The Next Signal to Watch

3 Mar 2017

by Jim Rickards, DailyReckoning:

Trump advisors believe they can avoid a debt crisis through higher than average growth. This is mathematically possible but extremely unlikely.

A debt-to-GDP ratio is the product of two parts — a numerator consisting of nominal debt and a denominator consisting of nominal GDP. In this issue, we have focused on the numerator in the form of massively expanding government debt. Yet, mathematically it is true that if the denominator grows faster than the numerator, the debt ratio will decline.

The Trump team hopes for nominal deficits of about 3% of gross domestic product (GDP) and nominal GDP growth of about 6% consisting of 4% real growth and 2% inflation. If that happens, the debt-to-GDP ratio will decline and a crisis might be averted.

This outcome is extremely unlikely. As shown in the chart below, deficits are already over 3% of GDP and are projected by CBO to go higher. We are past the demographic sweet spot that Obama used to his budget advantage in 2012–2016 (As I noted HERE – Obama Has Tied Trump’s Hands).

Total Deficits and Surplus

The Congressional Budget Office, CBO, estimates that inflation and real GDP will each grow at about 2% per year in the coming ten years. This means that nominal GDP, which is the sum of real GDP plus inflation, will grow at about 4% per year. Since debt is incurred and paid in nominal terms, nominal GDP growth is the critical measure of the sustainability of U.S. debt.

The Fiscal Budget

The Congressional Budget Office, CBO, estimates that inflation and real GDP will each grow at about 2% per year in the coming ten years. This means that nominal GDP, which is the sum of real GDP plus inflation, will grow at about 4% per year. Since debt is incurred and paid in nominal terms, nominal GDP growth is the critical measure of the sustainability of U.S. debt.

From now on, retiring Baby Boomers will make demands on social security, Medicare, Medicaid, Disability payments, Veterans benefits and other programs that will drive deficits higher.

The CBO projections show that deficits will increase to 5% of GDP in the years ahead, substantially higher than the hoped for 3% in the Trump team formula.

As for growth, we are now in the eighth year of an expansion — quite long by historical standards. This does not mean a recession occurs tomorrow, but no one should be surprised if it does.

Official CBO projections, shown in the chart below, expect approximately 2% growth and 2% inflation for the next ten years. That would yield 4% nominal growth, not enough to match the deficit projections. The debt-to-GDP ratio is projected to soar even under these rosy scenarios.

Growth of Real GDP

Inflation

The Congressional Budget Office, CBO, estimates that inflation and real GDP will each grow at about 2% per year in the coming ten years. This means that nominal GDP, which is the sum of real GDP plus inflation, will grow at about 4% per year. Since debt is incurred and paid in nominal terms, nominal GDP growth is the critical measure of the sustainability of U.S. debt.

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