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Paying America’s bills — What investors should know

Wells Fargo Investment Institute - October 2020

Detail of U.S. Treasury building

The U.S. budget deficit has increased meaningfully, and many of the current trends are unsustainable over the long run. Fortunately, we think there is still time to make corrections, but the necessary changes are likely to be more drastic the longer the U.S. waits to act.

Why doesn’t the federal budget balance?

Lawmakers have little wiggle room to reduce expenditures. The fact is only about one-quarter of government expenditures is discretionary — meaning they can be easily reduced. The bulk of government spending is actually considered “mandatory,” (Social Security, Medicare, etc.), which is somewhat of a misnomer. These “entitlement” expenditures can, in fact, be reduced, but doing so would be extremely difficult (and probably unpopular).

When the federal government does budgeting, the result often is a negative number, or a deficit.

With a greater proportion of spending going toward mandatory expenses, policymakers could face challenges down the road. The government spent 4.5% of gross domestic product (GDP) on mandatory expenses in 1966; in 2020, that figure skyrocketed to 22.4% due to pandemic spending. In 2021, the Congressional Budget Office (CBO) projects that mandatory spending will represent 15.2% of GDP.

Deficits — not necessarily a bad thing

Deficits are an important part of managing through economic cycles. In theory, deficits grow during recessions as the government increases spending to help stimulate economic activity while tax receipts decline. During better times, the opposite should occur. However, the government has run deficits on a fairly consistent basis — in both good times and bad — going back to 1929.

At more than $26 trillion, the federal debt’s size is indeed staggering, but remember that total debt numbers often include debt the government owes itself. The U.S. government holds its own debt in various trust funds, such as the Social Security and highway trust funds. We have also included Treasury debt held by the Federal Reserve in government-owned numbers. According to the U.S. Department of the Treasury, the U.S. government owns 39% of its debt, while 32% is held by U.S. investors and 29% is held by foreign countries.

A country’s public debt-to-GDP ratio is one measure of its government’s ability to pay its debt. Treasury debt owned by the Federal Reserve is considered public debt. If a country’s debt was equal to its annual GDP, the ratio would be 100%. Currently, the U.S. ratio is poised to pass 100% in 2021, the highest level since World War II — a dramatic increase from the 50-year average of 44%.

Steadily falling interest rates have afforded the U.S. a significant amount of fiscal flexibility despite the significant increase in total debt. A longer-term trend of increasing interest expense could have serious economic implications.

U.S. net interest as a percentage of the federal budget

Line chart, left y-axis: Interest as a percentage of the federal budget, 0% to 16%; x-axis: 1962–2030, line separates actual from projected results at 2020. Interest begins at about 6% in 1962, then rises to between 12% and 16% in the mid-1980s until about 2000. It falls sharply to just about 5% by about 2010, then fluctuates between about 5% and 8% for the remainder of the period. The projection after 2020 calls for an increase from about 6% to over 8% by 2030. Four call-outs highlight developments. In the mid-80s, historically high interest rates led to increased cost to finance debt. In the early 2000s, Treasury used low interest rates to refinance debt and reduce cost. Near 2020, there are two notes: 1. CBO projects the 10-year Treasury to average a yield of 2.6% between 2025 and 2030 and 2. If cost continues along projected trend, economic consequences could be serious.


$664 billion: Added interest expense in 10 years the CBO estimates in its projections as a result of increased debt and modestly higher interest rates

Source: Congressional Budget Office, 2020

Even if the country can sustain a meaningfully higher debt level, projected increases remain concerning. Keep in mind it is impossible to predict exactly how much federal debt the country could bear before investors lose faith in the government’s ability or willingness to pay, potentially pushing borrowing costs higher and the nation into a fiscal crisis. Even if a crisis is not imminent, the consequences of a significant national debt are likely to be real and far-reaching for citizens and investors.

Read the full report (PDF)