Fisher Investments Editorial Staff

CBO Dreamin’

By, 08/26/2011

Thursday’s volatility can’t hold a candle to what we’ve seen in recent weeks, though the S&P 500 down a bit more than 1.5% is still a pretty big swing. Big news of the day was mostly variations of the same themes we’ve seen all year. Greece encountered another hurdle (not insurmountable) to its bailout—evidently caused by its own unfamiliarity with its legal system. France, Italy and Spain announced they’d extend short sale bans (which are ineffectual, but no matter, since short selling isn’t the market boogieman many presume). Then too, jobless claims were unexpectedly higher—but claims were higher mainly tied to striking telecom workers.

Weak economy and debt fears—not helped out by other news this week: The CBO’s recent report on the US budget and economy noted cumulative budget deficits between 2012 and 2021 could reach $3.5 trillion. That’s 3.5 with 11 zeros after. With that figure, debt held by the public would amount to 61% of GDP. Certainly no drop in the bucket. But how reliable is the CBO estimate? Not very, as it turns out.

Case in point: In July 2000, the CBO projected by 2010, the United States would have a cumulative budget surplus of $4.5 trillion. What was that number actually? The US ran a budget deficit of $1.3 trillion.

Folks might say, “Yes, but a whole bunch of things happened in that ten years they didn’t predict.”

Exactly.

The world is an ever-changing place, but CBO forecasts are made in a perfect vacuum—they are given a set of assumptions and they run with it. For example, they take current tax revenues and extrapolate them out across their projections (accounting for legislatively mandated changes). However, their report has no ability to forecast how future tax changes may impact future tax revenue. Likewise, expenditures are assumed to continue at roughly the same pace. New legislation, new politicians, changing public will, meaningful innovations and economic events, etc., don’t happen in the CBO’s world. In this case, for 10 years. Absent cryogenically freezing the entire country for the next decade, that’s not very likely.

Say you ignore that fact, pretend the CBO’s projections are spot on and overall debt rises to 61% of GDP. (This is, interestingly, less than an earlier forecast tied to another set of assumptions that have since changed.) As we’ve written before, folks wrongly assume there’s an absolute debt level that’s problematic, instead of focusing on whether the debt is affordable. (In the US, it is.) So while the CBO report is a fun exercise in the “what if,” that’s really the extent of its usefulness.

Our view on debt fears remains the same: They aren’t going away. And Europe has some structural issues to sort out. But evidence continues to point to ongoing global growth and fundamental positives outweighing well-known negatives.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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