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From the perspective I have on fixing the so called "Fiscal Cliff," I'm in full agreement with Ron Paul in that "We're so far gone, we're over the cliff." I would argue we're in a fiscal ravine and the sun is going to set, at which point, the wolves and coyotes will come out.

Just how did America fall so deep into this ravine? Below is a chart of the total federal deficit/surplus:

(click to enlarge)

On the state and local level, there are also deficits. Here is a chart showing the state and local deficit/surplus:

(click to enlarge)

Lastly, another factor that is putting the U.S. deep in the fiscal ravine is our trade balance of payments. America simply buys more goods and services from overseas than what she sells overseas. Here is a chart of the total deficit for each year since 1992:

(click to enlarge)

We don't hear the term "twin deficits" like we did in 2005 and 2006 yet we should be talking about it more than ever today because it's the worst it has ever been. If we add up the total government deficits and the trade balance deficits, the twin deficits make us a basket case.

Here is a chart of the twin deficits as a percent of GDP:

(click to enlarge)

Source for data: Federal Reseve Bank of St. Louis

The above chart clearly indicates the true depth of the ravine that we're in.

The Economist.com website offers us a spreadsheet of all countries and their respective trade and budget deficits. Here it is below:

(click to enlarge)

Some of the world's worst offenders of the "twin deficit" include Great Britain, with a budget deficit of 7.9% of GDP and a current account balance of -3.2% of GDP which totals 11.1% of GDP. Greece faces a budget deficit of 7.0% of GDP and a current account balance that is -5% of GDP which totals 12% of GDP.

Both Greece and Great Britain are two countries that have found themselves deep in the ravine with a sun that has now set. Greece has had to deal with draconian measures of austerity, which include tax increases and spending cuts in order to have any chance of paying off their debts and staying in the Eurozone. In Great Britain, austerity programs are expected to last until at least 2018 and the government is expected to unveil a program that entails using so called "tax hitmen" to crack down on tax evasion.

It's not rocket science to appreciate just how the U.S. needs to fix these deficits. In the case of the budget deficit, we have to raise taxes and cut spending. In the case of the trade balance deficit, we need to import less and or export more. The problem is, this is easier said than done and I don't envy the politicians for being in the position to fix this.

The most troubling aspect to our deficit and debt situation is the forthcoming net interest payments. It is estimated that from 2013-2022, we will spend $5.889 trillion on interest. This is more than the total amount the White House expects to spend on non-defence discretionary spending, which is proposed to be $5.682 trillion (see table S-4). It's this interest expense that is what makes getting out of this fiscal ravine next to impossible. This is why I expect some sort of bond crisis to come as early at next year to as late as 2016.

The White House's own budget proposals project a deficit to GDP of 4.7% in 2013 and 3.9% in 2014. They also project on average, from 2013-2022, the deficit to GDP will average 4.2%. That would actually be good and buy some time, but the White House projections are always too optimistic. Do you recall this chart with their projections of unemployment with or without stimulus spending?

(click to enlarge)

Unfortunately, I have very little hope government can resolve our fiscal deficits or our trade deficits and that the markets will eventually solve them for us. By that, I expect as soon as next year to as late as 2016, that the impacts of the "market forces" will result in higher interest rates, just like in Greece, Spain and Italy. At that point, the wolves and coyotes come out demanding both austerity like cuts in social security and medicare and far tighter controls of our financial doings.

It's the confidence that is critical. The confidence that the U.S. will pay her debts off. This is what I see breaking down as a result of our inability to get out of this fiscal ravine.

A lack of confidence in the U.S. credit would result in higher interest rates which would send long term bonds into a panic sell off. So I would not want to own funds like iShares Barclays 20+ Year Treasury Bonds fund (TLT) or any long term bond denominated in U.S. dollars.

Corporate America would see a collapse in aggregate demand if the dollar was to lose a good deal of purchasing power as a result of destroyed confidence in our dollars. That collapse I would imagine would be met with price reductions to attract customers, which would hurt profit margins.

Corporate America may find it more difficult to raise capital and with interest rates higher, the cost of capital increases hurting profits and cash flows as well.

So stock funds like S&P 500 (SPY), Dow Jones Industrial Average (DIA) and Proshares QQQ (QQQ) could also see big drops in prices due to the reasons described above.

Gold and silver should prove a sound hedge against the loss in confidence of the dollar and the government's capacity to deal with the fiscal deficits. A fund like Central Fund of Canada (CEF) can be used in your portfolio for exposure to gold and silver. Buying the physical metal is even better as there would be little counter party risk.

In the near to medium term, 1-5 years out, patiently holding cash might also be prudent while we wait for better opportunities in stocks, real estate and used durable goods.

Source: Will We Get Out Of The Fiscal Ravine?