Obama’s Budget Makes Bonds Bad Investments

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President Obama’s budget and deficit projections don’t reveal the sick state of U.S. finances, casting serious doubt on the safety of U.S. bonds.

Obama plans significant initiatives in health care, environment, education, and jobs creation. Yet, the private sector, which must be taxed to finance government, is likely to grow slowly, resulting in too much federal borrowing.

To create jobs, businesses need customers and capital—without those they can’t sell what new employees make or buy equipment workers need.

Demand for U.S.-made goods and services remains weak, because Americans spend too many dollars on imported oil and other products that do not return to purchase U.S. exports.

The gapping trade deficit contributed mightily to the Great Recession, and President Obama's Administration offers few plans to turn that around.

After receiving more than $2 trillion in federal aid, the banks are still not lending enough to businesses. Most aid went to about 10 big Wall Street banks, which refuse to perform their traditional function of financing loans through the 8,000 regional banks.

J.P. Morgan (NYSE:JPM), Goldman Sachs (NYSE:GS) and others would rather trade currency futures, energy contracts and other derivatives than engage in the boring business of lending to smaller banks and businesses.

Financial sorcery generated $150 billion in bonuses last year, honest banking is for the stiffs, and little Treasury Secretary Geithner proposes fixes that dysfunction.

Reflecting slack demand and tight credit, economists are predicting substandard growth over the next several years. Something in the range of about 2.6 percent and well below what could be expected from productivity and potential labor force growth.

Yet, President Obama’s budget assumes the U.S. economy will grow 4 percent a year from 2011 through 2014 to bring his $1.6 trillion dollar deficit down to $706 billion.

The tax base will grow more slowly than President Obama assumes, and plans to hike taxes on high-income Americans, while exempting the middle class, must pass the Senate. Scott Brown’s landslide in Massachusetts will curb such populism.

Obama’s freeze on discretionary programs that do not enjoy his pet eye, will yield a paltry $25 billion a year, and his special bank tax only $10 billion.

For years to come, federal finances will likely look a lot like Obama’s 2010 projection—the deficit at more than 50 percent of revenues and the Treasury borrowing $100 billion every month.

Moody’s would be hard pressed to give any government with budget projections like those an investment grade rating, but the United States is different.

The Federal Reserve can print dollars if no one wants to buy new Treasuries, because the dollar is the global currency. But U.S. bonds are still risky.

Internationally, interest-bearing Treasuries function much like currency. Whether as Treasuries or currency, too many dollars will instigate inflation as the global economy recovers.

Just the fear of inflation causes investors to demand higher interest rates.

As Washington spends and borrows, the Treasury will be compelled to pay higher rates on new 10 and 20 year bonds, making securities issued in 2010 and earlier worth less in the resale market.

That interest rate risk makes U.S. Treasury securities lousy investments.

Washington’s monopoly on printing dollars makes difficult assigning U.S. Treasuries a conventional rating between AAA and D. Those bonds can’t default, but investors’ capital remains at risk.

Perhaps a special grade: “F” - flee now before you get stuck.

Disclosure: no positions