Earlier this week the U.S. government published its forecast for the budget deficit in coming years. In summary, the deficit is expected to narrow as a result of planned cuts on expenses but also, and this is where there seems to be a bit of an exaggeration, a substantial increase in receipts which, believe it or not, is hoped will come from expectations of a recovery combined with a planned increase in taxes and other forms of income. The goal is that the deficit drops from the current 10% of GDP to 3% by 2017.
So how realistic are these projections? I have a hunch that a large amount of the reduction actually bets on a strong recovery and that is where the problem lies. In the context of the current environment, it is difficult to see how the recovery can take on a sustainable path. Short term, maybe so, given the extension in tax breaks and the impact of the second round in quantitative easing, but longer term, probably not. In other words if the deficit, instead, remains stagnant or, worst case scenario, continues to widen, we can expect further pressure not only with regards to borrowing costs but also on the greenback. A weaker currency should undoubtedly help boost the economy by boosting exports to emerging countries, but if you factor in the brewing inflation troubles facing those same countries, the outlook suddenly looks bleak when compared to the "goldilocks" scenario of the government.
