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Debt Ceiling Dilemma: The Foul Choice Investors Are Facing


Ben Bernanke has managed to combine both negative returns and risk into a very unattractive investment brew.

However, we can be almost certain that their baseline assumptions about GDP and revenue growth that undergird the putative future deficit levels are unrealistic. They always are in these sorts of circumstances, which means the amount of future savings being bandied about are unlikely to be as robust as claimed.

For example, the most recent CBO budget projections (the foundation upon which the deficit reduction proposals are most likely built), assume that over the next five years (2011–2016) that revenue will grow at a compounded rate of 11.4% per annum (!), expenses by 3.9% and GDP by a whopping 4.95%.

Per year!


These assumptions are just silly. Costs have risen much faster, and revenue and GDP far slower, over the prior five years, and if these pie-in-the-sky projections do not come to pass then all of the deficit numbers will blow out to the upside in those future years.

For example, if we assume that GDP growth is 2.5% per annum instead of nearly 5% (and that revenues are tied to GDP),and that revenues will therefore "only" increase by 5% per annum (both completely reasonable assumptions at this stage) then the additional cumulative deficit that will accrue between 2011 and 2016 is $2.7 trillion dollars.

That will completely eliminate all of the projected savings from even the most aggressive of the proposals on the table. Is this unlikely? No, in fact these are a far more defensible set of assumptions than those currently being put forth by the CBO.

To really make a mockery of the current budget projections, there is absolutely no chance of the government both cutting its share of GDP by 2% per year and having the GDP grow by nearly 5% per year. Implied is a rate of economic growth in the private sector that would be truly extraordinary. Further, there is no chance of revenues climbing by more than 11% per year over the next five years without an enormous increase in taxes, which neither party is currently proposing.

In short, without knowing the underlying assumptions that are driving the projections, we cannot say much about the proposals themselves. All I can tell you for sure is that for as long as I have been crunching government numbers, taking their rosy projections and cutting them in half has always been a reliable and reasonable starting point.

A Dawning Awareness

What should not be lost on anyone is the degree to which some of the biggest names in the financial world are starting to openly question fiat money and the entire system of debt itself. They're even doing it on TV, in prime time and on the op-ed pages of the largest newspapers.

Again, by the time we are seeing such open questioning of the very firmament of the entire system, this tells us something about how far along in the narrative we really are. Just a few years ago such talk would have been relegated to the very fringes of the blogosphere.

Here are a few recent examples:

Debt talk damage has already been done.

As Washington dithers over raising the nation's debt ceiling, investor confidence is flowing away.

"The issue is not just whether Moody's or Standard and Poor's were to downgrade (U.S. Treasury debt), it's whether the market decides to downgrade," said Rochdale Securities bank analyst Richard Bove.

"If they lose faith in the Congress and the government to, in essence, create a solid security for the buyers of that security, then you get the downgrade," he said.

The sentiment was echoed overseas, where many countries hold U.S. Treasuries as an investment. "An adverse shock in the United States could have serious spillovers on the rest of the world," warned Christine Lagarde, the managing director of the International Monetary Fund.

"We live in a highly interconnected international financial world that is really based upon confidence," said financial services industry lobbyist Paul Equale.

"And without confidence, both domestically and internationally - that the United States is mature enough and has a system that can handle making the big decisions - without that confidence we're going to see things like the dollar becoming less important as the world's reserve currency."

Debt-based fiat money relies on multiple levels of confidence. There has to be confidence that the money will not be over-produced in response to every perceived crisis (oops), that its allocation is justified and fair to all parties when it is placed into circulation (oops, again), and there has to be confidence that the future will be exponentially larger than the past to justify ever-increasing levels of debt (this is the big "oops").

We are drawing ever closer to the recognition that endless growth is simply neither possible nor a reasonable expectation. There are even doubts now that growth as we've recently know it will return for one last cameo appearance over the next five to 10 years.

With the evaporation of that all-important narrative of growth, everything else becomes immediately suspect, especially money itself.

Sometimes you will hear or read someone exclaim that ever since the slamming of the gold window in 1971 that US dollars are not backed by anything. This is not true, they are backed by debt. Debt is an incredible motivator and assures that the person, entity or country under its yoke will dedicate some portion of their productive efforts towards servicing that debt.

Another Big Round Number (and a Nice Symmetry)

On August 15, 2011 we experience the 40th anniversary of the slamming of the gold window back on the same date in 1971. Perhaps we should all bow our heads and have a silent moment to mark the occasion.

Interestingly, that's almost exactly the date, give or take a few days, on which the US Treasury will run out of money here in 2011:

"We don't think there will be a default," Ahrens, head of U.S. rates strategy for UBS in Stamford, Connecticut, said yesterday in a telephone interview. He estimates the Treasury has enough cash to make all payments until Aug. 8-10.


Forty years between a final abandonment of the last vestige of external restraint on money/credit creation and the dawning recognition that the US has simply gone too far, spent too much, and is now in an enormous fiscal predicament. In the annals of history that's just about right for the lifespan of a purely fiat currency.

Mark the date on your calendars: I'll certainly be observing the anniversary. Forty is a big, round number and therefore important.

Follow Chris Martenson on Twitter @CHMartenson.

No positions in stocks mentioned.

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