Quick Bites | US Government Fiscal Reform – Precursor to Recession?

Quick Bite –US Government Fiscal Reform – Precursor to Recession?

To quote Yuval Noah Harari: clarity is power. Yet clarity is sorely lacking right now, given the policy agenda being implemented by the world’s most powerful person, President Trump. In light of the violent reactions seen across financial markets since Liberation Day, it is understandable that analysts have focused primarily on how tariffs will impact the US economy in the period ahead. However, it would be remiss not to also consider the implications of Trump’s agenda to shrink the federal government.

As readers will know, the Trump Administration strongly recognizes that the fiscal sovereignty of the United States is under increasing pressure due to structural fiscal deficits driving public debt to excessive levels. But how is “excessive” defined? As Clime’s founder, John Abernethy, simply put it: debt is excessive when a government allocates more funds to interest payments than to defense and healthcare (see following chart).

Against this backdrop, what happens to the economy as government deficits are reduced? The chart below paints a concerning picture. Except for the COVID-19 recession, prior US recessions (the shaded sections of the chart) have typically occurred alongside periods of reducing government deficits (or surpluses, as in the late 1990s). This is intuitive, as government deficits represent a surplus of funds transferred to households and businesses. Given the acute need to reduce the current government deficit, US economic growth will likely be challenged in the period ahead—over and above whatever impact tariffs may also have.