With the recent downgrade on U.S. government debt by Moody’s and a tax bill making its way through Congress that’s projected to widen the federal deficit by a quarter trillion dollars per year over the next decade, how worried should we be about the federal government budget deficit? Peter and Jonathan discuss the deficit, its possible consequences and how we can potentially balance the budget. Plus, learn about the Jonathan Clements Getting Going on Savings Initiative.
Hosted by Creative Planning’s Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Transcript:
Jonathan Clements: This is Jonathan Clements, Director of Financial Education for Creative Planning. With me is Peter Mallouk, President of the firm, and we are Down the Middle. It seems every month investors are hit with a new worry: tariffs, recession, the currency markets, you name it. Lately for many folks, the big concern has been the federal government’s budget deficit. Roughly speaking, the federal government these days is spending $7 trillion a year and pulling in just $5 trillion in revenue. Peter, how worried should we be about the federal budget deficit?
Peter Mallouk: I think this is one of those things that actually is concerning. This is not one of those things we can say, “Oh, don’t worry about it. Let’s set it aside and not think about it.” You know, I was talking to a client yesterday sitting in their living room in the upper Midwest, and this was a big concern of theirs. And they said, “Well, is this something that you’re not too worried about?” I said, “Actually, no. I think this is a real threat to the United States.” And I think if you were to say, “Well, what is the single biggest existential risk of the United States?” It is the national debt, which grows with a deficit. One thing about economics I think that can be helpful is to think about things as a household. I know there’s a study out there that talks about when a problem is so overwhelming, so dramatic, people can’t get their brains around it.
This is one of those things that’s just completely incomprehensible to people. And also there’s so much information coming at us, we can only focus on what’s going on in our backyard. Like what’s going on in the school? Are my property taxes up? A couple national issues is about all we can handle. So a lot of people don’t understand this for very good reason. We’re busy with other things, and there seems to be no direct consequence. But if we think about that household, if we think about a family that’s got a $200,000 income but living on a credit card and spending $500,000 a year, there’s no problem until there is a problem, right? It goes on and on and on, and then all of a sudden the credit card company goes, “We’re not going to issue you credit anymore.” And now we’ve got an existential crisis and the house of cards crumbles.
That’s basically the scenario here. You have debt increasing and increasing and increasing, and the United States has never really been punished for it. In a world where there were alternatives to the U.S., lenders would say, whether it’s an individual investor like those listening to this podcast or a university like an Ivy League school or a sovereign wealth fund or country like China or Singapore’s wealth fund, they would say, “Well, the United States has a lot of debt. I’m worried about them paying me back. It’s so much debt. Can they even keep up with this debt? Maybe I’ll go lend money to somebody else.” But the reason the U.S. has gotten away with this is there is no somebody else right now.
Who are you going to loan the money to? Are you going to loan it to a country in South America or Africa? Okay, now we can take those two off the table. A lot of credit issues there. What about China, a superpower? Well, demographic issues, the population’s dramatically declining. There’s not a lot of trust in Chinese accounting systems. There’s not a lot of trust, and you need trust to invest. Are you going to go with the EU? There’s a very substantial group of people that think the EU is not going to exist in 25 years, right? That the UK leaving was just the beginning. So what is the alternative? And that is why the U.S. has gotten away with this for so long.
But there have been a couple of things that have happened that have really combined to make other countries and investors say, “We are close to having enough.” So one of those is during the beginning of the Russia-Ukraine War, President Biden did something pretty unprecedented. We have a system called the SWIFT System, where basically the money throughout the world goes through this system and it’s controlled by the United States. And President Biden’s administration elected to use that as a weapon and basically say, “Hey, we’re going to kick Russia out of this system.” So economic warfare. That might be great, debate whether that’s great for having another thing to fight with Russia about. But the message it sent to the world was you can not count on the U.S. to not use this as a weapon.
So other countries started to move away from using that system, from relying on the dollar, from loaning money to the U.S. government. And you started to see anybody that has a problem with the United States, like China, or may someday have a problem with the United States go, “You know what, we’ve got to spread our eggs around.” That was problem number one on top of the deficit. Problem number two was the Trump administration started all the tariff wars. Now also, like with the Biden comments, we can debate whether or not tariffs were fair and things shouldn’t be negotiated. I mean, it’s pretty clear things weren’t perfectly fair, right? They could have been renegotiated.
But what the Trump administration did was they basically sent the message, “Hey, we are going to be an erratic partner when it comes to this economic policy. We might just at any given moment decide that the tariffs going to be 115%. A week later, it might be 50%. A week later it might be 90%.” And it sends a message to China and the EU and Canada, “Don’t rely on the United States. Go do deals with other countries.” So we had this growing deficit. Then you had the Biden administration policy and the Trump administration policies, both economic warfare. These combined have basically told the whole world, “Go do something else.” And we’re starting to see the rest of the world use other currencies and not be so eager to loan the U.S. money.
And so, Jonathan, I’m reaching a conclusion on this question. What this means is when people want to loan money, if you’re loaning money to say a company that’s really, really, really strong, like Nike, they’re going to pay you a small percentage. You’re going to be happy to get whatever it is, let’s call it 4% from Nike or McDonald’s or Facebook. A company that’s not doing great has to pay you more than 4% to entice you, right? That might pay you six or seven or eight. This is what the U.S. is having to do now. It’s saying, “Okay, you’re not as interested in loaning to us at four. Well, we’ll pay you five,” just using general numbers. So the cost of the debt is now higher, right? And so every time bonds come due and the U.S. has to go borrow more, we’re borrowing at higher rates, which is accelerating this problem that’s resulted in Moody’s downgrading the U.S. And this is a real problem.
Jonathan: So we had Moody’s recently downgrade U.S. Treasury securities. On top of that, we’ve got this budget bill moving through Congress that will cause a quarter trillion dollar budget deficit for each of the next 10 years, roughly speaking. And this has indeed pushed Treasury yields higher. Meanwhile, we’ve got $36 trillion in debt. So those increases in Treasury yields mean we have to pay more to service that debt. Isn’t there a risk that all this is going to cause this whole situation to become even more perilous, because the interest that we’re paying is added on top of all the other spending that the federal government does and that we may be at a tipping point here?
Peter: Yes. There’s only two outcomes here. At some point, the United States solves this problem, or the free market will eventually provide an alternative where we either have to pay so much in interest that we have economic collapse or some other country becomes stronger and the world starts to favor them as the reserve currency and lend money to them and so on. There is a path out of this, and the path out of this is a budget that doesn’t come with a huge deficit, and Republicans and Democrats can fight about this endlessly, but both have failed the American people miserably. The only difference between Republican and Democrat presidents for the last few decades is what they spend the money on, but they’re both overspending. So you go back to the household that’s making 200,000 a year. Tt’s spending 500,000 a year. When one spouse has the credit card, they’re overspending on private chefs. When the other spouse has the credit card, they’re overspending on nannies and landscapers. Who cares? They’re overspending, and that’s the real problem. The path out of this is to have a budget that actually balances, where the money that’s coming in equals the money that going out.
By the way, all 50 states have to do this by law. So let’s just have the federal government actually doing it. I think the second part that’s not talked about a lot in the media, and I think it’s more confusing, is this economic warfare element that is really fuel to the fire. We have to stop the economic warfare. And this is another thing that both Republicans and Democrats have brought to the table in the last decade that really had never been done before.
Jonathan: So when we talk about trying to balance the budget, of course one of the problems is that so much of federal spending is essentially locked in. If you add up defense spending, government interest costs and spending on things like Social Security, Medicare and Medicaid, we get to 85% of federal government spending. There’s really relatively limited room to cut on the spending side of things. So is the only alternative to raise taxes? Is there another way out of this conundrum?
Peter: I think there is another way out. And I think if you go back to the household, this household that’s built all this debt over spending doesn’t actually have to pay down their debt to get out of the problem. What they have to do is get their spending to match their income. So if this household’s spending 500 on 200 of income, instead spend 200 on 200 income, and 20 years later the house has probably doubled or tripled in value and the debt is now manageable relative to the house. Now to your point, how are we going to get to this balanced budget if so much of it is interest and other things?
Believe it or not, this is a pretty manageable deal, and you can get there by simply eliminating built-in growth on a lot of different things. So a lot of programs from military to social spending and so on have built-in budget increases. You could have freezes, very modest cuts that are telegraphed well in advance so organizations can get their brains around it. And what will happen then is the world will see, “Hey, the U.S. has their fiscal house in order,” and we will be able to pay lower interest on future debt. As our debt comes due, we refi in the lower debt and we have a big pile of, you know, almost 40 trillion of debt, but the economy will grow faster and the balance will get back to normal.
Obviously, there’s, you know, a million ways to get from here to there, and it’s not totally painless. What we do know now is you cannot tax your way out of this. It’s absolutely impossible. I don’t care if we raise taxes a little bit or decrease taxes a little bit. It’s irrelevant. It’s not going to solve the problem. This is 100% a spending problem, and that’s how it’s going to have to get fixed.
Jonathan: Yes, it’s spending problem, but it’s also really a demographic problem. And what we’re seeing with the federal budget deficit is a reflection of the aging of America. We have fewer and fewer workers and more and more people dependent upon their labor heading into their retirement years. And I would contend that if we really want to sort out the federal budget deficit, what we need to do is encourage people to stay in the workforce for longer, not with a stick by cutting back Social Security but with incentives, creating incentives for people to stay in the workforce for longer by perhaps taxing them later or creating incentives for employers to keep them on. If we can get people to stay in the workforce for longer, we’ll have more tax revenue, we’ll have less spending, and potentially that will help to close the budget deficit.
Peter: I also think another solution is immigration. And let’s just take politics out of it, say legal immigration, right? We have a line of millions and millions and millions of people that want to come to the United States legally that are highly skilled. We have a shortage of nurses. There’s a bunch of nurses that want to come to the United States. If we could open up legal immigration, we can also rebuild the tax base. This is a big advantage the United States has over a China or Japan. Both of those countries have demographic issues much worse than the United States, but you’re not going to have a big line of people wanting to immigrate into China, into a police state, and in Japan, which is a very ethnocentric country.
But there is a big, big, big line of people that want to come into the United States. You can also solve a lot of issues that way. That’s what’s tragic about this crisis — it is completely self-inflicted. This isn’t like COVID. This isn’t like 9/11 or ’08-’09. This is something that is being intentionally done over and over and over again because the consequences of the person with the credit card are not felt by that person. It’s going to be felt by somebody coming in later.
Jonathan: All right, Peter, on this issue, I just have to bring up one more question, which is this: A lot of people are worried about Social Security. I mean, I hear this all the time, that Social Security cuts are inevitable, you know, the Social Security trust fund is going to dry up, blah, blah, blah, blah, blah. Do you think the people who depend on Social Security should be worried? Or do you think that this is a non-issue?
Peter: I think they should absolutely not be worried. I think it’s a non-issue. I think that this is in the long list of things to get cut would be the last thing. I think if they approach Social Security, it would be something like this. “Hey, we only charge payroll taxes up to a certain amount of money. We’re going to charge them on even more. And hey, if you’re under 35 years old, we’re now going to push the Social Security age out to age 72. And hey, if you make over a million dollars a year and you’re less than 50, we’re not going to pay out Social Security ever to you.” It’s going to be a solution like that. There is zero chance that they’re going to offend the largest voting block in the history of the United States and guarantee getting swept out of either party ever eliminating Social Security. So you’re getting a check or you’re over 50 at least, I would not spend one second thinking about this.
Jonathan: So Peter, normally at this point in the podcast, we have our tip of the month, but I’m going to steal your time for the tip of the month and combine it with mine and talk about something that’s very close to my heart. This is my self-serving tip of the month. When I first got my cancer diagnosis, it was suggested that they launch a journalism award in my memory, and I was like, “The world does not need another journalism award.” And I made a suggestion that there be a financial literacy effort where we try to get young adults from less affluent families to open Roth IRAs and perhaps seed it with $1,000. Well, this idea I had has come to fruition. The Jonathan Clements Getting Going on Savings Initiative has been launched. They’re now raising money for this, and the idea will be tested in Boston this summer.
Kids, young adults in Boston who have summer jobs will have the opportunity to open up Roth IRAs and in some cases be given $1,000 to seed that account. This is a program that has been overseen by three academics. They’re going to study whether the kids really stick to it. They’re going to help these kids learn about investing and see the advantages of funding a Roth IRA. And to fund all of this, they’re accepting donations. And if you’re interested in donating, go to boglecenter.net, that’s boglecenter.net. You can make a tax-deductible donation to the Clements Initiative. It’s right there on the homepage, and it’s really a good cause.
In order to support the program, not only is there taking donations directly, but also there’s a book of my old Wall Street Journal columns that’s available called “The Best of Jonathan Clements.” All the proceeds from that are going to support this initiative. So if you’re feeling generous, if you’d like to get a young person launched on a lifetime of investing, I’d really encourage you to support this initiative, to buy the book. There’s no money in it for me. There’s no money in it for anybody else. It’s purely for the good of these kids. So that’s my tip of the month, and it’s your tip of the month as well, Peter.
Peter: Well, I’m doubling down on it. And, by the way, if you have not read the coverage about Jonathan in the New York Times and the Wall Street Journal, those are great articles to check out. But I applaud what you’re doing here, Jonathan, and doubling down on your tip of the month.
Jonathan: So that’s it for this month. This is Jonathan Clements, Director of Financial Education for Creative Planning. I’ve been talking to Peter Mallouk, the President of the firm, and we are Down the Middle.
Disclosure: This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.
