David Sterman

It's the feel-good story of 2013 that nobody is talking about.

The nation's budget deficit, which had been spiraling out of control, is finally returning to manageable levels. Thanks to higher government revenues and lower government spending, this year's shortfall (for the fiscal year ended Sept. 30) will likely be around 40% lower than a year ago.

In fact, the Congressional Budget Office (CBO) predicts the budget deficit will fall below $400 billion by fiscal 2015. Good news, indeed.

Or is it?

Should we be pleased the budget deficit will still be larger than the entire economy of many mid-sized countries? And for investors, does that falling budget portend good news for stocks and bonds? Before we answer those questions, let's take a closer look at the road ahead for the U.S. government's finances.

A Fast-Shrinking Deficit ($billions)

Source: Congressional Budget Office

Despite the current good news, demographic forces threaten to push the deficit higher later this decade. Until policy makers adopt additional measures to raise revenues (likely through tax increases) and cut government spending, the CBO forecasts a $650 billion deficit by fiscal 2019 and an $800 billion deficit by 2022, as a growing pool of retirees absorb a higher amount of retirement and health care benefits. 

How much higher? The CBO notes that Congress is currently spending around $2 trillion every year on mandatory spending such as Social Security and Medicare, though that figure is expected to swell 75% to $3.5 trillion by 2022.

No matter how large or small, the deficit is still troublesome to the rising $16.7 trillion national debt. And all that debt means the government doles out more than $300 billion a year in interest payments on that debt, which plays a role in keeping the budget from coming into balance.

To be sure, the current interest payments actually benefit from the current era of low interest rates. When interest rates start to rise, the government will likely pay much higher sums. Erskine Bowles, who has been leading a government council that seeks to tackle the persistent deficits, paints matters in starker terms:

"We'll be spending over $1 trillion a year on interest by 2020. That's $1 trillion we can't spend to educate our kids or to replace our badly worn-out infrastructure," said Bowles at a November 2012 forum hosted by IHS Global Insight.

"What makes it doubly bad is that trillion will be spent principally in Asia because that's where our debt is," he added.

David Sterman

David Sterman has worked as an investment analyst for nearly two decades. He is currently an analyst for StreetAuthority.com