Six Shocking Facts about the Federal Deficit

It’s widely known that America’s federal deficit is out of control. But so many dire deficit warnings have been issued so often, they now fall mostly on deaf ears.

But due to six devastating facts they’ve chosen to ignore, the government’s day of reckoning is now near:

Fact #1. Sheer size. According to the government’s official estimate, the federal deficit for fiscal year 2009 will be $1.84 trillion, which I estimate will come in at close to 13.4 percent of GDP!

Regardless of the precise figure, however, it’s clear that the deficit has now exploded to a level which is so far beyond the range of anything we’ve experienced before, it’s impossible to imagine any scenario in which it does not have a disruptive impact.

Fact #2. The actual deficit could be much larger. The Obama administration’s $1.84 trillion deficit forecast presupposes a turnaround in the economy, which, by definition, will be extremely difficult while the government runs trillion-dollar deficits. We ask:

How can the Obama administration predict an economic turnaround when its own Treasury Department is sucking nearly $2 trillion in funds out of credit markets?

Similarly, how can the government predict a turnaround when its own borrowing frenzy is already driving up mortgage rates and undermining real estate, the one sector that’s most responsible for the economy’s decline in the first place?

Fact #3. No end in sight. Since the United States declared its independence nearly 233 years ago, the only time the federal deficit approached or exceeded 10 percent of GDP was during major wars — the Civil War, World War I, and World War II. But in each case, the deficit financing began promptly — and ended promptly — with the war.

Unfortunately, that’s not the case this time. Although the U.S. is fighting wars in Iraq and Afghanistan, their cost represents only a small fraction of the budget shortfall.

Fact #4. Today’s deficits are far worse than those of the Great Depression. America’s first big peacetime deficits came in the 1930s. Tax revenues plunged with the sinking economy. And in the years that ensued, government expenditures — mostly for a series of programs to bail out the economy — went through the roof.

But even with a 90 percent collapse in the stock market in 1929-32 and even after three years of GDP declines that make today’s look mild by comparison, the federal deficit in 1933 was just 3.27 percent of GDP, less than one-fourth of what’s projected for this year.

And subsequently, even when the U.S. government embarked on the most ambitious stimulus and bailout programs of its 150-year history, the biggest single deficit — in 1936 — was 4.76 percent of GDP, only about one-third the size of today’s.

Fact #5. Structural deficits. Our nation’s second encounter with large peacetime deficits was in the 1980s, but with a big difference: This time, there was no Great Depression. Instead, the fiscal woes were mostly structural — deeply ingrained in the bloated size of government and in our society’s dependence on government for much of its sustenance.

And eventhen, the federal deficit never rose to more than 5.63 percent of GDP, less than half its size today.

Today, structural deficits are far larger than in the 1980s, while the government is now liable for $65 trillion in future payments for Social Security, Medicare, government pension benefits, and other obligations that are kicking in at a quickening pace.

Fact #6. Massive new commitments. Beyond the $1.84 trillion of red ink projected for 2009 and beyond the trillions more in future obligations, the U.S. government has just assumed responsibility for as much as $14 trillion in new loans, commitments, and guarantees to bail out brokers, banks, insurers, auto makers, and the broader economy.

If these suffers greater-than-expected losses, we could see wave after wave of new demands on the government to honor its guarantees, bloating the deficit further.

Why the Federal Reserve Can’t
Stop Treasury Bonds from Falling

It’s not for lack of trying.

In a massive attempt to boost Treasury bond prices launched March 25, the Fed has now bought $145.5 billion in Treasury notes and bonds, the most ever in such a short period of time. But despite all the Fed’s buying, T-bond prices have continued to plunge and interest rates have continued to surge.

Plus, in an even larger effort to support mortgage prices — and to suppress mortgage rates — the Fed has poured a whopping $507 billion into direct purchases of mortgage-backed securities (MBSs). But again, even after spending more than a half trillion dollars to bid them up, mortgage prices have still collapsed and rates have still surged.

In sum, the U.S. Federal Reserve has failed to stop this new phase of the crisis, and one of the key reasons is obvious:

To buy bonds, the Fed must print money. But the more it prints, the more it fans inflation fears and the more it chases away bond investors, who realize they’ll be paid back in cheaper dollars.

Some pundits seem to think the Fed can simply print all the money it wants to finance the massive deficits. But in the real world, it doesn’t work that way.

The reason: As I explained last week, the government has not one, but two debt problems simultaneously:

1. The NEW debt problem: Massive Treasury borrowings of close to $2 trillion just to fill the gaping holes in the current federal budget.

2. The OLD debt problem: $14.5 trillion in Treasury securities, government agency securities, and MBSs outstanding. If just 10 percent of those are dumped on the market, it would trigger the sale of $1.45 trillion worth, easily overwhelming the Fed’s purchases.

The dilemma: The main reasons investors sell — fear of inflation and damage to the U.S. government’s credit — are, themselves, fueled by the Fed’s money printing and bond buying.

End result: The more the Fed buys bonds, the more it risks triggering massive investor selling.

So if you’re counting on the Federal Reserve to bail out the U.S. Treasury Department, forget it.

In the government’s grand balance sheet, printing money does nothing more than shift debts from one government account to another. It does not create wealth. It certainly has not stopped bond prices from plunging and interest rates from surging.

Far-Reaching Consequences

Never underestimate the impact of bulging deficits and surging interest rates — especially with near double-digit official unemployment and the worst debt crisis since the Great Depression.

Rising interest rates in this environment will be pure poison for:

• Many of the nation’s insurance companies loaded with long-term corporate and government bonds.

• Many of the nation’s banks counting on low interest rates to raise funds for close to nothing.

• Many utilities that must continually borrow large sums of long-term money to finance their massive investments in power plants and facilities.

• Home prices that can only fall when available credit in the nation is hogged by Uncle Sam’s massive borrowing and when mortgage rates rise.

• Investors! Stocks, long-term bonds, and virtually all types of real estate properties are vulnerable to surging interest rates.

Your Action Plan

FIRST: Get the heck away from long-term bonds and shift to shortest term securities.

SECOND: Use the resources provided with my new book, The Ultimate Depression Survival Guide, to find a truly safe bank near you. Or to bypass banks entirely, hop online to www.TreasuryDirect.gov and consider 13-week Treasury bills.

THIRD: Use any temporary market recoveries as an opportunity to sell off assets you don’t need, such as investment real estate and vulnerable stocks. Keep your 401(k). But within your 401(k), shift to the safest, shortest term alternative available.

FOURTH: To profit from falling bond prices, more aggressive investors should consider inverse ETFs designed to rise as Treasury bonds fall.