the past six presidents after adjusting for inflation. The first thing that struck me about this chart is the consistency in first-term trajectories for the four presidents preceding President Obama. Each racked up between $1.2 and $1.9 trillion (in current dollars) of red ink in their first terms. However, the Clinton presidency produced sizable surpluses in his second term, while the Reagan and Bush 43 presidencies continued to run up tabs to the tune of over $3 trillion for their full tenures. Bush 41 was defeated in his reelection bid.
Moving on to more modern times, things have pretty clearly gotten out of control. The Obama administration, faced with an economic contraction on a scale surpassed only by the Great Depression, spent liberally in order to support the economic recovery. By the time he left office his cumulative deficits surpassed $8 trillion (again, in today’s dollars). I can remember wondering at the time whether the massive increase in federal debt would continue to be so readily absorbed by the markets (without driving up borrowing costs). That worry was clearly misplaced. But I can also remember wondering if such massive amounts of debt would inhibit or cap future rates of economic growth. The answer to that question is more nuanced. My suspicion is yes.
Fast forward to the fourth year of the Trump presidency, and cumulative deficits are now on track to handily exceed the Obama deficits. The green line in the chart does not include the next round of economic assistance, which as noted could be between $0.5 and $2.5 trillion. And there could be another round after that. Is this spending necessary? Much of it is, yes. Could some of the economic assistance and stimulus spending have been avoided or at least spent more efficiently? Yes, almost certainly. Would we be in better shape had we not passed the 2017 tax cuts and subsequent spending increases? Yes, but probably not dramatically so. My point is that the federal government is spending so far beyond its means that major sacrifices, including by investors, will be required in the years ahead.
The fact that the markets have so easily absorbed all this additional debt so far does not mean it will go on forever. The Fed is desperately trying to increase inflation as a way to help manage through these trying times. Each of these factors would argue for a strategy of keeping bond durations relatively short. High-quality stocks with reasonable dividends yields will also be an important way to navigate the investment challenges ahead. Stay off the thin branches of risk! We would also advise you to keep your return expectations somewhat modest over the intermediate term. There is value to be found, but it won’t be nearly as easy as it’s been in the past several years.