The US Deficit and the Long Term Impact on the Economy

The US Deficit and the Long Term Impact on the Economy

Who isn't talking about the deficit?  It is front page news and a segment in the nightly news every day. The US deficit will have both short and long term financial consequences on the country’s economy. Many of us have heard the discussions on C-Span, NPR, and News Talk shows that are being considered to cover the budget deficit.  As a real estate professional do you understand what the US deficit is and the impact that it is having on the economy?  The effects of the deficit are evident in almost all walks of life.    As real estate professionals it is necessary as trusted advisors that we understand what it is, what the long term affects are and what can be done to protect your clients from its effects.

Let’s start with defining  the US Deficit or US Deficit budget.  The US government has practiced a trend of spending more than it earns and have been suffering a current deficit from 1982 to the present with the exception of one year. To cover this deficit, the US Treasury took help from foreign investors and other sources of borrowing, in loans equaling trillions of dollars. This borrowing was also used to support two long wars, the economy through fiscal stimulus and rescue of the country’s financial system.

Since the limit of the national debt today has reached the constitutional limit of $16.39 trillion, there are consequences that we will faced if the government’s ability to borrow is not extended. The United States has never failed to increase its debt limit and several economists have stated that if the debt limit raising trend is not stopped the government could easily go into default and face a heightened fiscal crisis.  This does not exclude the rating companies from down grading the US Credit Rating and increasing interest rates and deceasing consumer and market confidence.

Both the economy and citizens benefit from the deficit spending of the government in the short run, however the impacts are not so beneficial in the long run. Economist term federal debt as driving the economy with brakes on, as it tends to slow it down. It is a normal and known behavior that as the debt taken increases; lenders will increase the rate of interest as the risk of not being repaid gets higher with the growing debt level. This surplus interest normally deters governments from allowing their debts to exceed self-imposed limits.  It’s like paying the minimum interest payment of a credit card at 21% interest and eventually defaulting or going bankrupt because the interest payments have exceeded your income.   This is what congress and the President is concerned about.

The long term effects of the US budget deficit will result in the governments inability to cover the benefits promised to future generations.    Revenue generated through levying more taxes as the debt ceiling has already been reached will be insufficient.  The government has ruled out the possibility of taking on more loans from other countries.  In addition to increasing taxes, rebates and benefits will also be curtailed to cover the deficit.  This is what is being described as the fiscal cliff and it is really a Cliff over which  appears to be a bottomless pit that seems to have no end.

Another long term impact that is faced by the country is that many countries who lend to the US increased their US Treasury bond holdings considering them a safe haven.  Safe and “Risk free” means low interest on the Loans given to the US.   The US foreign Treasury holdings increased from 13% in 1988 to 31% in 2011. Countries like China and Japan increased their holdings during the recession period to keep the value of their currency low in relevance with the dollar.

The excessive foreign ownership of US debt is another long term economic recession indicator. The latest information as of September, 2012 indicates foreigners hold approximately $5.455 trillion or almost one third of the entire US debt. China holds the largest share with $1.155 trillion dollars followed by Japan, oil producing countries, Brazil, Caribbean banks, Belgium, Taiwan, Switzerland, Russia, and Hong Kong respectively. Since all these foreign US debt holders are investing their economy, the demand for US treasuries is diminishing thus again increasing the interest rates and further slowing down the economy. A lower demand indicates Dollar and dollar dominated treasury securities will become less desired and decline in value. Decline in dollar value indicates that the debt will be repaid in a currency that is less in value further decreasing its demand.

These are the broad long term impacts that the US Deficit will have on its economy, if the deficit budgeting is not solved.  What we can do to escape the effects of the US deficit?

1. Make sure that we do not face a deficit on a personal level through earning less and spending more.
2. It is clear that interest rates will increase in the future, so be wise in your spending and debt levels.
3. In all your real estate investments focus on cash-flow and not appreciation.  We have learned that cash-flow can weather a storm but appreciation may be wiped away by the same storm.
4. Diversify your income and assets.  Speak to your investment advisors about commodities and precious metals as they may be a safe haven in recessions.
5. The economic effects will be seen in all areas and sectors of the society. Always be aware of which policy affects you and in what way.
6.  Finally be ready to receive less spendable income as you will be hit with extended taxes and diminishing tax deductions that were previously allowed.

Going through the effects of a budget deficit is inevitable for all of us.  Through a thorough analysis of the situation and strategic planning, a way can be found to diminish the impact of the Crisis on our lives and the clients we serve.  The Power to do so is now.

The opinions express in this message are my own and do not represent the opinions of PrimeLending, the OC Realtist , the National Association of Real Estate Brokers or any affiliate.  They are my own.  For or questions comments please email eric.frazier@thepowerisnow.com.