- Folks fear rising federal budget deficits could derail sustained economic and stock market revival—especially after the CBO recently released some "alarming" projections.
- The widely reported $7.1 trillion projection is a cumulative number—the sum of the individual years from 2010 through 2019.
- CBO projections are based on many assumptions—it's impossible to accurately predict what will happen years into the future.
- Deficits aren't necessarily bad for stocks, and total federal debt is projected to be 53.8% of GDP in 2009—on par with most of the 1990s, which were hardly viewed as disastrous times.
"Uh-oh, SpaghettiOs!" If yelled by a person under the age of five, it's your warning an upended-bowl-of-something-liquid is in your immediate future. If pronounced by our nation's Congressional Budget Office (CBO), you know it's just business as usual. The CBO on Tuesday forecasted $7.1 trillion in additional debt by 2019, 11 years from now—while the White House projected $9 trillion! Sounds huge! And the news fanned fears that rising federal budget deficits could derail sustained economic and stock market revival.
Except that $7.1 trillion (or $9 trillion) isn't for just one year—it's cumulative, reached by adding each year's deficits for 2010 through 2019. Meanwhile, individual annual projections actually show the deficit shrinking in each of the next four years (how realistic do you suppose that is?) before resuming expansion. And contributing to the seeming staggering projections are the recent financial bailouts and the Troubled Asset Relief Program (TARP) money, which the government has thus far turned a tidy profit on as some participants have repaid. Some of that debt (albeit, a relatively small part) gets wiped out—with interest—as more firms start repaying.
The real question is, how seriously should we take these projections if the CBO itself states they are "not intended to be a prediction of future budgetary outcomes"? Their projections aren't really much of a projection. They simply make a straight-line assumption that nothing changes—that all current spending programs stay static. Cooked into this is also the riotous assumption that Congress will keep future spending increases inflation-adjusted. Before you infer that deficits will get much larger still, consider anything can happen in 10 years (and frequently does). Changes to tax laws, unforeseen economic events, changes in administrations, and sea change in policies—none are included in the CBO's projections.
Heck, their record indicates as much. Example: In the fall of 1993, the CBO's 5-year projection forecasted a 1998 deficit of $200 billion. In actuality, there was a surplus of $70 billion. Oops. Or how about its initial 2009 forecast—issued in 1999—projecting a $381 billion surplus? The CBO now expects a $1.6 trillion deficit this year. Give or take a couple trillion dollars, they were spot on.
Our best guess is they're well shy of an accurate 10-year forecast yet again. But suppose they're not? As we've shown here in the past, deficit peaks don't automatically mean bad stock returns; in fact, historically the reverse has been true. Nor is the overall debt level—projected to be 53.8% of GDP by the end of 2009—particularly alarming. No one found a similar level of debt in most of the 1990s to be disastrous. So, while we wouldn't much fret the looming specter of higher deficits in the near term, we'd bet a whole lot of SpaghettiOs that, 10 years from now, the CBO will be caught wearing a bowl on its head once again.