The Federal Budget & Federal Deficit. Also: A New Restaurant in SRQ

Here’s the link to the latest Congressional Budget Office (CBO) projection: “The Budget and Economic Outlook: 2024 to 2034,” https://www.cbo.gov/publication/59946. Hat tip to Byron Callan (Capital Alpha Partners) for instructive analysis of the defense components.

 

 

Readers, IMHO the current worst-case versus best-case difference for the entire defense funding in this present year is a gap of about $100 billion. We continue to be overweighted the aerospace defense sector in the US Equity ETF portfolio. And we continue to believe that in the end, the defense needs of the United States will be fully funded. Putin (Russia), Kim (North Korea), Assad (Syria), Khamenei (Iran), Iran’s proxies like the Houthis (Yemen), and others are dangerous to America and to the alliance of democracies, including NATO member countries. America will either fund this budget proactively or will be doing so at much higher cost after some event galvanizes public opinion. It took a Pearl Harbor or a 9/11 to jolt US politicians. At the current speed of war, the luxury of delay can be very costly if the House of Representatives’ few obstructionists continue to compromise the safety and development of American defense. Every indication suggests that a release of this full defense funding budget to the full House without any obstacle from Speaker Johnson would obtain an overwhelming bipartisan “yes.”  
   
Let’s get to the budget outlook.  
   
The CBO report’s executive summary says:   
  

The Budget Outlook  
   
Deficits  
In CBO’s projections, the federal budget deficit grows from $1.6 trillion in fiscal year 2024 to $2.6 trillion in 2034. Deficits also expand in relation to the size of the economy, from 5.6 percent of gross domestic product (GDP) in 2024, when the collection of certain postponed tax payments temporarily boosts revenues, to 6.1 percent of GDP in 2025. In 2026 and 2027, revenues increase faster than outlays, causing the deficit to shrink to 5.2 percent of GDP by 2027. Thereafter, outlays rise faster than revenues. By 2034, the deficit returns to 6.1 percent of GDP—significantly larger than the 3.7 percent that deficits have averaged over the past 50 years.”  
   
Debt  
Debt held by the public rises each year in relation to the size of the economy, reaching 116 percent of GDP in 2034—an amount greater than at any point in the nation’s history. From 2024 to 2034, increases in mandatory spending and interest costs outpace declines in discretionary spending and growth in revenues and the economy, driving up debt. That trend persists, pushing federal debt to 172 percent of GDP in 2054.

I strongly advise readers to take ten minutes and look at the full document to understand this issue. The graphics are very easy to follow and will save you a lot of time. In sum, you will see that there is very little discretionary spending. Forget what the politicians are saying. They are trying to mislead you. The numbers speak for themselves.   
   
To correct this rising fiscal deficit trend will take tough policy decisions. And in the current environment of culture war “hater” politics, they do not appear to be likely to be made. So, I expect US deficits to grow, as CBO projects.   
   
Note that the fiscal deficits grew large under both Trump and Biden. If Trump is president again, my expectation is that the deficits will be ignored by him; that is what he did in his previous term. Trump makes noises about cutting taxes but doesn’t say where or how. He makes noises about raising tariffs (which really means sales taxes on Americans – tariffs are paid for by Americans, not by Chinese or other foreign companies). And he makes noises about spending that are obfuscating.  
   
If Biden is reelected, I expect large deficits to continue. There is some restraint, but it is minimalist. Biden hasn’t reduced or eliminated Trump’s tariffs.  
   
The only discipline on spending is coming from the internal culture wars in the two chambers of Congress. There is some mature behavior in the Senate. Some, but not a lot. And there is a frozen, dysfunctional House with the majority functioning as the party of “no” and the minority waiting and watching as the majority destroys itself because it is held captive by a very few members who are partisan alt-right extremists. Note that the obverse situation could occur if the Democrats obtain a very slim majority in the House. The narrower the majority the more power is in the hands of the extremes, whether from the left or from the right.  
   
Also, please note that the most up-to-date projection midpoint estimate has the Social Security Trust Fund at zero in 2033. No one wants to talk about that. No presidential candidate, no Senator, no House Member. Without any change, Social Security benefits would drop by 25%. We don’t expect that to happen. There will be some last-minute fix. But there is no leadership on the issue appearing from our government, either from the Republicans or the Democrats. IMHO, both political parties are failing us. Hat tip to Ed Lane for calling this to my attention. See Levy Economics Institute, Bard College, Working Paper 1042, February 2024 (https://www.levyinstitute.org/publications/saving-social-security). Edward Lane is a former pension actuary and university professor of finance and economics.  
   
Will the current fiscal deficit turn into a crisis? Maybe so, in the future. Right now, in my opinion, the answer is no. Financial markets indicate that the US may still be either the best place or the “least bad” place to invest; but either way, it is at the top of the list of creditworthiness, and America still operates under the rule of law. Of course, I worry about that one, with all the political madness in this election year. Anyway, we assume that the rule of law will prevail.   
   
The alternative to losing America’s rule of law is something I don’t want to contemplate.   
   
If you get into the CBO document, you will notice that the primary deficit is flat. This is important. Here’s a definition from Financial Express:  
  

Primary Deficit indicates the borrowing requirements of the government, excluding interest. It is the amount by which the total expenditure of a government exceeds the total income. Note that primary deficit does not include the interest payments made. Also, primary deficit shows the borrowing requirements needed for meeting the expenditure of the government.   
(https://www.financialexpress.com/what-is/primary-deficit-meaning/1623441/)

A flat primary deficit at 2% of GDP is curable (meaning it could be brought into balance) – if there is the political will to do it. Why? Because the rising fiscal deficit is due only to interest payments. Will Congress have the courage and leadership to fix the budget? As Hamlet intoned, "To be or not to be, that is the question." What does it take to give the Congress an existential wake-up call?  
   
For the immediate future, we do not see the fiscal issues impacting the financial markets dramatically. The credit default swap (CDS) issue we often write about is now adding about $55–60 billion to the annual federal budget interest cost. That is due to the House Chaos Caucus antics. They could fully pass budgets, stop the CR nonsense, and take this issue off the recurring political agenda. This would immediately reduce this cost, in my opinion. Otherwise, the $55–60T annual cost will gradually rise if the political antics continue. We can now project future CDS rates, since we have enough data points to construct a CDS yield curve.  
   
Now let’s segue to a note on how Florida greeted the arrival of the CBO report. Here’s a link to a report of an actual earthquake that occurred off the Florida coast: https://earthquaketrack.com/p/united-states/florida/recent. This is a rare event!   
   
And finally, an advisory about a new little gem of a restaurant in downtown Sarasota. About a city block from Cumberland’s office, Casami is found at 1272 N. Palm Ave. See www.casamibistro.com. Chef Luigi and his wife Shatara are friendly, gracious hosts. This is their restaurant, and they are new entrepreneurs and a beautiful team to watch. The “amuse bouche” changes daily and was a surprise. A bread assortment is elegantly served with a truffled oil and balsamico. My dinner began with a Caesar salad starter. Luigi makes the petite square croutons from polenta and sears them so that each square is a savory addition to the traditional Caesar salad. The veal chop I enjoyed is first marinated and then cooked (fired) so that it presents as an exquisite seared outside with enticing browning, and inside the succulence of the juices from the marinade exude in the mouth with each bite. It ranked among the best chops I have ever tasted. I had his homemade Italian-style cheesecake for dessert. Yummy!  
   
Chef Luigi and Shatara have been open about a month. Tell them David sent you. Depending on when you try Casami, I may see you there, since my intention is to return and sample other dishes. Note that the wine list selections are very workable. A fruit-forward primitivo accompanied this meal easily and with distinct enhancement. Buon appetito! 

David R. Kotok 
CoFounder and Chief Investment Officer 
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