Prepare and Prosper From These Greatest of Crises

The greatest fiscal nightmare of all time — a $1.6 trillion deficit for 2010, another $1.3 trillion in red ink for 2011, and continuing massive deficits until 2020 – as presented by the Office of Budget and Management (OMB) is going to be even worse – by $1.2 trillion – according to the nonpartisan Congressional Budget Office (CBO) who maintain that the OMB’s view that federal deficits will fall below 4 percent of GDP by the middle of the decade is wishful thinking. They contend that the deficits will start growing rapidly after 2015, forcing the Treasury to continue borrowing lavishly and sending the national debt soaring to 90 percent of GDP. Words: 1017

In further edited excerpts the original article* Martin Weiss (www.moneyandmarkets.com) goes on to say:

Unfortunately, however, even these new, uglier numbers from the CBO suffer from serious deficiencies in their underlying assumptions. They assume:
1. No double-dip recession in 2010, 2011, or any other time in this decade — a scenario that a growing number economists consider highly unlikely …
2. No significant rise in unemployment benefit costs and no declines in corporate tax revenues — inevitable consequences of a weaker-than-expected economy …
3. No selling — or even reduced buying — of U.S. government debt by foreign creditors, and …
4. No resulting spike in the government’s borrowing costs — a scenario that’s very hard to imagine in the wake of the huge deficits already cited in their reports.

In summary, neither the White House nor the CBO have adequately considered the real impact of the very deficits they themselves are projecting. While they admit the deficits will be off the charts they fail to connect the dots from that admission to its obvious natural consequences — no fewer than FIVE ominous, vicious cycles …

Vicious Cycle #1: Surging Interest Rates
a) Big deficits drive interest rates higher.
b) Rising interest costs create still bigger deficits.
c) These bigger deficits drive rates even higher.

Vicious Cycle #2: Credit Squeeze
a) Government borrowing and higher interest rates literally shove consumers and businesses out of the credit market.
b) Consumer and businesses, unable to borrow, slash spending and gut corporate earnings.
c) The government sees tax revenues collapse, rushes to borrow still more to fill the growing budget gap, and drives interest rates surge even higher.
d) The cycle accelerates.

Vicious Cycle #3: Unemployment
a) Bigger deficits crush the economy, and unemployment rises.
b) Rising unemployment forces the government to spend far more for jobless and other social benefits.
c) These surging costs bloat the deficit even more, squeezing the economy even further … adding to the ranks of the unemployed … and causing still larger federal deficits.

Vicious Cycle #4: Global Selling
a) The dire outlook for the U.S. budget and economy prompt the nation’s creditors — especially those overseas — to reduce their purchases of U.S. government bonds, or worse, our creditors start dumping their existing holdings.
b) Global demand for U.S. debt — issued by the U.S. Treasury and government-run agencies — plunges.
c) The Federal Reserve seeks to replace that demand by buying U.S. government securities for its own account, printing vast amounts of U.S. dollars to finance its purchases.
d) This rampant money printing sends the signal that the U.S. is, in effect, intent on effectively defaulting by paying back creditors with devalued dollars.
e) Fear of the de facto default by the U.S. government drives America’s creditors to dump more of their U.S. bonds … prompting the Fed to print still more money … and pushing creditors into an even greater bond-selling frenzy.

Ultimately, these vicious cycles speed up beyond the threshold of absurdity. The government reaches the end of the line, its final day of reckoning. It cannot borrow without driving interest rates to a level beyond which borrowing becomes virtually impossible. It cannot collect enough tax money without bankrupting the very taxpayers it’s trying to tap. It cannot print enough money fast enough to replace the money its creditors are pulling out for fear of money printing. Its back is against the wall. It has no choice but to do what it should have done from the outset — cut back, and do so massively.

Alas, it’s the above conundrums that lead to:

Vicious Cycle #5: Massive Government Cutbacks!
a) The U.S. government has no choice but to slash spending and to do so aggressively involuntarily depressing the economy with cutbacks.
b) The sinking economy bloats the federal deficit one last time, forcing a final round of Draconian cutbacks.

Summary
In the never-ending yin-yang of history, however, it is out of the worst of times that we have the potential to get the best of outcomes and it is in this disaster — no matter how painful in the near term — that I see the greatest hope for America’s long-term recovery.

These worst of times will:
a) punish an entire generation of borrowers and spenders but it will also teach a new generation the value of work, savings, and sacrifice.
b) push America to its limits but it will also spur its citizens to rise to the challenge, much as they did in worse wars and deeper financial crises of prior centuries and
c) devastate investors who are complacent.

That may be so, but it could also richly reward those who are well prepared and who can transform the greatest of crises into the greatest of opportunities.

*http://www.moneyandmarkets.com/gravest-dangers-and-greatest-profits-38184 (Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. To view archives or subscribe, visit http://www.moneyandmarkets.com.)

Editor’s Note:
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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