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Another Financial Crisis To Come

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 23, 2010

IN THIS ISSUE:

1.  The Massive Healthcare Bill Becomes Law

2.  National Debt Soars $2 Trillion Under Obama

3.  Moody’s Issues US Credit Rating Warning

4.  Think Greece Welcome to the Third World

5.  Have We Passed the Tipping Point?

Introduction

America is headed for another much more serious financial crisis in the coming years.  Trillion- dollar annual budget deficits are skyrocketing our national debt – now at a record $12.6 trillion – which could double over the next decade.  As I will discuss below, Moody’s, one of the nation’s oldest credit rating firms, warned recently that the US government could lose its triple-A credit rating in a few years if the current runaway spending is not reduced.

Whether the government loses its triple-A credit rating or not, those who buy our trillions in government Treasury securities are becoming increasingly nervous about our ability to make good on those supposedly risk-free obligations.  Foreigners own over half of our outstanding national debt.  When these creditors decide they no longer trust our commitment to make good on this exploding debt, we will enter a financial and currency crisis that will make 2008 look like a walk in the park.  

More and more Americans are coming to realize this.  As the healthcare reform debate has raged on for over a year, President Obama and congressional leaders Nancy Pelosi and Harry Reid and others have assumed that the American people who oppose a government takeover of healthcare simply do not know what is best for them.  But they miss the point, in my opinion. 

More and more Americans now realize that the healthcare reform bill that was passed on Sunday by the Democrats will cost over a trillion dollars over the next decade, and that this is simply more out-of-control government spending.  They understand that we face a massive financial crisis in the next few years if the US continues down this path.

Of course, new taxes and cost savings are supposed to more than cover this trillion-dollar boondoggle, at least according to the Congressional Budget Office.  However, considering that the CBO projected the cost of the Bush Prescription Drug Program at about $400 billion and it ended up costing about three times that much, I have ZERO confidence in this estimate.

All of my trusted sources (including BCA that I am no longer allowed to quote in these pages) now agree that the US will face a much greater financial crisis sometime in the next few years.  Some fear that we will face a multi-year crisis and depression – sooner rather than later – if we continue to run trillion-dollar budget deficits and balloon the national debt.

This week and in weeks to come, I will focus on this issue.  If we do not take action to reduce our out-of-control spending and deficits, it will lead to the devastation of our investment markets – all of them – at some point.  And many fear that point is already on the horizon.  If so, this subject is well beyond a political issue.

The Massive Healthcare Bill Becomes Law

After all of the political hullabaloo over the past year, the healthcare bill is now the law of the land.  We still don’t yet know all of the political deals (read: bribes) that were made to get the number of votes required, but I think we can be sure there were plenty.  And to think Obama ran on ushering in a new age of government “transparency” – yeah, right!

There’s an old saying about how a camel is really a horse built by committee.  The healthcare bill is probably the ultimate culmination of that idea.  Only time will tell just how bad this hodgepodge of provisions will be for healthcare, future deficits and the national debt.  I have received many negative comments from those who supported this healthcare initiative and all I can say is, be careful what you wish for.  Unfortunately, by the time they see that their hopes were misplaced, it will be too late.

I’ll leave my comments on the passage of healthcare to that, but keep in mind that this first step toward government-run healthcare will cost much more than projected (as all government-run programs do), and it will only make the problems I discuss below be even worse.

National Debt Soars $2 Trillion Under Obama

The Treasury Department recently released data showing that the national debt has increased over $2 trillion just since President Obama took office.  The national debt now stands at over $12.6 trillion.  On the day Mr. Obama took office it was $10.6 trillion.  The national debt has never increased this much in such a short time.

Again, this is not a political observation.  Former President George W. Bush still holds the record for the most debt run up on his watch, $4.9 trillion.  But it took him over four years to rack up the first $2 trillion dollars in debt.  It took President Obama only 421 days in office to do so!

Obama and his administration routinely blame the Bush administration for inheriting a budget surplus and turning it into years of record-breaking deficits and debt, and then leaving it on the doorstep of the new president.  They also cite the credit crisis of 2008 as another reason for the surge in debt.  The president has said on more than one occasion:

“I walked into office facing a massive deficit, most of which was the result of not paying for two wars, two tax cuts, and an expensive prescription drug program. When we walked in, we had a deficit of $1.3 trillion and projected debt over the course of a decade of $8 trillion. The lost revenue from this recession put us in an even deeper hole. And the steps we took to save the economy from depression last year have necessarily added to the deficit -- about $1 trillion, compared to the $8 trillion that we inherited.”

Much of the above is indeed true.  Long-time clients and readers will recall that I routinely criticized President Bush for running huge budget deficits, the worst of which was in FY 2008 when the deficit topped $459 billion.  But President Obama’s answer to record budget deficits is to spend even more.

The actual federal budget deficit for FY 2009 was a record $1.413 trillion according to the Congressional Budget Office.  This was the last federal budget submitted by President George W. Bush, and President Obama made no effort to reduce it.  In fact, he is on course to increase it in 2010 and 2011.  Here are the CBO’s deficit projections for 2010 through 2020 based on Obama’s FY 2011 federal budget projections (in trillions):

2010

 

$1.500

 

2016

 

$0.894

2011

 

$1.341

 

2017

 

$0.940

2012

 

$0.915

 

2018

 

$1.001

2013

 

$0.747

 

2019

 

$1.152

2014

 

$0.724

 

2020

 

$1.253

2015

 

$0.793

 

 

TOTAL  $11.260 Trillion

If we count the FY 2009 deficit of $1.413 trillion, that will more than double the current national debt by 2020, and it will likely be even worse.

Based on the 2009 deficit and these CBO projections, Obama will add over $5 trillion to the national debt in his first four years in office alone!  Unfortunately, these numbers are very likely too optimistic.  The CBO’s economic assumptions are overstated in my opinion and those of other respected analysts.  For example, these projections assume there will be no recessions over the next decade; never mind that we’ve had two in the last decade.  And this does not include any expenditures for healthcare.

Projected Deficit

Note in the chart above that the darker bars represent the CBO’s “baseline” deficit projections before Obama announced his proposed federal budget for fiscal year 2011 on February 1.  Following the unveiling of his record large $3.8 trillion budget for 2011, and his budget projections for the next 10 years, the CBO went back and adjusted its deficits projections accordingly, which are represented by the much larger lighter-colored bars above. 

The impact is enormous, and this is why I and many others believe that another larger financial crisis looms ahead! 

Moody’s Issues US Credit Rating Warning

While the gloom-and-doom crowd has been wringing their hands over the possibility of a downgrade of the US triple-A Treasury bond rating for years, most have just dismissed this as much ado about nothing.  After all, everyone else in the world seemed to be worse off than the US, so by comparison, we looked pretty good.

Unfortunately, the glass-half-empty crowd got a big boost recently from a report issued by none other than Moody’s Investors Service, one of the major US bond rating companies.  While Moody’s report noted that the AAA rating currently enjoyed by US Treasury bonds is in no immediate danger, it also warned that if the US continues down the road of out-of-control deficit spending, that our AAA credit rating could be a thing of the past. 

This isn’t the first time that Moody’s has made comments in regard to the vulnerability of America’s top credit rating.  Previous reports have had similar warnings.  However, the latest report contained one of the most sobering quotes I have ever seen in regard to the consequences of uncontrolled deficit spending:

“Growth alone will not resolve an increasingly complicated debt equation.  Preserving debt affordability at levels consistent with Aaa ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion.”  

In other words, welcome to Greece if we don’t get our act together.  We have become spoiled by the fact that the US economic engine has pulled us out of past scrapes.  The US economy has surprised on the upside for over 25 years, and recessions have been fairly mild over that period.  That is until the credit crisis/recession in 2008-2009, which was a warning of what is to come, in my opinion.  If Obama and Congress keep spending like drunken sailors, any substantial economic growth is going to face a fierce headwind, or worse.

Following the startling Moody’s report, President Obama wound-up Treasury Secretary Tim Geithner and marched him out in front of the cameras to do some damage control.  Geithner said there was “no way” that the rating agencies would downgrade the US bond rating.  Speaking before the House Appropriations Committee, Geithner said:

“What people who look at our country – credit rating agencies, investors, Americans – what they look at is whether we have the political will to restore gravity to our fiscal position.”

Apparently, Mr. Geithner assumes that President Obama and the politicians who surround him in Washington have the political will to cut spending and reduce the trillion dollar deficits at some point before we go over the cliff.  Frankly, I don’t believe they do!  I’m not really sure Geithner believes it either, but he has to make the public believe he does, and he’s not doing a good job of convincing anyone. 

Think Greece Welcome to the Third World

While I realize that there is no immediate threat to the US Treasury debt rating, I think it would be instructive to consider just how the US would look if Treasuries were to lose their triple-A rating.  The first and most obvious effect would be that the Treasury would have to pay a higher rate of interest on its debt.

This isn’t World War II where citizens bought war bonds to help fuel government military spending.  Today, over half of our public debt ($7.5 trillion according to the Treasury Dept.) is held by foreigners, most of which have no patriotic motivation for holding our Treasuries.  While some have global trade reasons for making sure the US economy continues to stay strong, they may still want a higher rate of interest to compensate for lending us money going forward.

Higher rates on Treasury debt securities would also mean higher debt servicing payments.  Under the current conditions, annual interest payments on Treasury debt are expected to grow significantly over the next 10 years.  A recent CBO report contained the following statement about future debt service:

“With such a large increase in debt, plus an expected rise in interest rates as the economic recovery strengthens, interest payments on the debt are likely to skyrocket. CBO projects that the government’s annual net interest spending will more than triple between 2010 and 2020 in nominal terms (from $207 billion a year to $723 billion) and will more than double as a share of GDP (from 1.4 percent to 3.2 percent).” [Emphasis added, GDH.]

If Treasury yields have to rise to stimulate global demand for our debt, that will flow through to the economy by raising long-term interest rates across the board.  That’s the last thing a struggling economy and a still slumping housing sector need, whenever it occurs.  The government would also be competing for loans with private business, making it harder for the economy to grow and prosper.

Finally, having a national debt ($12.6 trillion) approaching our GDP ($14.3 trillion), foreign owners of our Treasury debt are increasingly becoming nervous about our record deficits.  Considering that they own over half of our outstanding debt, it is no wonder that they are making their concerns known.  China, the largest foreign holder of Treasury debt, has publicly chided the US over the out-of-control spending proposed by Obama.

And in case you haven’t heard, the Treasury Department reported that China has reduced its holdings of US Treasury debt over the last three consecutive months.  While the amount of this reduction by China is not seen as significant, it may well be a harbinger of things to come if we continue to run trillion dollar deficits.

Have We Passed the Tipping Point?

Most economists agree that the worst of the credit crisis and the recession is behind us, and I would agree – for now.  Most analysts agree that the US will experience mild economic growth over the balance of this year and perhaps into the first half of 2011.  But beyond next year, there is no consensus on what lies ahead over the next several years.

What we do know is that the US is increasingly dependent on foreigners who: 1) buy and hold over half of our national debt; and 2) hold trillions in US dollars.  Everyone agrees that should these foreign holders of Treasury debt and US dollars ever decide to stop buying (or worse, start unloading) our debt securities and dollars, it’s game-over!  

Yet the Obama administration’s own projections show the national debt almost doubling over the next 10 years, as noted earlier.  Of course, Obama doesn’t get all the blame.  Every president in recent decades has run budget deficits, including Ronald Reagan, who I also criticized at the time in my Forecasts & Trends paper newsletter.

With the exception of Bill Clinton, who managed budget surpluses in FY1999 and 2000, we have had annual budget deficits for years.  Making matters worse, those deficits have gotten larger almost every year.  As noted above, the federal deficit reached a record $459 billion in President Bush’s last year in 2008.  President Obama’s deficit in 2009, and the projections for 2010 and 2011 (shown above), are nearly triple Bush’s last deficit!

It is as if we are snubbing our collective noses at the foreign buyers of our debt who make this record spending and ballooning deficits possible in the first place.

The question is whether we’ve reached the so-called “tipping point,” where we have gone too far to remedy the problem short of a disastrous end.  Based on President Obama’s own budget and deficit projections (which may be too optimistic), he will have added $5 trillion to the national debt from FY2009 to the end of 2012.  The national debt would then be apprx. $17.6 trillion, and I believe it is safe to also assume that our foreign creditors will be up in arms by then.

There are some that believe there is no great problem with the national debt exceeding GDP ($14.3 trillion).  Japan, after all, has done it for a number of years, as have some other smaller nations.  There are some who believe that the US economy is going to bail us out yet another time.  Yet even if the economy was to somehow return to annual growth of 5-6%, or even more, that would not make a huge dent in the deficit projections.  And with bank lending still in the tank (as discussed in my March 2 E-Letter), there is little chance of that happening.

Another possibility is that Congress and the Obama administration come to their senses and move to cut federal spending dramatically.  Yet in order to balance the budget, it would require significant cutbacks in discretionary spending AND mandatory programs including entitlements that make up over 60% of the federal budget.  Obviously, that is not going to happen; in fact, just the opposite is happening with the latest healthcare entitlement.

With the economy not expected to boom in the next several years, and with no cuts in entitlement spending, that leaves only the markets and our foreign creditors to enforce the discipline on our lawmakers and ultimately, the general public that elects them.

At some point – and no one knows exactly when – foreigners will balk at buying more US debt; likewise they will begin to unload US dollars.  When this happens, I believe we will face a financial crisis that will be much worse than that of 2008-2009.  I believe it will usher in a new depression if something is not done.

I know there are those who will disagree.  Here’s one common argument: China has to keep buying our debt to keep the US – its largest customer – afloat and healthy.  To a degree this is true, and it explains why China is the largest foreign holder of US Treasury debt.

But let’s not forget that age-old banking saying: I’m more concerned about the return of my money than I am about the return on my money.  I believe that if we continue down this path of trillion dollar deficits, our foreign creditors will reach the point where they decide to bail on the US, and that will spell disaster.

Think of the US housing market in 2005, 2006 and early 2007.  Home prices were going through the roof.  If someone had predicted that home prices across the country would dive 30-40-50%, the response would have been: That simply cannot happen! 

But it did happen.  Bubbles always burst, and it’s rarely pretty.  If a $5 trillion (40+%) surge in the national debt in only four years is not a bubble, I don’t know what is.

Sorry to be so negative this week, but I believe we are headed for a train wreck, and it’s just a matter of time.

Wishing I had better news,

Gary D. Halbert

SPECIAL ARTICLES

Democrats to Americans: Drop Dead
http://www.washingtonexaminer.com/opinion/Democrats-to-America-Drop-dead-88785812.html

Healthcare: Liberal governance with a very steep price
http://online.wsj.com/article/SB10001424052748703775504575135881813148208.html

Healthcare: The Lie of Fiscal Responsibility
http://reason.com/archives/2010/03/22/the-lie-of-fiscal-responsibili


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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