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Debt Meter: USA Structural Deficits to inspire bond vigilante crisis in 2022

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After a decade of monitoring the issue, TrendLines Research began publishing alerts in early 2009 warning that the USA Federal Government is headed for an inevitable Investor Crisis with respect to its treasury auctions.  With concern over the integrity of sovereign debt, bond vigilantes are increasingly monitoring Deficit/GDP & National Debt/GDP ratios.  It appears the current Wall Street spotlight on European nations will be donned on American Treasury activities within twelve short years.

This time line has been extended three years from our last update by the apparent current sentiment within Congress to extend the Bush tax cuts set to expire at year end.  Today's chart projections, with a significantly lower ultimate deficit and accumulated Debt in 2040, assumes no intervention by the November deadline.  This is a very positive development that could chop over two trillion dollars off the accumulated Debt by 2020.

Due to an increasingly corrupt electoral system, members of Congress and successive Presidents appear beholden to donators to their multi-million dollar fundraising campaigns.  Add in immense lobbying activities to the fray, and we see legislation catering to the social engineering agenda of the Progressive left and providing obscene levels of subsidies and favours to corporate and union sectors.  Partisanship has become polarizing to the point that some legislation efforts are seen to have become dysfunctional.

As a result, the Federal Gov't is on a path that would double today's $13-trillion National Debt by 2025, and triple it by 2034.  Bad as that sounds, refusal to extend the Bush tax cuts would hold the Debt/GDP ratio virtually constant @ 93% (it's 91% today).  Most buyers of US Treasuries are unaware of these precise numbers, but they have had a sense for a while that America's fiscal well being is suffering from substantial mismanagement.

Albeit the time line is open to subjective interpretation, foreign Investors are cognizant continued failure to address this behemoth will lead to:  (a) demands for increased interest rates on Treasury notes;  (b) select offerings in alternative currencies;  (c) rating downgrades;  (d) still higher yields ... perhaps 4% greater than today; & (e) the temporary shunning of Treasury Auctions by tier-1 buyers in an effort to stage an intervention.

Clues to the proximity of another and almost inevitable American financial crisis can be found via the trend of the USDollar exchange rate.  Misgivings in the commitment of Congress & the Administration in addressing their Deficit/Debt responsibilities began in January 2002.  In the succeeding six years, the disfavoured currency plunged 46% from its USA:EUR rate of 1.16 to 0.63.  The secular decline was interrupted in 2008 by safe haven seekers during Russia's incursion into Georgia & the Liquidity Crisis; but the trend resumed in March 2009.  Mass withdrawal of foreign (and some domestic) buyers of Treasuries will be known to be imminent upon deterioration of the USA:EUR exchange rate to new lows.

Left unimpeded, the rise in Debt interest, unfunded Social Security liabilities,  Entitlements for Medicare/Medicaid and Universal Health Care would drive the National Debt to $51 trillion over the next 30 years.  On the very short term, there is definite relief.  Albeit the 2010 $1.3 trillion Budget Deficit represents a scary 9% of GDP, our analysis of CBO costing of the current Obama ten-year Budget indicates the ratio will decline to "only" 2.5% ($440 billion) by 2014 as programs dealing with the liquidity crisis (TARP etc) and the Recession (fiscal stimulus) and the full Bush tax cuts expire.  This virtually guarantees the stability of Treasury sales to both domestic & international investors over the next 48 months.

Discussions surrounding the 2015-2025 Budget will see resumption of very heated debate ... domestically and across the globe.  The Deficit/GDP ratio is scheduled to drift back to 4.2% and hold at that level.  It will become common knowledge that no reprieves are apparent over the next 25 years.  Somewhere along the way, Congress will be forced to acknowledge that the raising of new funds is having diminishing returns due to the realities of compound interest.

As part of a diversionary tactic that started in February, Wall Street & Cable News have been engaged in faux outrage at the prospect of Greece's 14% Deficit/GDP & 115% Debt/GDP ratios, accompanied by mucho finger-pointing at the other PIIGS.  Congress got away with its own extravagance this time 'cuz it was a sanctioned spike deemed necessary by the G-8 & G-20 to avert an economic Depression.  But the future episode will clearly be a child of structural Deficit budgeting.

With its 10-year horizon, the Pelosi-Reid-Obama Budget process has shone a light on the whole structural deficit issue that TrendLines has been raising awareness about for almost a decade.  The foundations cross several administrations.  Hopefully, closer Media & think-tank scrutiny will spawn anticipatory action by a more fiscally responsible Congress and/or President.  Hey, at least they formed a non-partisan committed in March!  If action is not forthcoming, current CBO data indicates that left unchecked, the annual Deficit rockets to $3.3 trillion by 2040, $3.5 trillion by 2050 & $16.5 trillion by 2075.  Meanwhile, the National Debt surges to $81 trillion & $312 trillion respectively by the latter two dates.

Gratefully, this "would/could/might" scenario is only an academic exercise.  If Congress fails to address this issue responsibly, most of the foreign and even some domestic players will simply withdraw temporarily and shun the Treasury Auctions that fund "the habit".  The dark and ominous path illustrated in the chart will be truncated when these Investors sense the Federal Gov't is approaching tipping points where they deem it prudent to exit the venue.

Weighing the USA's situation, TrendLines Research judges such an Investor Crisis will occur in 2022 ... with the National Debt @ 91% of GDP and the Deficit @ 4.2%.  That's only twelve years away.

The unholy alliance between Wall Street, Cable News (and possibly the White House) has been sly in diverting scrutiny away from itself by a smoke&mirrors campaign highlighting poor financial fundamentals in Argentina, Iceland, Dubai-UAE, Greece, Ireland,  Spain, Hungary, Portugal & Italy.  When they run out of countries, be assured the same scrutiny will be applied to the fiscal soundness of the USA.  TrendLines Research takes the position the spotlight is in fact back on USA already by the savvy, and in increased awareness, and there has been a resumption of the secular decline of the USDollar.  The  recent safe haven moves escalated the USDollar to 0.83, but it has already drifted back to 0.77 vicinity.

Present trajectory suggests new lows for the USDollar will occur prior to the end of the decade.  A more aggressive scenario (reflected via our Barrel Meter) predicts an accelerated version of this crisis, with the USDollar plunging to 0.62 (= 1.61) by 2011Q4.  Such a EURO spike would certainly act as a wake-up call for policy makers, bringing about immediate intervention strategies to initiate a prompt retreat.  I am confident the crisis won't last long and the Dollar will bounce back.

On the positive side, the string of USA Export records seen in 2006/2007 should resurface in early 2011 as importers see nicer prices.  Manufacturing could also surprise when domestic consumers start to shun high priced foreign goods and associated ever increasing transportation costs of those products.  With a corrected trade surplus, crude oil back to $56/barrel, and an bi-partisan agenda towards fiscal responsibility, the USA will begin the long road back.  Towards that end, and before the 30-yr bond is declared junk status, President Obama has set up a bipartisan commission tasked with recommending mitigation options.  In a July 28th hearing they revealed that by present projections, 1/4 of Social Security recipients must be dropped by 2037 to maintain the plan's integrity.  Consensus of submissions has been consistent with most agreeing a 60% Debt/GDP ratio should be sought by 2018-2022.

 



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