September 30, 2013 is the end of fiscal year 2013 and the expiration of the continuing resolution, which has funded the government since March. With the new fiscal year comes the drama of establishing a new budget, or at least a continuing resolution to fund government agencies. This has to be done by September 30; otherwise, on October 1, 2013, a government shut down may occur.
What is historically unique about this year’s process is that it comes on the heels of a required debt limit increase, nomination of new Fed chief, and possibly, the tapering of quantitative easing.
In 2011, the United States nearly defaulted on its debt as a result of Congress’ delay in raising the debt ceiling. The result was the first ever downgrade of the United States’ credit rating, removing its long-standing AAA S&P rating. The effects were felt across the stock market with major averages falling nearly 16% in one month. The Budget Control Act of 2011 created a new fiscal cliff, a new debt ceiling, and kept the government running. In January 2012, however, we again reached that limit. After more delays, the debt ceiling was eventually raised to nearly $17 trillion in May 2013. We think the debt ceiling has been patched, but never really fixed.
On a positive note, since 2011, the federal budget is actually shrinking, thanks to the sequester that began January 1, 2013. Due to Congress’ inability to come to an agreement on a deficit reduction plan, nearly $1 trillion in automatic, across-the-board budget cuts took effect in 2013.Also aiding the nation’s financial situation has been a payment from Fannie Mae and Freddie Mac and some provisions in the 2012 Tax Act that have helped keep the government afloat.
The Congressional Budget Office calculated annual outlays of about $3.6 trillion in 2011. Spending fell to $3.537 trillion in 2012, and is on pace to fall below $3.45 trillion in 2013. The 4% decrease in the last two years is the first time expenditures have fallen two consecutive years since the Korean War. We have also seen government revenue increase by 14% from last year. The deficit could continue to fall for the next several years, should economic growth accelerate to historically normal levels.
Despite the progress, we believe we are in for a rough fall, as indecision creates volatility for the markets. Congress will likely push a compromise until the last minute.
We believe that our current fiscal dysfunction has been masked by monetary policy. One reason we’ve been able to keep an easy money policy for so long is that there has been little inflation and slow economic growth. This is a result of the fiscal policy merely being patched and not cured. When fiscal policy is fixed, we believe we’ll see a rise in economic growth and potentially inflation.
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