Video Update: America Will Solve the Deficit Problem

The debt ceiling crisis is finally over.

Over the weekend, Congress passed, and President Biden signed, the Fiscal Responsibility Act.

But what does this Fiscal Responsibility Act mean for the economy?

In today’s video update, Chief Analyst Adam Galas explains why this act solved 15% of our overall annual debt problem for the next two years, and what major changes need to be made before 2053 in order to prevent the annual deficit from rising to 12% of our overall GDP. 

He’ll also show you how stronger growth can solve America's deficit problem, and why he’s confident the American people will rise to the occasion.

Click below to watch the video or read the transcript.

Happy SWAN (sleep well at night) investing,

Brad Thomas Editor, Fortress Portfolio

Welcome Fortress Portfolio members to part five of our debt ceiling series.

The exciting conclusion about one of the most important but misunderstood topics in investing.

So let's start with a summary of what just happened with the debt ceiling and what it’s likely to mean for the economy and budget deficit in the short to medium term.

Then I'll show you with spreadsheets and math in this video how America can and almost certainly will solve its long term debt deficit problem in the future.

So first, what just happened?

Well, over the weekend, Congress passed, and President Biden signed, the Fiscal Responsibility Act.

And here's what this act does. It suspends the debt ceiling until January of 2025 after the election.

It freezes discretionary 2024 spending at 2023 levels and then caps 2025 spending at 1%. It also raises the Pentagon budget by 3.3%, and cuts $20 billion from the $80 billion increase to IRS funding.

The act also mandates work requirements for food stamps, and actually expands food stamp eligibility for veterans and disabled Americans.

And most exciting, in my opinion, it streamlines regulatory approval for energy projects, including pipelines and renewable energy. And we'll talk about why that's good news in a few minutes.

Now, the Congressional Budget Office (CBO) estimates this will cut the deficit by $1.5 trillion in the next decade.

But that's a small fraction of what we actually need.

So how much do we really need to cut the deficit?

Well, according to the CBO, to be sustainable, meaning debt to GDP and interest to GDP remain stable or falling over time.

The deficit cannot be larger than nominal GDP growth over time, which simply means GDP plus inflation is the sustainable deficit cap now.

Long term, that means about 4% annual deficits, 2% growth plus 2% inflation.

Now, over the next ten years, the CBO estimates the deficit will average 8% of nominal GDP.

So to put it another way, the CBO estimates that before this bill was passed, we could afford no more than $10 trillion in deficit through 2033, and we were on track for $20 trillion.

Now we're on track for $18.5 trillion.

Another way to put that is we solved 15% of the problem with this bill.

Now, as I'll explain in a few minutes, that's actually more impressive than it sounds.

But let's talk about what that means for the economy.

Oxford Economics has crunched the numbers and estimates that due to lower spending in 2023, the GDP decline likely peak in the recession at about 1.7%, based on the worst scenario.

Now, the 1.7% GDP decline is annualized.

For context, the average since World War II is 1.4%, so today it’s slightly worse than average.

Now, the recession is expected to start in July and last six months, at least according to Oxford Economics Bank and a few other economists.

Next week, I'll explain why we might already be in a stealth recession.

But the important thing to note is that the long-term negative effects of the bill are likely to be minimal or even positive.

That's because I've seen reports that the new regulatory reforms mean that over the next decade, up to $620 billion in additional energy projects could be completed, which would be a boost for the economy.

But, what about the long term deficit?

We only solved 15% of the problem.

Well, according to the CBO, this is a major problem because by 2053, our annual deficits would rise to 12% of GDP.

And from 2044 to 2053 the average deficit would be 10% of GDP. That would require 8% growth in GDP for it to be sustainable.

And CBO, like the Fed, only expects 1.8% GDP growth over time.

So we're talking about a $12 trillion deficit in 2053.

Now, the good news is, that's only if we keep all spending and tax policies currently in place for the next 30 years. And don't make any changes.

It's unsustainable because it's 195% debt to GDP.

Now, that sounds terrifying and it certainly is bad, but that would make us only the third worst in the world behind Japan and Greece.

Mind you, these are hardly two thriving economies we want to emulate.

Fortunately, there are many options we have to avoid that grim future. The best one is growth.

That is the ultimate solution to our long term debt problem.

Because with stronger economic growth, the debt problem will literally solve itself.

And I will explain why.

Now, first, I have to explain something very important about national debt.

It is not like a budget for a household. It's more like a budget for a corporation.

There are two important things you have to understand about government debt.

The first is that the U.S. government borrows its own currency and can print as much as it wants.

Now, obviously, it can't actually print infinite amounts of money or else we’d get runaway inflation, as we saw after the pandemic.

We printed 60% more money than we needed to fill the pandemic gap.

That's why we had the worst inflation in 42 years.

Famous examples of this in other countries include. Venezuela. Weimar Germany. Zimbabwe.

Or just take a look at Argentina with 109% annual inflation and a poverty rate of 39.2%.

For context, in the U.S., the annual poverty rate is just 11.6%.

Now, the other big difference, the government has is that it is eternal, just like a corporation… Assuming that it's not driven into bankruptcy by poor management.

Now, rating agencies estimate that the risk of the U.S. government collapsing in the next 30 years is between 0.07% and 0.29%.

That's what a AA+ to AAA credit rating actually signify.

Now, let's use Apple (AAPL) as an example of why high debt on its own is not actually unsafe.

Apple today has $56 billion in cash and $110 billion in debt.

And it generates $101 billion in annual free cash flow.

So to put it another way, its net debt (if it were to use all of its cash to pay off its debt) is $54 billion. And it could pay that off in six months with its free cash flow.

But Apple is never actually going to pay off its debt, and that's a good thing.

That's because its average borrowing cost is 3.4% and its return on invested capital is 54%.

So if it were to pay off its debt, it would be sacrificing 54% returns to save just 3.4% on interest.

That's a very bad idea.

The only limitation on how much debt Apple can safely borrow is what it can invest in to generate returns higher than interest costs and its interest coverage ratio.

In other words, how many times does its cash flow cover its interest costs?

Now, rating agencies say that A+ is safe for Apple, and today its interest coverage ratio is 32.3.

In other words, Apple could safely borrow up to $330 billion more without losing its investment grade credit rating.

Now, of course, it shouldn't actually borrow that much unless it can profitably invest in things that generate high return then the borrowing costs.

Now, let me show you another example of how debt really works for corporations and governments.

Imagine a company with $1 billion in debt and $1 billion in annual cash flow.

Now the debt to cashflow ratio or leverage ratio is 1. The ratio is usually 3 or less.

So a rating of 1 is considered safe for most companies.

Now, assuming a 4% interest cost, that means the interest coverage ratio will be 25, more than three times the safe limit.

Now imagine this company increases its debt over time ten fold to $10 billion, but it invests in smart projects that generate positive returns higher than interest costs.

So by the time this happens, it's generating $20 billion per year in cash flow.

Now, the debt to cashflow or leverage ratio is just 0.5 and its interest coverage ratio is 50, twice as high as it was (and more than six times the safe limit).

So you can see even with ten times more debt, the company is now safer and at lower risk of going bankrupt.

That's what's so important to remember about corporate and country debt. It is theoretically eternal.

The actual amount of debt doesn't matter. It's the ratios that do.

That's why government debt isn't like household debt. The rules on sustainable budget deficits are very different.

This applies to other countries like the U.S., such as Canada, Australia, Japan, the U.K., the EU, New Zealand, countries that borrow in their own currencies.

Now, remember, they do have limitations in terms of debt ratios, interest coverage ratios and, of course, inflation.

So for context, the European Union (and this is in their charter) says that 60% debt to GDP is sustainable and rating agencies agree.

Now, few European countries actually managed to achieve that.

Here are few that do.

And non European countries that also do a good job are Australia at 45% and New Zealand at just 19%.

Interestingly enough, New Zealand’s income tax rate is 10% lower than America's.

The point is, sustainable national debt is possible if we work together as a country and pursue good policies.

Now, in order to do this, the main priority of the America should be maximum sustainable growth, which would solve all of our deficit and fiscal problems (and most of our social problems as well).

And it would allow us to do this without actually changing current spending policies.

Here's why that matters. Every spending package that exists today is somebody’s sacred cow.

That's why it exists.

Defense spending? Well, that's a very popular sacred cow.

Social Security and Medicare? Well, that's the only thing retirees care about.

Ethanol subsidies? Even the GOP House bill had to add those back in before Republican congresspeople from Iowa would vote for the bill's passage.

So let me show you a quick example of how stronger growth can solve America's deficit problem.

Here is what America's budget deficit will look like if we ran maximum sustainable deficits of 3.8% with 3.8% long term growth, which is 2% stronger growth than what the Congressional Budget Office currently estimates is likely to happen.

The maximum sustainable deficit this year would be $969 billion, and by 2053 it would be as high as $2.9 trillion.

And even with that high of a deficit, the debt to GDP would fall from 123% to 106%.

More importantly, the interest as a percentage of the economy would fall from 4% to about 0.5%.

All while the national debt almost triples to $83 trillion.

Now, why did I use 2% as an example? I'll explain in a moment.

But first, let me show you the most extreme example with 15% economic growth.

I'll explain why I'm using that number in a few minutes.

Now, in this most extreme example, if the U.S. did grow at 15% adjusted for inflation, we could sustain annual deficits by 2053 of up to $222 trillion.

And yet our debt to GDP ratio would fall significantly from 123% to 88%.

Meanwhile, interest to GDP would fall by about 1%.

So why is this such an extreme example?

To give you that answer let's use Bernie Sanders as an extreme example to tell a very interesting story.

Now, you might know Bernie Sanders as the self-described socialist and senator from Vermont. When he ran for president, he promised the sun, the moon, and the stars to his progressive base.

According to the CBO, those policies that he promised would cost about $10 trillion per year on top of what we already spend, that's about 16 trillion.

Now, Sanders also theoretically favors universal basic income, although it's not one of his policy proposals.

So let's say that we want to add this to the socialist wish list.

$1,000 per month for every man, woman and child in America, adjusted for inflation forever.

That would cost about $4 trillion today and pushes up government spending to $20 trillion per year.

Now, assuming the same growth rate that the Congressional Budget Office estimates over the next 30 years, that would mean that those policies would cost $75 trillion or 94% of GDP.

Obviously, that's crazy. But what if America was growing at 15%, adjusted for inflation?

If the U.S. did grow at 15% adjusted for inflation, we could sustain annual deficits by 2053 of up to $222 trillion.

Then the cost is only 0.004% of GDP. We could fund that socialist utopian wish list while balancing the budget and cutting taxes by 75%.

Now, obviously, I'm not actually advocating that we do all that. That's simply the most extreme example. But it shows how the power of maximum sustainable growth can literally let us have our cake and eat it too.

And everyone can be a winner.

The budget hawks can balance budgets. Conservatives can get tax cuts up to 75%, and the progressives can get every socialist wish list they want and then some.

So you might be wondering why I chose 15% is this extreme example.

That's because, according to experts such as Moody's, Bloomberg, the Federal Reserve, the National Bureau of Economic Research, the U.S. National Institutes of Health, and the CDC, along with Goldman Sachs, 15% is the maximum theoretical economic growth rate of the United States (adjusted for inflation).

That is, if we pursue every long-term growth policy with perfect efficiency.

In other words, if we did everything right, we could theoretically grow as much as three times faster than China.

Now, remember how that first deficit table is 2% faster growth?

Here's why... Let's face it, we live in a democracy and not everyone is going to agree, which means perfect policy making is impossible.

But, consider the five greatest presidents of all time according to historians: Lincoln, Washington, FDR, Teddy Roosevelt and Eisenhower. They were estimated to be 90%, 85%, 84%, 79%, and 73% right on policy issues, respectively.

Now, let's take a look at how fast we actually need to grow to avoid debt doomsday decades moving forward.

According to the Congressional Budget Office, in order to achieve the minimum sustainable levels of deficits with today's tax policies, including keeping the Trump tax cuts, which the Republicans are very much in favor of, and not changing any spending policy, which the Democrats, of course, would like… The U.S. would need to grow by 3.42% over time.

And that's 1.6% faster growth than is currently expected. But guess what?

There is a single common sense policy solution that can achieve exactly that.

According to the American Association for Civil Engineers, we need to spend an extra $2.6 trillion over the next ten years to fix existing infrastructure.

Now, I'm not talking about green energy transition spending.

I'm talking about the roads, the dams, the airports. Just what we have now, according to the ACA.

This would generate 7.8% returns on investment, meaning we could literally fund this with long term bonds if we just borrowed for it and didn't raise taxes or didn't cut spending.

And what about lead removal?

Well, there's 3 million homes that currently still have lead.

Now according to a study from the NIH and CDC, removing this at a cost of $167 billion over ten years would generate about $3 trillion higher economic growth in 20 years. This would boost growth overall by 0.4% per year.

Now, according to all these experts I've been researching for weeks, here are their various policy proposals.

There are a lot of smart policies we can use for lead removal. For every dollar you spend, it's $17 in extra economic output.

Also according to the study, every dollar spent on research and development (R&D) would generate $2.10, infrastructure would generate $1.6, and dozens of other spending proposals would increase our economic output.

So what does this actually mean?

It means that some policies are so effective that they would literally pay for themselves, even if we cut no spending, raise no taxes, and just borrow to do it.

For example, lead removal and the infrastructure we already have would cost $2.75 trillion.

But in 20 years, it's estimated that the economy would generate $14 trillion as a result. And that would be using today's tax rates, keeping the Trump tax credit tax cuts in place.

That means tax revenues would be $2.6 trillion higher. So as you can see, it almost does pay for itself.

It's good for people. It's good for the economy. It's good for the stock market, and it's basically free. These are two policies alone that would also get us to debt sustainability without taking away sacred cows from anybody.

Now, of course, there are a lot more ways to boost growth.

Goldman Sachs and the National Bureau of Economic Research estimate that artificial intelligence like ChatGPT alone, could boost growth by 2.6% to 2.7% over the long term.

Now, that would more than solve all our problems right there, and we wouldn't actually have to do anything.

Of course, there are other smart policies that we haven't even talked about yet.

My personal favorite example is called the sovereign wealth fund, which Norway utilizes for its oil revenue.

Now, imagine if the U.S. were to borrow $1 trillion at 4% for 30 years, literally just sell $1 trillion in 30 year bonds over 30 years.

That would cost $2.4 trillion, including the interest.

Now, imagine you invest that in the S&P 500, America's best companies, world beater Blue Chip All-Stars. In 30 years, analysts think that trillion dollars would be worth $19 trillion or $16.6 trillion net profit instead of a $12 trillion annual deficit.

Then we would have a $4.6 trillion surplus. Instead of arguing over austerity and how we're screwed… We could focus on figuring out what to do with that giant surplus, the biggest in history.

Do we pay down debt? Do we cut taxes? Do we increase social spending? Do we pay every American a democracy dividend by UBI? Or do we do some combination of all of them?

We could literally balance the budget with the sovereign wealth fund.

And eventually, if we did this every year, get to the point where all government spending, at the federal, state and local levels would be funded by the sovereign wealth fund.

No corporate taxes, no income taxes, no sales taxes, no taxes of any kind for anyone.

Talk about a utopian vision. That's literally the power of smart, pro-growth policies.

Of course, we don't actually need to be 100% perfect on any single policy.

We just need some combination of all of them, or at least several of them that add up to 12% of the potential maximum growth rate.

Now, for context, according to historians, the worst president in history was James Buchanan, the 15th president.

And he was right 22.7% of the time on policy.

You might be wondering, my God, what did he do that made him such a terrible president?

Well, he was president from 1857 to 1861. And his policy blunders led directly to the Civil War, which killed 650,000 Americans.

In other words, as long as Americans can come together and be just half as stupid as the guy who inadvertently caused the Civil War, our debt problem will be solved.

Now, why am I so optimistic that we can be 12% optimal and half as dumb as Buchanan?

Well, to quote Churchill, “Americans always do the right thing once they accept exhausted all possible options.”

Now, look, as Americans, we screw up a lot and we can screw up for a long time.

But when the chips are down, we come together and we get it done.

In February of 2020, congressional Democrats and Republicans couldn't agree on the color of the sky. But then the pandemic hit, and in March of 2020, we passed the CARES Act.

We prevented a depression that the St. Louis Fed estimated could have led to a 32% GDP contraction and 50% unemployment.

For context, the Great Depression was a 25% contraction over four years and 25% unemployment. In other words, it could have been far, far worse.

But we solved that and we solved it in less than two weeks.

Why? Because we're Americans, dammit.

And let me give you my favorite example of all. Why it's good to always be bullish and optimistic about the future of America.

At the start of World War II, Franklin Roosevelt asked Congress in America to build 50,000 warplanes.

When the Germans heard about this, they thought it must be pure propaganda. No one could do that.

At the time, the U.S. had the 18th largest air force in the world and the 12th largest army, smaller than Brazil's.

Well, American manufacturers turned out 96,000 bombers, 86,000 tanks, 2.4 million trucks, 6.5 million rifles, 3000 liberty ships, an average of two every day of the war.

And in 1940 alone, we were producing just 331 tanks. Three years later, 29,500. And that was with 140 million Americans coming together to become the arsenal of democracy.

Well, today there are 340 million of us. And by 2050, the Census Bureau thinks they'll be 384 million with an inflation adjusted economy of $80 trillion.

Now, politicians like to say America is the greatest country on Earth.

And in the most important way possible, that's true.

America has its faults. We don't have the best medical stats. We don't have the best poverty stats. We don't have the best life expectancy stats.

But according to Goldman Sachs, we have the most dynamic economy in the world. And that's why our hundred million immigrants want to move here, right now, more than any other country on earth.

Why? Because America is the nation where almost anything is possible.

We built the Panama Canal. Something many engineers thought was impossible under our fourth best president, Teddy Roosevelt.

We sent a man to the moon in 1969 with a computer less powerful than the iPhone.

We invented the Internet and helped topple the Soviet Union.

We saved democracy in World War II by harnessing our companies as citizens to build more weapons, and pump more oil, and raise an army of 16 million… Something that most economists and generals around the world thought was impossible.

But nothing's impossible because we're Americans.

So don't tell me America's doomed because of our debt. Because we're not.

There are plenty of ways to save the Republic, just as we proved with the recent debt ceiling crisis.

Now, you might be wondering why I am so confident when we only solved 15% of our deficit problem.

But we spent two weeks debating on 11% of the budget. In other words, we solved 36% more of the problem than you would have expected.

And we don't just have two weeks to solve this problem. We have 30 years.

That's why I'm bullish on America, our economy, and the world's best blue chips in our stock market.

We’re Americans, and together we can move mountains, visit other planets, and invent world changing technology like no one else.

Just take ChatGPT. This is something that didn't even exist in November.

Now, 2 billion people around the world use it, including 40% of American.

Who invented that? Americans.

And that's just one example of America.

Even with all of its flaws, it still remains the shining city on the hill for global democracy, prosperity, and innovation.

I come from a family of immigrants and that makes this country all the more special to me. So thank you for joining me today and listening to my pro-America speech and our last video of the debt ceiling series.

As a reminder, please send us your questions and feedback so I can respond to them in these videos and our monthly issues. Just remember, I cannot provide personalized investment advice.

Thank you for joining us this week and I hope you join us next week when I examine the economic data that suggests we might already be in a stealth recession. I’ll also talk about what that means for the stock market and most importantly, why Fortress Portfolio members don't have to worry at all.

Until then, this is Adam Galas, wishing you safe investing, and you and your family a healthy, relaxing, and joyous week.