If you prefer fiscal years to calendar years, this report is not for you. If you prefer reports generated by bureaucrats for bureaucrats, using accounting standards which would make the boys at Enron blush, this report is not for you. For you guys, I'm sure Tim Geithner will have a shiny new 500 page PDF ready for download in a good 10 or 11 months. You can sit in front of the fire with a big mug of cocoa and take in all the pretty charts. For everyone else, pour yourself a strong one and make sure you are sitting down. In this report, we will use raw, unadulterated, cash flow data from the daily treasury statements (DTS) to get a true snapshot of the deficit situation. The DTS is cash, it's near real time, and I believe it's the best data set available for analyzing the deficit without interference from any government accounting funny business.
As mentioned above, we use DTS to identify daily/monthly/annual cash inflows and outflows by category. From there, the only adjustments we make are related to tax refunds. On the DTS, refunds are categorized as outlays. However, what they really represent are reductions in revenue. To correctly account for this, we simply subtract refunds issued from revenues and outlays. Note that this adjustment has no effect on the deficit we calculate, but not making this adjustment would overstate annual revenues and outlays by nearly $400B.
The US cash deficit for 2012 ended up at $1.096T, a $168B improvement over last year's $1.264T, a 13% improvement, but not enough to avoid the fourth consecutive year of trillion dollar deficits.
Looking at the chart we can clearly see slow but steady improvement for three straight years after the deficit topped out at nearly $1.6T in 2009. Accounting for the cash deficit is exceedingly simple. There are no accruals, no depreciation, no goodwill, and certainly no amortization, whatever that is. Cash in less cash out, nothing more, nothing less. So let's dig into the details, starting with revenues.
As I discussed in About That Revenue Problem 2012 posted the highest revenues ever, surpassing even the boom year of 2007 by a solid $60B. At $2.755T, revenues surged 6% over 2011 for a $159B improvement. 2013, with the payroll tax increase on everyone (or expiration if you prefer) and the tax hikes on the "wealthy", should further build on 2012's revenue gains and could get close to $3T, a trend I will be watching closely as the year progresses. Moving on, if revenue increased $159B, and our total deficit decreased by $168B, you can probably guess where annual outlays ended up.
Outlays were nearly flat for the third year in a row. There are a lot of moving pieces, but we see Social Security outlays growing at a pace of about $65B per year and Medicare/Medicaid together increased at about $30B, both trends expected to accelerate. On the other hand, payments to defense vendors were down, as were unemployment benefits, education, and "Other". Looking ahead to 2013, with few spending cuts in the fiscal cliff deal and sequestration likely to be watered down, it seems likely that the categories that saw outlays decrease in 2012 will probably stabilize while outlays will continue to grow in the entitlement programs at around $100B. Add in some spending for "Super Storm" Sandy and whatever disasters 2013 brings our way, and 2013 could get close to the $4T mark for outlays unless there is some fight left in the Republicans and they make a stand on spending before raising the debt limit this February.
Speaking of debt, Treasury Secretary Geithner correctly projected that we would hit the debt ceiling at year end. As I discussed in Geithner Hits Debt Limit Early To Squeeze Republicans there was nothing all that surprising about hitting the limit because the date was always Geithner's to choose by simply issuing debt up to the limit and banking the cash. The true day of reckoning comes when we are at the debt limit, and run out of cash, which will probably be between mid February and early March with the big unknown being whether or not some tax refunds will be delayed and how long.
Over 2012, debt additions totaled $1.210T slightly exceeding 2011 additions of $1.198T. You may notice that the total is now $16.433 while the debt limit is actually $16.394T. There is a small subset of the debt that is not subject to the limit, primarily the discount on debt issued under par. It's not a loophole, more like an accounting technicality.
Looking ahead again to 2013, projecting what will happen isn't exactly rocket science. Revenues will likely increase, I'll eyeball it at $2.95T. Outlays are likely to increase as well, let's put them at $3.95T, leaving 2012 with around a $1T cash deficit and say +/-$100B to cover anything unexpected. Debt will pretty much follow that and we'll add a bit for "Intragovernmental Holdings" and just round it off at $17.5T of debt outstanding at the close of 2013. After over a month of political battle, this is apparently what success looks like, pretty much the same.
The bottom line is that we are still digging our hole at a ferocious pace. We have seen marginal improvement for several years running, but nothing near enough to stop the flood. The American public has spoken, and they simply have no appetite for spending cuts or anything other than symbolic tax increases. Over the last ten years, debt outstanding has increased $10,000B, and it will likely increase at least another $10,000B over the next ten. The recent "cliff deal" of $600B of new taxes on the "wealthy" is utterly inconsequential in the big picture and will hardly even register on the charts at a mere $5B per month.
It is long past time that we stop kidding ourselves. For anyone willing to look, the end to this story is all but written in stone. The United States will default on its on and off balance sheet liabilities at some point in the future. When and how is still quite uncertain. Having the ability to print money, sell our own debt to ourselves, pay ourselves interest on that debt, and manipulate interest rates to zero will certainly help extend the game longer than you would probably expect. But extending the game does not change the outcome. Sooner or later, the game will end, and it is about time that investors seriously start thinking about how that will affect them.
I won't even pretend that I know how it will all play out. The United States "going Greece" is going to be a complex and unpredictable sequence of events with far reaching consequences. Perhaps the last ten years, over which debt increased $10T will provide some insight into what will happen in the next ten. Below is a comparison of prices, in USD between 2002 and 2012. There is nothing scientific about this selection or analysis, but the trend is quite clear. I picked a handful of metals, energy, and food commodities.
All but one, natural gas, has more than doubled in the past ten years, with the average being 3.32X. Compare that to the government's own inflation calculation, CPI, at only 27%. Who are you going to believe, the government, or your lying eyes? 10 years ago, a million dollars invested in 10 year treasuries would earn somewhere around $50k of income a year, enough for a solid middle class retirement. Today, that same million dollars won't even generate $20k of income, right around the poverty line. It seems clear to me that deficits do matter, and that the policies of the last decade are actively destroying the purchasing power of the US dollar, even if official statistics deny it. The headlines of the last decade may have all been about oil, gold, and other commodities hitting highs, but the reality is that the measuring stick, the USD, is simply shrinking.
Going forward, I have to believe that this trend of increasing commodity prices will continue and is likely to accelerate the more obvious it becomes that our government is incapable of fixing the problems. So what is an investor to do? Being in the market does appear to provide some protection over holding dollars, but fell well short of keeping pace with commodities over the last ten years. Individual commodity producers, granted an extremely limited sample, appear to have done better on average, but as always there is risk that individual companies will underperform.
Perhaps then, rather than picking winners, one would be better off avoiding obvious losers. I for one cannot comprehend why anyone would lend money to the US government. Here, you have an entity with on the books debt nearly six times more than their annual revenues, and growing at a trillion dollars a year. There is no capacity for debt repayment, and no prospect for debt repayment in the foreseeable future. Instead, debt will continue to grow at an astonishing rate. Furthermore, they have the ability to not only manipulate interest rates to near zero and print money, both of which they have shown a willingness to do.
Finally, investing in treasuries means that you have some degree of faith in our government. Faith in our congress that has a 20% approval rating. Faith in our political parties who led us into this mess. Faith in our economists who seem to get just about everything wrong. If you still believe treasuries are risk free, I have some Greek bonds I'd love to sell you at par.