TIMETOREBUILDTHEARK:

WhytheU.S.cannotGrowoutofitsDebt.
As we watch the European Union struggle with the high debt burdens of several of its members, one pondersifasimilarscenariocouldoccurintheUS.TheUSNationaldebtisapproximately$14Trillion andgrowing.TheGDPisestimatedat$14.7Trillion.AmericasDebttoGDPratioiscurrentlyat95% andclimbing.ThequestioniswhatdoesthistrulymeantotheaverageAmericanandiftheDebtistruly aproblem,whatstepsmustwetaketocorrectit?Thisisnotaboutpoliticalideology.Thesenumbers aretellingtheirownstoryandthestoryiscompelling. During a discussion about the Deficit over lunch in December, 2009 with one of Colorados Congressmen,theCongressmancasuallystatedthattheUSwill growitswayoutoftheDebt. That statement,althoughsoundedrational,raisedseveralflagsinmymind.Coulditbethateasy?Thisshort analysis will discuss the Debt, the reporting of the Debt by the various Governmental Agencies, and outlinetwoscenarioswhichmodelthefinancialimpactoftheDebt.Referencestothedataandvarious sourcesofinformationareincluded.Youareencouragedtoinvestigatethisissueandmakeyourown evaluationofthedata.Formanypeoplewhohavenevergivenmuchthoughtto thesubject,whatis containedhereinmayturnouttobeaseriouswakeupcall.

1.UNSUSTAINABLEPATH
EveryGovernmentagencyisprojectingthatthecurrentpolicycourseisunsustainable.Why? Figure1:ProjectedFutureInterestCostsonDebt(2010TreasuryReport)

http://www.fms.treas.gov/fr/index.html

Spending under current law for Medicare, Medicaid, and Social Security is expected to grow much fasterthanGDPoverthenext75yearsashealthcarecostsriseandthepopulationages.Revenues,on theotherhand,areexpectedtogrowonlymodestlyfasterthanGDP.Together,thesetwotrendsimply that without policy changes, the difference between spending and revenues (the budget deficit) will grow larger as a share of GDP. These estimates illustrate that current policies are not sustainable. InterestaloneontheDebtisprojectedtosoarbyboththeTreasuryandCBO(Figure1). Figure2:ProjectedGrowthoftheUSDebt(2010TreasuryReport)

During World War II, there was a huge national effort to buy War Bonds to support the War effort. Althoughtimeshavechanged,everyoneknowsthefullscenarioshowninFigure2isunachievable. EveryagencyhasstatedthatthecurrenteconomicpoliciesoftheUSGovernmentarechartingacourse foreconomicdisaster.Apparently,thequestionisnotif,butwhen?Gettingtothebottomofthe whenissuewasthequestofthisstudy.

2.NATIONALDEFICIT&DEBT
Beforewecananswerthatquestion,weneedsomebackgroundfirst.TheCongressionalBudgetOffice providesCongresswiththeannualbudgetandDeficitnumbers.TheCBOstatestheUS2010Deficitwas $1.342Trillion,withacumulativedebttotalof$8,797Trillion.(http://www.cbo.gov/budget/budget.cfm) TheTreasuryDepartmentprovidesTotalPublicDebtOutstanding.Onewouldnaturallyassumethe Treasury would take the CBOs annual Deficit numbers every year and add them to the prior years TotalPublicDebtOutstandingnumbertoarriveatthetotalUSdebtnumber.However,onequickly realizesthereportedCBODeficitnumbersarefarsmallerthanthosereportedbytheTreasuryforthe sametimeperiod.Asanexample,theCBOreportedthe2008BudgetDeficitwas$455Billionwhilethe Treasury reported it at $1.015 Trillion. As stated above, the Total Public Debt as of the end of fiscal

2010, as reported by the CBO, was $8.797 Trillion, while the Treasury reported it at $13.562 Trillion. (http://www.treasurydirect.gov/NP/BPDLogin?application=np) WhyisthereanydiscrepancybetweenthesetwoGovernmentsources,letaloneofthismagnitude? Figure3:CurrentDebtasreportedbytheTreasury(January14,2011)

Figure4:UnitedStatesAnnualBudgetDeficit

 Interestinglyenough,thetermDeficit,asusedbytheCBO,isdefinedbyCongress.TheCBODeficit numbersessentiallyonlyincludenumbersreferredtobytheTreasuryasDebtHeldbythePublic,and donotincludeIntragovernmentalHoldings.Thedifferencebetweenthesetwoaccountingschemesis visuallyapparentasseeninFigure4. DebtHeldbythePublicisthatportionofthedebtwhichisfinancedbytheTreasurythroughseveral types of Treasury Securities. These securities are publically traded and purchased by individuals, financialinstitutions,States,localandforeigngovernments.CurrentlyChinaandJapanhold17%ofall USDebtheldbythePublic.(http://www.ustreas.gov/tic/mfh.txt) IntragovernmentalHoldingsisdebttiedtoborrowingofthecashsurpluswithintheSocialSecurity& Medicarefunds.Until2010,SocialSecuritywastakinginmoremoneythanitsoutlays.Medicarehas enteredintotheredin2007(Figure5).Foryears,thesurplusfundswereplacedintotheSocialSecurity & Medicare Trust Funds. In order to decrease the amount of money the Treasury borrows from the public, the Treasury has sucked the surplus cash funds out of the Social Security and Medicare Lock Boxes and replaced the cash with nontradable Treasury IOUs called Government Account Series. NowthatSSpayrolltaxesarelessthanoutlays,SSwillstartredeemingtheTreasuryIOUstofundthe balance. To obtain the needed cash, the Treasury will have to raise the needed funds by selling Treasuriestothepublic(DebtHeldbythePublic).Tosaythissimply,therearenocashholdingsinthe SSorMedicareTrustFunds,therearenoexcesscashreservesstackedupintheTreasurysvaults,and nowthatthepayrolltaxreceiptsarelessthanoutlays,theGovernmentwillhavetofundthedifference withmorePublicDebt. Figure5:SocialSecuritywillfallintoDeficitSpendingthisDecade

200 Billions of 2007 dollars 100 0 -100 -200 -300 -400 -500 -600 -700 -800 -900 2005 2010 2015

Social Security cash deficit 2017

Medicare HI cash deficit 2007

2020

2025

2030

2035

2040

Figure6showstheimpactoftheeconomiccrisisonSocialSecuritypayrolltaxes.Astheresultoflower taxcollections,SocialSecuritywillfallintoDeficitspending6yearsaheadofearlierestimates. Figure6:The2008EconomicMeltdownAcceleratedSocialSecurityDeficitDate(CBO)

Miscellaneous Budget Exclusions are those Federal expenditures not reported by the CBO Budget numbersandmayormaynotshowupundertheIntragovernmentalDebtcategory. Specificexclusionswhichdonotshowupineitherdebtnumberarethosefinancialoutlaystobailout Fannie MaeandFreddieMac,asoutlinedintheHousingandEconomic RecoveryActof2008.Atthe time the conservatorship was put in place, the obligations were just over $5 Trillion. Most of these fundshavebeenrepaid.However,allofthesemoniesareexcludedfromallDebtnumbersreportedby boththeCBOandtheTreasury. In addition, the Temporary Liquidity Guarantee Program guaranteed large amounts of obligations by banks, mutual funds and certain corporations. These guarantees are offbalance sheet and therefore arealsoexcludedinthecalculationoffederaldebt. SupplementalAppropriationsarepassedbyCongressinemergencysituationsandareexemptfrom Congressional Budget enforcement rules. Disaster relief is one example. However, the Supplemental AppropriationsoptionhasbeenhistoricallymisusedbyCongress.Asexample,mostofthecostsofthe IraqiandAfghanistanwarshavebeenfundedbySupplementalAppropriationsandhavenotshownupin theCBOBudgetanddeficitnumbers.CBOestimatesthatappropriationsforoperationsinAfghanistan andIraqsince2001throughFebruary2008total$752billion.PresidentObamawasrequiringthecosts ofthewartobeincludedwithinthe2010FederalBudget.(http://cbo.gov/ftpdocs/89xx/doc8971/Letter.2.1.shtml)

SincethereareinsufficienttaxreceiptstocovertheCBOsreportedbudget,alloftheIntragovernmental Holdings, Miscellaneous Budget Exclusions, Supplemental Appropriations and Earmarks are all funded bydebt.Evenmoreinteresting,eventhoughallfourcategorieslistedabovearefunded100%through debt,allsuchdebtisspecificallyexcludedfromtheCBOdeficitnumbers. During many years since 1996, the Treasury annual deficit numbers are 2X larger than the Deficit numbersasreportedbytheCBO.AquickwaytoevaluatewhetherananalysisisusingCBOorTreasury deficit numbers is to always look at year 2000 (see Figure 1). The CBO reports the US tax receipts exceededexpenditures(theUSwaspayingdownthedebt).TheTreasuryshowstheUSactuallyranan $18 Billion deficit that year (Figure 4). Anytime an analysis shows tax receipts were greater than expenditures in year 2000, then you will immediately know the CBOs numbers were used and only a fractionoftheactualDebtwasincorporatedinthatanalysis. Apersonquicklyrealizes,afterworkingwithGovernmentaccountingdata,thatGovernmentaccounting andstatisticsareoftensetuptomisleadyou.Inmostcases,theGovernmentattemptstopaintarosier picturethanreality.

(CBOforwardlookingbudgetprojections,2011.Notethesurplusshownforyear2000.)

3.DEBTTOGDPRATIO
100% of all US Governmental Public Debt is interestonly cumulative debt and will never be paid off. When a Treasury note matures, the outstanding principal is paid off with new debt. This is why you neverseeareductioninUSDebt.TheUSDebtalwayscontinuestogrow. HowevertheDebttoGDPratiodoesvary.AttheendofWWIItheDebttoGDPratiowasgreaterthan 100%(Figure8).Duringtheyearsfollowing,theGDPgrewsignificantlywhiledeficitspendingduringthe sameperiodwasnearlyeliminated.TheDebttoGDPratiodeclined,fallingtothelow30sbythemid 1970s(Figure8).ThisrelationshipisknownasGrowingoutofDebt.ThequestionisCanwedoit again? TheGAOhasestimatedthatdoubledigitGDPgrowthwouldberequiredforthenext75yearstogrow outoftheDebt.http://www.gao.gov/cghome/d08446cg.pdf

 U.S.GDPgrowthaveraged2.7%from1990to2008(WorldBankdata,Figure7). Figure7:Annual%GrowthintheUSGDP(WorldBankData)
8 7

ANNUAL % GROWTH IN GDP

6 5 4 3 2 1 0 -1 -2 -3
1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Year
(Data:http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG)

(AnnualpercentagegrowthrateofGDPatmarketpricesbasedonconstantlocalcurrency.Aggregates arebasedonconstant2000U.S.dollars.GDPisthesumofgrossvalueaddedbyallresidentproducersin theeconomyplusanyproducttaxesandminusanysubsidiesnotincludedinthevalueoftheproducts. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. Source: World Bank national accounts data, and OECD National Accountsdatafiles.) AlsonotedinFigure8istheNetGDPGrowthovertheDeficitSpendingcurve.TheGDPwillusually grow with increased Deficit Spending, however, if the annual GDP growth is less than the deficit spending,thenthe%DebttoGDPratiowillrise.AsseeninFigure8,theNetGDPgrowthoverDeficit Spending was in the positive and averaged $100 Billion/year from 1980 to 2008 (ignoring the 2008 financialcollapse).ThismeansiftheDeficitSpendingwas$1.63Trilliondollarsin2010,itwilltake16 yearsofNetGDPgrowth($100Billion/year)justtogetbacktowherewestartedatthebeginningofthis fiscalyear(ignoringtheinterestonthe$1.6T). ItiscleartheUSwillnotbeabletogrowoutofthedebt.

 Figure8:PercentageofDebttoGDP(http://www.bea.gov/national/index.htm#gdp)
2500

WWII
2000

1500

32%
1000

500
Net GDP Growth Over Deficit ($B)

120 110 100 90 80 70 60 50 40 30 20 10 0

-500

-1000

-1500

-2000

-2500

NIXON FORD CARTER

REAGAN

BUSH SR.

CLINTON

BUSH JR.

OBAMA

4.GROWTHOFTHEMONEYSUPPLY
Since October, 2008, the U.S. monetary base has more than doubled (Figure 9). One would naturally thinkitwouldleadtothedevaluationoftheDollar,orobviousinflation.Sofarinterestratesremainat nearhistoriclows. However,pricesofcertaincommoditieshavedoubledduringthistimeperiod,includingoil,gold,copper etc.,whiledeflationisoccurringwithhousingandequities.Sowhatishappening? GDP=M*V,whereMismoneysupplyandVisVelocityofmoney(therateinwhichmoneyislentand movesthroughtheeconomy).Themoneysupplydoubledin2009,andyettheGDPfell,whichseemsto indicatethatthevelocityofmoneyhadtosignificantlydecrease.AsTomZanecchiastatesinaprivate memorandum he wrote Currently, banks can borrow from the Fed at near zero interest rates and reinvesttheproceedsinUSTreasurysecuritiesyielding3%to4%.Thereisnoincentivetolendfroman investment perspective as there is significantly less risk investing in Treasuries versus individual or commercial loans. In addition, as one bank owner we know states, the contradictory demands to increase loans while bank regulators continue to take harder looks at loans adds another layer of

paralysis. This is the policy problem for the Fed. They have increased money supply substantially. Normally, banks would then multiply the money by lending it out, increasing velocity. But that is not happening. Bank lending has fallen percentage wise the most in almost 70 years and is still falling at about15%annualizedin2010.Ouch. Figure9:MonetaryBaseoftheUSfrom1980to2011

http://research.stlouisfed.org/fred2/series/BASE

SowhenwilltheFedborrowingslowdownand thecommercial lendingbuild?Thisisa keyquestion when making future GDP predications. Future GDP predications are the essential ingredient when formulatingfuturetaxreceiptspredictions.

5.TWOECONOMICPROJECTIONSENARIOS
TheCBOprovidesCongresswithaforwardlookingprojectionofthebudget.Thebudgetisbrokendown into three basic areas: Mandatory expenditures (Social Security, Medicare, Medicaid, and Military retirementetc.);DiscretionaryExpenditures(Defense,roads,education,subsidiesetc.);andintereston theDebt. As stated in Section 2 herein (National Deficit & Debt), items like Supplemental Appropriations, Earmarks,MiscellaneousBudgetExclusions,andallIntragovernmentalLendingarespecificallyexcluded from the CBO numbers and projections. Excluding these items makes the CBO projections deceptive and overly optimistic. The goal of this evaluation was to attempt to create a more realistic forward lookingprediction. However,inaneffortnottodivergefarfromtheCBOnumbers,onlytwovariablesweremodifiedand thefollowing#1through5datawereusedinallmodeledscenarios:

1. CBOhistoricalandfutureprojectedbudgetedexpenditures; 2. Belowisthe2010CBOprojectedtaxreceiptpercentagesoftheGDP: 2010 16.48% 2011 17.32% 2012 18.06% 2013 18.30% 2014 18.31% 2015 18.45% 2016 18.55% 2017 18.63% 2018 18.69% 2019 18.80% 3. Below is the revised 2011 CBO projected tax receipt percentages of the GDP. In one year, pleasenotehowtheCBOINCREASEDthepercentageapproximately1.5%: 2011 17.48% 2012 18.73% 2013 19.37% 2014 20.05% 2015 20.09% 2016 20.38% 2017 20.59% 2018 20.76% 2019 20.90% 4. CBOGDPforfiscalyear2010(GDPstartpointusedforallmodeledscenarios):$14.750Trillion; 5. CBOhistoricaldeficitdataforyearspriorto2010; 6. Treasuryestimated2010deficitof$1.63Trillion. A) Variable1:FutureGDPPrediction TheCBOestimatedtheU.S.GDPfortheyears2011to2019.Projectedtaxreceiptsarebasedupon apercentageoftheprojectedGDP.TheannualgrowthoftheGDP,assumedintheCBOsprojection forecastsare: 2011 2.8475% 2012 4.0620% 2013 5.9740% 2014 6.3112% 2015 4.9014% 2016 4.7112% 2017 4.5638% 2018 4.3877% 2019 4.2830% Are the CBO numbers realistic or optimistic? If they are optimistic, future tax receipts will be overstated.

A study completed of more than 250 historical crises in 66 countries details the relationship of governmentdebttoGDP:
Real GDP growth as level of government debt varies
Select advanced economies (1790-2009)
Central (federal) government debt/GDP Below 30% Average Median Number of observations 3.7 3.9 866 30% to 60% 3.0 3.1 654 60% to 90% 3.4 2.8 445 90% and above 1.7 1.9 352

Select emerging market economies (1900-2009)

Central (federal) government debt/GDP Below 30% Average Median Number of observations 4.3 4.5 686 30% to 60% 4.1 4.4 450 60% to 90% 4.2 4.5 148 90% and above 1.0 2.9 113

(Source: "Growth in a Time of Debt" by Carmen M. Reinhart and Kenneth S. Rogoff as of January 7, 2010)

Ifthisistrue,thenasanadvancedeconomy,theU.S.GDPcannotbeexpectedtohavelongtermgrowth beyond2%goingforward. Therefore,itwasclearthatonekeycriterionneedingtobemodeledwastheannualgrowthrateofthe GDP.TheannualgrowthratewasloweredfromtheCBOs4%to6%growthprojectionsdownto2.0%. DecreasingtheGDPlowerstheprojectedtaxreceipts,andhenceraisestheprojecteddeficit. B) Variable2:FutureInterestRatesPrediction TheCBOestimatedthefutureinterestrateonthedebttoaverage3.2%in2010andincreaseto3.8%by 2019.Mostpeoplesuspectinterestratesaregoingtoriseduetothedoublingofthemoneysupplyand thehugeprojecteddeficitspending.InordertoattractinvestormoneytotheincreasingTreasurysales, higher interest rates will be required by the investor. Currently interest rates are extremely low as investorsfleeEuropeandebttomoresecurehavens,andalsoduetobankpurchases.AstheU.S.debt continuestoclimb,Treasurysecuritieswillmostlikelylooklessfavorable. Interestrateswerethesecondkeycriteriontobespecificallymodeled.Interestrateswereincreased from3.2%in2010to5.4%in2019.Ahighinflationscenariowasaddedbytakinginterestratesfrom 3.2%in2010to12%in2019.Thehighinflationscenarioisnotrealisticbecauseitisalmostimpossible tomodeltaxreceiptsaccurately.Regardless,theimpactofhighinflationisveryapparentandgivesa reasonwhytheFedsareworkingtokeepinterestratesdown.

 SENARIO1:TheCBOBaseCaseForecast The CBO Budget, interest rate, and tax receipt projections, combined with the historic CBO debt data wereusedtocompilethe Scenario1projection.In essenceitshowsastablefuturewithtaxreceipts stayingupwithgrowthinspending(Figure10). Before you get too excited, one must realize a number of expenditures are missing, including the Intragovernmentalborrowing,SupplementalAppropriationsandearmarks.ItalsoincludesGDPgrowth ratesnotseeninrecenthistory,andrequiresthecontinuationofnearhistoriclowinterestratesonthe debt. This is the only scenario which displays a stable forecast for this decade. The Budget numbers usedhereindonotincludetheprojectedbudgetanddeficitcostsofthenewObamaCareentitlement program(freehealthcareforover30millionpeoplelivingintheU.S.). Figure10:CBOBasedProjectedBudgetandTaxForecast

CBO Projected Budget (2011)

8000 7000 6000 5000 4000 3000 2000 1000 0 1970 1980 1990 2000 2010
Note the incredible rate of growth in projected tax receipts CBO shows tax receipts exceeded expenditures. This is accounting trickery. The surplus never occurred.

Projected

3.2% inc. to 3.8%

Total Tax Receipts

2020

Year

 SENARIO2:The2%GDPGrowthandVariableInterestRatesForecast TheCBOBudget,2%GDPgrowthtaxreceiptprojections,andinterestrates,combinedwiththehistoric TreasurydebtdatawereusedtocompiletheScenario2projection.ReducingannualGDPgrowthto2% has a chilling effect on tax receipts. By 2020, the projected annual budget deficit would be equal to annualtaxreceiptsandgrowing. The impact of the various interest rate scenarios is also shown in Figure 11. In the event significant inflationoccurs,theimpactontheinterestpaymentsonthedebtwouldbedevastating. Regardless of which interest rate scenario is employed, the failure to increase annual GDP growth to levelsabove4%willleadtoseriouseconomicrepercussionsthisdecadeandimpliesapotentialfuture currencycrisisforthedollar. Figure11:ProjectedInterestRateSensitivities
Mandatory Programs are Growing Faster than GDP Projected
3.2% inc. to 12%

8000 7000

3.2% inc. to 5.4%

6000 5000 4000 3000

3.2% inc. to 3.8%

$3.0 T Deficit

Assumes unemployment drops below 6% in 2013, & economy pops back during the next 2 years.

Total Tax Receipts

2000 1000 0 1970 1980 1990 2000 2010 2020
$3.37 T Receipts

Used: - CBO Budget Data; - Treasury Debt Data; - Grew the GDP at 2% per year; - Bush Tax Cuts extended for 2011 & 2012.

Year

BeforeyoucompletelyembracetheScenario2projection,nominalGDPgrowthestimatedforyear2010 is estimated to be approximately 2.8%. This is growth rate is 0.8% higher than the modeled 2.0%. NeitherScenarioshownhereinmodelsforanotherpotentialU.S.recessionthisdecade.

Since the Dollar acts as the Global Currency, the world community will tolerate more from the U.S. thanfromacountrylikeGreece.Thatsaid,therearestillfinanciallimits,andtheunsustainablegrowth inexpendituresovertaxreceiptsmustbetakenseriouslyanddealtwithquickly.

6.CANWETAXOURWAYOUT?
Personal Income Taxes provide between 43% to 45% of the total annual tax receipts received by the Government(Figure12).Itisestimatedthat2010PersonalIncomeTaxreceiptswillbeapproximately $0.936 Trillion. The Treasury is estimating the 2010 deficit will be $1.63 Trillion. The Federal GovernmentwouldhavetodoublePersonalIncomeTaxestobalancethebudgetthisyear. Increasing taxes usually has a negative effect on GDP growth. More often than not, the Federal Governmentwillprovidetaxreliefduringtimesofeconomicdownturnstohelpspurtheeconomy.So whatdoestheFedneedtodo? SomehaveproposedtoallowtheBush2001&2003taxcutstoexpirein2010.However,theBushTax Cuts were extended another 2 years. If allowed to expire, Democratic Congressional Campaign Committee Chairman Chris Van Hollen estimated the expiration will result in the collection of $850 Billionofadditionalrevenueover10years. FormerGAODirectorDavidWalkerstated:"Somepeoplethinkthatwecansolveourfinancialproblems bystoppingfraud,wasteandabuseorbycancelingtheBushtaxcutsorbyendingthewarinIraq.The truthis,wecoulddoallthreeofthesethingsandwewouldnotcomeclosetosolvingournation'sfiscal challenges.(http://en.wikipedia.org/wiki/United_States_federal_budget#cite_note92) Figure12:U.S.FederalReceiptsbyIncomeSource,2010(inBillionsofDollars)
Corporate Income Taxes:
$157B 7%

Other:
$124B 6%

Excise Taxes:
$73B 3%

Social Security & Social Insurance:

$876B 40%

Individual Income Taxes:

$936B 43%

http://www.whitehouse.gov/omb/budget/Historicals

AccordingtotheTaxPolicyCenter,About47percentwillpaynofederalincometaxesatallfor2009. Either their incomes were too low, or they qualified for enough credits, deductions and exemptions to eliminatetheirliability.Theresultisataxsystemthatexemptsalmosthalfthecountryfrompayingfor programsthatbenefiteveryone,includingnationaldefense,publicsafety,infrastructureandeducation. It is a system in which the top 10 percent of earners households making an average of $366,400 in 2006 paid about 73 percent of the income taxes collected by the federal government.
(http://finance.yahoo.com/news/NearlyhalfofUShouseholdsapf1105567323.html?x=0&.v=1)

TheU.S.fiscalproblemisfarlargerthantheBushTaxCutsandwillrequireacombinationofbothtax increasescoupledwithsignificantspendingcutswithbothdiscretionaryandmandatorybudgeteditems. AllAmericans,includingthemiddleclass,willneedtoshoulderthisburden.Tosaythisinotherterms, toeffectivelytacklethisproblembysignificantlyraisingtaxesoneveryoneanddecreasingentitlement spendingwillmeanpoliticalsuicide. Canwetaxourwayout?Theanswerisclearlyno.

7.CANWEINFLATEOURWAYOUT?
During 2009 & 2010, tax revenue was only sufficient enough to cover the entitlement programs. All Discretionaryprograms,Defenseand100%oftheinterestonthedebtwasfundedbydebt(Figure10). Inflation may certainly help with the existing debt service, however how do you inflate out of future Defense,education,highwaysandbridges,etc?Theproblemisfargreater.

8.TIPPINGPOINTS
The question is what can you do about it? If Congress is unwilling to seriously tackle the Deficit problem,economicupheavalisprobableinourfuture.Thecrisiswillprobablycommenceastheresult of a selloff in U.S. Treasuries. This will occur at the point in time when the market realizes the U.S. cannotservicethedebt.Thequestioniswhen?Scenario2(Figure11)indicatesthatwithoutpolicy changes,itcouldoccurthisdecade,andperhapssoonerratherthanlater.Someitemstolookforare: 1. Low GDP growth numbers below the CBO forecasts. This will mean tax revenues will be less thanprojected; 2. HigherinterestratesonTreasuries.Higherratesmeanhigherdeficit.Higherratesusuallylead tolowerequitiesandaretreatofthestockmarket; 3. Unemployment numbers remaining high. Unemployment expenditures will stay high and tax revenueswillbelower(seeFigure10,year2009OtherMandatory); 4. War with Iran, North Korea etc. which will cause Defense spending to climb. Any additional expendituresofanysortareallfundedwithborrowedmoney. 5. Oil prices spiking above $100/BBL. High oil prices act like a tax and usually drive the worlds economiesintorecession. Themomentinvestmentcapitalbecomesspooked,everythingchangesalmostovernight.Itisliketrying tocatchafallingelephant.Thekeyistorecognizethesignsbeforeithappens.

AtthepointintimethemarketrealizestheU.S.willbeunabletoserviceitsdebt,lifeasweknowitwill change.

9.CONCLUSION:BUILDINGTHEARK
If you are unable to change the course of Washington, you must prepare personally. You are at a decisionpoint.Thisisnotaboutpoliticalideology.Thenumbersspeakforthemselves.Notsurewhat tobelieve?Grabthedataandmakeyourownevaluation. Asforinvestments,Ihavedecidednottomakeanyrecommendationsforobviousreasons.Youneedto sit down with your financial planner and see if you agree with your investment portfolio. There are always good investment opportunities, however one must carefully manage your portfolio and adjust accordingly.Asanexample,ifyouthinkinflationmightbeonthehorizon,doyouwanttobelockedinto longtermlowfixedinterestTreasuriesorMunicipalbonds?Arethosecompanies,whoseproductsor servicesarereliantuponFederalsubsidiestobecommercial(i.e.windandsolar),stillgoodinvestment opportunities?WhatwillhappentoequityP/Eratiosifinflationstartstocreepin?Arehardassetsgood investmentopportunities?Whattypesofdebtshouldyounotbecarrying?These,andahostofother questions,needtobeaddressedwithyourfinancialadvisor,soonerratherthanlater. Figure13:PriceofGoldappearstobeTrackingDeficit

1200 1100 1000

2500

120 110 100

2000

900 800 700 600 500 400 300 200 100 0 -100
0 500 1000 1500

90 80 70 60 50

Gold $

40 30 20 10 0

Deficit $
-10

(NotetheJimmyCarterbubble)

10.FINALEXAM:DONTBELIEVEEVERYTHINGYOUREADANDHEAR
When it comes to the Federal Deficit and Budget, always evaluate the validity of what you read and hear.TheFederalbudgetnumbersaresetuptodeceiveandthereareplentyofmulletsinthepublic, pressandonthenewstheCBOpreysupon.Thispaperprovidesthebasicunderstandingandtoolsyou need to avoid being sucked into opinions of those who have not completed their homework. As an example, what is wrong with the following (Parade Magazine, March 28, 2010)? The answer to that questionshouldnowbeimmediatelyobvioustoyou.Ifnot,youneedtogobackandcloselyrereadthis paper. Itsyourfuture.Goodlucktousall.

Prepared by: Gary C. Stewart 475 17th Street, Suite 540 Denver, CO, 80202 303-298-9415 gary@eMelange.com
AdditionalDataLinks: http://www.cbo.gov/budget/budproj.shtml http://www.cbo.gov/budget/budget.cfm http://www.cbo.gov/ftpdocs/108xx/doc10871/Historicaltables2010Jan_forweb.XLS http://www.bea.gov/national/index.htm#gdp http://www.publicdebt.treas.gov/ http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG

InflationWithMetals

Vincent Matthews, State Geologist and Director, Colorado Geological Survey, 2011

Velocity of M2 Money Stock (M2V)

http://research.stlouisfed.org/fred2/series/M2V