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U.S. Debts and Deficits. 20 th April 2010 Morgan Goble, James Hurrell, Karina Melamed, Andre Watson & Tian Wang. Total U.S. federal outlays hit a twenty-year high in 2009, while receipts hit a twenty-year low.

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U s debts and deficits

U.S. Debts and Deficits

20thApril 2010

Morgan Goble, James Hurrell, Karina Melamed,

Andre Watson & Tian Wang


Total U.S. federal outlays hit a twenty-year high in 2009, while receipts hit a twenty-year low.

  • The Budget of the United States Government is a proposal made by the U.S. President where he recommends funding levels for the next year.

  • Major receipt categories include individual income taxes, Social Security/Social Insurance taxes and corporate taxes.

    • Since 1990, receipts have grown 93.4%

    • On average, receipts have been 18.1% of GDP; in 2009 they were at a low of 14.8%

  • Major outlay categories include defense/homeland security, social security and Medicare/Medicaid.

    • Since 1990, outlays have grown 180.7%

    • On average, outlays have been 20.3% of GDP; in 2009 they were at a high of 24.7%

    • Given the unparallel growth in receipts and outlays, combined with an original deficit in 1990 of $221,036 million (or 3.9% of GDP), the U.S. deficit has undoubtedly grown. At the end of 2009, the deficit stood at 9.9% of GDP or $1,412,686 million.

Source: Office of Management and Budget (www.whitehouse.gov/omb)


The 2009 deficit was 9.9% of GDP. While receipts were slightly lower than usual, the main contribution to the deficit was an increase in government spending.

  • Decline in receipts: can be attributed to a difficult economy.

    • Individual income taxes have averaged 8.2% of GDP since 1990. In 2009, individual income taxes were at an all time low since 1990, at 6.4% of GDP.

    • Similar to individual income taxes, corporate taxes were at an all time low in 2009 at 1.0% of GDP, compared to an average of 1.9% since 1990.

    • Social insurance and retirement contributions have remained flat in comparison to the other major contributors at an average of 6.5% of GDP.

    • Increase in outlays: expenditures have increased in every major outlay category.

    • National defense expenditures have averaged 3.9% of GDP since 1990. In 2009, defense outlays were 4.6% of GDP, the highest since 1992.

    • Social security expenses were at a twenty year high in 2009 at4.8% of GDP, compared to an average of 4.4% since 1990.

    • Medicaid/Medicare outlays have grown steadily since 1990, peaking in 2009 at 3.4%.

Source: Office of Management and Budget (www.whitehouse.gov/omb)


The Congressional Budget Office (CBO) forecasts that the current record high deficit of over 9% of GDP is to fall to around 3% of GDP by 2020.

  • Total Revenues and Outlays (Percentage of gross domestic product) Source: Congressional Budget Office.

  • 2009 Budget Deficit at $1.4 trillion (9.9% of GDP) was largest since World War II.

  • 2010 Budget Deficit is expected to be second largest at $1.3 trillion (9.2% of GDP), assuming current laws and policies remain unchanged.

  • Current Summary:The US faces a large deficit as a result of (1) historical imbalance of outlays and revenues, and (2) low revenues and high spending due to recession of 2008 and federal spending policies implemented to aid recovery. The 2009 focus was on financial aid, while the 2010 focus is on income support.

  • 2011-2020 (see chart) Deficits average $600 million over period, dropping from 6.5% of GDP in 2011 to 4.1% in 2012. 2013-2020 deficits are forecasted to be 2.6% to 3.2% of GDP. Outlays are forecasted to gradually increase to reflect increase in healthcare spending per person due to the retirement of baby-boomers.

  • Assumptions built into baseline forecast;

  • Slow GDP and Revenue growth reflects assumption that recovery from recessions that are triggered by asset price decline tend to be protracted (2-5 years).

  • Reduced taxable income, public spending, and limits on ability to borrow all limit reduction of deficit.

  • 10 yr income tax cuts introduced in 2001, 2003, and 2009 will not be extended beyond current expiration date of 2012.

  • Alternative minimum tax (AMT)will not be extended to affect many more taxpayers.

  • Outlays rise only with inflation not with GDP.

*Based on CBO baseline predictions released March 5th 2010


The Congressional Budget Office (CBO) forecasts that U.S government debt is to increase from 53% of GDP in 2009 to 67% in 2020.

  • Debt Held by the Public and Net Interest (Percentage of gross domestic product) Source: Congressional Budget Office.

CONSISTENT DEFICIT -> GROWTH OF GOVERNMENT DEBT

ECONOMICAL RECOVERY -> INCREASED INT RATES AND INT PAYMENTS

  • 2009: Government debt was 53% of GDP with relatively low interest payments (1.4% of GDP) due to the current economic climate.

  • 2010->2020 DEBT: Accumulated government budget deficits (see previous slide) drive the imperative for increased government borrowing year-on-year as shown in chart above. Debt is therefore forecast to climb from $7.5 trillion in 2009 to $15 trillion in 2020 which represents an increase from 53% of GDP to 67% of GDP.

  • 2010->2020 NET INTEREST: Increased debt coupled with anticipated increase in interest rates to mirror the economic recovery will result in very high net interest payments. In nominal terms, the government’s interest payments are forecasted to triple between 2010 and 2020- this represents an increase from 1.4% of GDP to 3.2% of GDP (see above).

  • Real GDP growth rate will average 4.4% 2012 to 2014 which closes the gap between potential output and actual output (current output vs. potential output if the entire labour force was employed) completely. Source: Congressional Budget Office.


Inputs in cbo s forecast as stated in the analysis of the president s 2011 budget cbo
Inputs in CBO’s government debt is to increase from 53% of GDP in 2009 to 67% in 2020. Forecast(as stated in the Analysis of the President’s 2011 Budget, CBO)

2011 to 2015:

  • CBO’s estimates incorporate both supply-side effects (influences on the economy’s potential output such as the amount of production that corresponds to a high level of resource use) and demand-side effects (temporary movements of actual output relative to potential output). *

    2016 to 2020:

  • CBO’s estimates incorporate only supply-side effects, because the magnitude of demand-side effects depends on the state of the economy, which is especially difficult to predict over longer horizons. *

  • The Federal Reserve might offset the demand-side effects of policies that are foreseen well in advance in order to maintain economic stability. *

    The Detailed Inputs:

  • In both periods, the budget will be influenced through changes in taxable income, changes in outlays (for unemployment insurance, for example), and changes in the interest rate on government debt, among others. *

  • Without accounting for those economic effects, CBO estimates that the President’s proposals would add a total of $1.4 trillion to deficits over the 2011–2015 period and $2.3 trillion over the 2016–2020 period. *

    Outside Factors Affecting the CBO Forecast

    1. Effect of President’s recent budget proposal

  • Compared with CBO’s current-law baseline projections, deficits under the budget proposals would be approximately 2% of GDP higher in fiscal years 2011 and 2012, 1.3% higher in 2013, and continuing to be above baseline until 2020.

  • Measured relative to the size of the economy, the deficit under the President’s proposals would fall to about 4 percent of GDP (which is above baseline) by 2014 but would rise steadily thereafter.

  • By 2020, the deficit would reach 5.6 percent of GDP, compared with 3.0 percent under CBO’s baseline projections (see baseline deficit forecast in slide above).

    * Source: Congressional Budget Office: Analysis of the President’s 2011 Budget.


Inputs in cbo s forecast continued
Inputs in CBO’s Forecast government debt is to increase from 53% of GDP in 2009 to 67% in 2020. (continued)

Outside Factors Affecting the CBO Forecast (continued)

2. Effects of health care

  • This is the greatest influencing factor to the stability of the government budget over the next 10 years.

  • Currently outlays for Medicare and Medicaid total approx 5.5% of GDP.

  • With current law unchanged, this is expected to be 6.6% of GDP by 2020 and potentially 10% by 2035.

  • The reason for this is the increase in the number of recipients of Medicaid and Medicare due to the aging population, coupled with the increase in spending per person that grows faster than the per capita GDP.

  • CBO recommends that the spending on health care be revised in order to construct a more sustainable health care fiscal policy.

    Demand Side

  • Government policies such as tax cuts or spending increases can increase demand and thereby hasten a return to the potential level of output. Thus, budgetary policies that raise private and public consumption would boost output toward its potential level. *

  • Nevertheless, demand-side effects are generally considered to be only temporary: They raise or lower output beyond what it would be otherwise for a certain period of time to stabilize the economy. *

  • Policies that aim to increase demand above its potential—by increasing government purchases or by spurring consumer spending—are likely to decrease national income in the long run because such policies tend to increase government borrowing and eventually reduce the nation’s saving and capital stock. *

  • Therefore, policies that increase demand often involve a trade-off between boosting economic output in the short run and reducing output in the long run.*

    * Source: Congressional Budget Office: Analysis of the President’s 2011 Budget.

The Effect of Changes in Economic Circumstances and Government Policy on the Deficit

  • (as stated in the Analysis of the President’s 2011 Budget, CBO)


The Effect of Changes in Economic Circumstances and Government Policy on the Deficit (continued)(as stated in the Analysis of the President’s 2011 Budget, CBO)

Supply Side

  • The government’s budgetary policies also can influence the economy by affecting its supply side, by changing the potential level of output. *

  • Changes in tax rates affect people’s willingness to work and to save, possibly influencing short-run demand but also affecting sustainable, long-term supplies of labor and capital. *

  • Changes in government spending for goods and services or in government transfers (such as unemployment insurance or Social Security payments) can affect short-run demand but also can increase or reduce people’s willingness to work and to save, which affects the long-term size of the labor force and the capital stock. *

  • The economic effects of government policies that change revenues and spending depend on how those changes are financed. In the short run, reductions in revenues or increases in spending create larger budget deficits. Over the long term, however, in order to prevent unchecked growth in government debt relative to output, other policy changes are needed to offset lost revenues or increased spending. *

  • The nature and magnitude of anticipated future changes in policy can significantly influence the long-term economic effects of the initial change in spending or revenues. *

    * Source: Congressional Budget Office: Analysis of the President’s 2011 Budget.


With decreased receipts, increased outlays, and increased interest rates, we can expect deficits to accumulate and grow over the next 10 years.

Congressional Budget Office Director Douglas Elmendorf describes three possible 10-yr interest rate

scenarios, as they relate to the current US deficits in the Analysis of the President’s Budgetary Proposals for

Fiscal Year 2010 (published in May 2009).

  • Scenario 1: 10-yr Treasury notes would average 3.75 in 2009 and increase thereafter to the average rate from 1991-2000 (6.6%)

  • Scenario 2: 10-yr Treasury notes would average 3.75 in 2009 and increase thereafter to the average rate from 1981-1990 (10.5%)

  • Scenario 3: 10-yr Treasury notes would be consistent with the average of the projections of the top 10 Blue Chip economic forecast (leveling out near 6.4%)

Fortunately, the US Dollar continues to be a currency that many countries are willing to keep on reserve, leading to the strong likelihood that the US will be able to continue to borrow against itsstrength. However, there are no guarantees that given the current fiscal situation, this will always be true. This concern has been voiced by President Obama in his recent calls to curb government spending and by opponents that believe the only way to reduce the deficit is to increase taxes.


Comparison between the advantages and disadvantages of investing in us treasuries

PROS interest rates, we can expect deficits to accumulate and grow over the next 10 years.

Low Default Risk: The US Treasury Bond is historically risk-free. Default risk is still considered extremely low.

Currency Strength: The US Dollar continues to be a currency that many countries are willing to keep on reserve.

USD/RMB Exchange Rate: We forecast the RMB appreciation against the US Dollar to taper off in the near future.

US Economy Recovery: The US economic recovery will lead to increased tax income (and therefore income tax revenue) for the US government, and possibly a shrinking budget deficit. This means a decrease in the future supply for US Treasury Bonds, which will add upward pressure to the price of the bonds.

Avery stable and secure investment.

CONS

Inflation Concerns: High budget deficit and government borrowing, caused by the current expansionary Monetary Policy from the FED, could lead to inflation, thus adding upward pressure to long-term interest rates.

Interest Rate Expectation: The shot-term interest rate has been flat but started to go up in the past months. The near term outlook for short-term and long-term interest rates is overwhelmingly positiveand indicatesa parallel shift in US Treasury Yield Curve in the near future.

The price of US Treasury Bonds purchased today could worth less in the future.

Comparison between the advantages and disadvantages of investing in US Treasuries.


Our recommendation based on cic s short term and long term investment objective buy
Our recommendation based on CIC’s short-term and long-term investment objective : Buy

Common Objective for Sovereign Wealth Funds*

  • Protect and stabilize the budget and economy through diversification

  • Earn greater returns than on foreign exchange reserves, and increase savings for future generations

  • Assist monetary authorities in dissipating unwanted liquidity

  • Sustainable long term capital growth

  • Fund social and economical development, and political strategies

    Common Investment Strategies

  • Overall: Diversification and hedging

  • Short Term: Duration match with liquidity needs

  • Long Term: Buy and Hold

Short-Term

  • No immediate currency depreciation and default risk but be very mindful of interest rate risk

  • Speculative play not recommended due to high possibility of price decrease

Long-Term

  • Purchase at regular interval to smooth out the effect of price fluctuation

  • Best time to begin the investment program is Year 2011, when interest rate, inflation and US economy further stabilizes

RECOMMENDATION - BUY

*Source: SWF Institute (http://www.swfinstitute.org/swf.php)


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