Structural Deficits will induce Bond
Rating downgrade to "B" in 2020
Nov 25 2012 delayed
FreeVenue public release of Aug 25th MemberVenue guidance ~ The
TRENDLines Debt Wall
model gauges current deficit financing will require another raising
of the Federal Debt Limit ($16.394 trillion) by Dec 26 2012.
These partisan negotiations rarely highlight the decadal effects of
accumulated deficits and the realities of compound interest. After expressing concern over this issue for over a decade, Trendlines Research began
in early 2009 to publish regular graphic alerts warning that unless there is
a sea change in fiscal management, the USA Federal
Gov't is inevitably headed for its own sovereign debt crisis. Bond vigilantes are increasingly monitoring
Deficit/GDP & Nat'l-Debt/GDP ratios. The bond rating agencies
have since joined the fray albeit as late pilers-on. It
is certain the current
Wall Street spotlight on periphery European nations will be donned on American
metrics within eight short years as it becomes clear at
that juncture the future redemption of newly issued instruments are in jeopardy.
Current legislation will see the Deficit/GDP ratio plunge
from 2009's 9.9% high-water mark to 4.7% in 2015. From then
however, the momentum of unaffordable entitlements and a sea change
in demographics combine and force the ratio to a secular uptrend,
rising to a crippling 19% by 2040. Failing mitigation, impatience with Congress's ability to
hold the line on the budget imbalance will culminate in 2020 in
the form of surging yields at the weekly Treasuries auctions ... and
a downgrade of USA short-term debt to "B" ratings.
The USA's current $16 trillion Federal Gov't National Debt (100% of
GDP) is poised to double to $32 trillion in 2025 (121% of GDP) and
compound interest sees it triple to $48 trillion by 2029 (146% of
The international (and domestic) investment community will be seen
to be increasingly concerned with the ability of the USA to honour
redemptions at expiry of its long-term instruments. This will
come to a head in 2022 when it becomes common knowledge that the
ratio exceeds the 110% threshold. The resultant second surge in yields
will induce a
downgrade of USA long-term debt to "C" if Congress
continues to be perceived as dysfunctional and incapable of prudent fiscal
management. Having the ability to print currency, it is of course
highly improbable the Federal Gov't could ever actually default.
Rather, rising yields will reflect the potential of excess printing,
currency debasement and the dim prospect of currency losses upon repatriation of
foreign invested funds.
Building on certain measures within the January Obama Budget, the
Tea-Party was instrumental in using the Debt Limit vote to
negotiate further present-decade expenditure cuts. This served
to postpone the Deficit/GDP ratio exceeding 3% 'til 2022.
However, all the good seemingly good intentions only means the Debt
by 2021 will $23 billion instead of $22 billion. And that sets
the date for my forecasted first sovereign debt downgrade ... to "B"
from "A". 3% has long been the accepted threshold past which
it is difficult for a jurisdiction to maintain sustainable budgets.
Indeed the USA is three times that today, but sunsetting of
Recession fiscal policy measures and this Summer's scheduled cuts
should see the ratio dip to 1.0% in 2018. After that date and
barring further intervention, structural deficits take command of
the USA's demise taking the Deficit/GDP ratio to 24% over the next
When we commenced this graphic, most buyers of US Treasuries were
unaware of these precise numbers, but they have had a sense for a
while that America's fiscal well being was suffering from substantial
mismanagement and a potentially unsustainable future.
Albeit the time line is open to subjective interpretation, the
foreign investment community is cognizant continued failure to
address this behemoth will lead to: (a) demands for increased
yields on Treasury notes; (b) select offerings in alternate
currencies; (c) sovereign debt rating downgrades; (d)
still higher yields; & (e) ultimately the temporary shunning of
Treasury Auctions by tier-1 buyers in an effort to stage an
intervention and/or avoid product with even more serious downgrades
to "B" & "C".
In addition to a secular rise in
yields demanded, another clue to the proximity of another and almost inevitable American
financial crisis will be a further debasing of the USDollar.
Uncertainty with the commitment of Congress & the Administration to
address their Deficit and Debt
responsibilities began in February 2002. In succeeding years,
the disfavoured currency plunged from its EUR:USA exchange rate of
0.87 to 1.59 in early 2008.
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. Today the USD enjoys a
rebound to the 1.34 rate, but the general downtrend will prevail
until the Debt Wall is dealt with.
Mass withdrawal of foreign (and some domestic) buyers of Treasuries
will be known to be imminent upon deterioration of the EUR:USA
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 $97 trillion over the next three decades.
It is my opinion the 30-yr Gov't instruments have junk status.
Under current legislation and regulations the US Gov't cannot honour
its obligations on the expiry dates. Still, the int'l
community has some faith common sense and mitigation will prevail.
OTOH, short and medium term obligations appear fiscally manageable
and this virtually guarantees the stability of Treasury sales
to both domestic & international investors over the next several
That said, discussions surrounding the
2015-2025 Budgets and future Debt Ceiling negotiations will see very heated debate ... domestically and
across the globe. The Deficit/GDP ratio is scheduled to drift
back to near 7% by 2022 on a journey ultimately leading to 24% by 2040.
It will eventually become common knowledge no reprieves are to be
had. Congress will be forced to acknowledge the raising of new
funds will have diminished returns due to the realities of
compounded higher interest rates and successive Debt downgrades by
As part of a diversionary tactic that
started in February 2010, Wall Street, Cable News & the White House have been engaged
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 or
perhaps Greater Depression.
But the future episode will clearly be a child of structural Deficit
With its 10-year horizon, the
2009 Pelosi-Reid-Obama Budget process shone a light on the whole
structural deficit issue about which Trendlines Research 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 Barack Obama founded a
bipartisan committee in March 2010 to suggest new paths!
Before the 30-yr bond is declared junk status, the President tasked
to recommend 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 to an aspirational target 60% Debt/GDP
ratio by 2018-2022.
If resultant action is not forthcoming
however, current CBO data indicates that left unchecked, the annual
Deficit rockets to $8 trillion by 2040, $22 trillion by 2050 &
$236 trillion by 2075. Meanwhile, the National Debt surges to
$242 trillion & $2,589 trillion respectively by these 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 the investment
community senses the Federal Gov't is approaching tipping points
where they deem it prudent to exit the venue.
Weighing fully the USA's situation,
Trendlines Research judges the first such investor intervention or
Treasuries Crisis will
occur in early 2022 ... upon the Deficit re-attaining 3.1% ($900
billion) of GDP followed quickly later the same year upon the
National Debt again exceeding 90% ($22 trillion) of GDP .
That's only eleven years away.
$440 billion will be required in 2022 merely to pay the interest on
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.
As they ran out of countries, my past prediction that the same scrutiny
would be applied to the fiscal soundness of
the USA itself has come to fruition in recent months.
On the positive side, the string of USA Export records seen in
2006/2007 have resurfaced in early 2011 as importers see nicer
prices on American goods and services. Manufacturing could
also surprise when domestic consumers start to shun high priced
imported goods and associated ever increasing transportation costs of
those products. With a corrected trade balance, crude oil back
to $62/barrel in 2013 (reflected via my
projections) and a bi-partisan agenda promoting fiscal
responsibility, the USA will begin the long road back...
Due to an increasingly corrupt electoral system, members
of Congress and successive Presidents appear beholden to
donors 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 virtually dysfunctional.
~ (rev 2010/9/17)
The scenario above is defined by legacy legislation and
ramifications of the Obama 2010-2020 Budget as
interpreted by the CBO. Over the long term, it
will never be allowed to happen. As seen by the
Canadian experience of the mid 90's, program spending
will be the eventual victim of these structural Budget
Deficits. Ever larger annual Debt Servicing forces
the Government-of-the-day into a realm of cuts in
services and/or the raising of taxes.
While populism affords the Obama Administration the
ability to tax upper incomes today, eventually realities
of the Laffer Curve will force policy makers to spread
the taxation among the "other 95%" or severely pare back
One of the first taxes will be a 2% hike in
payroll withholdings to rectify the expected shortfall
in Social Security obligations from 2017 to 2057.
A modern economy cannot sustain structural Deficits
forever. Eventually, debt servicing becomes so
great that it crowds out program spending. This
usually occurs when interest consumes 30% of Gov't
revenues, and is accelerated as interest rates rise when
coming out of Recessions. New Zealand, Canada,
Argentina, Greece & the UK are empirical examples of
jurisdictions having faced "the wall".
Devaluation of their currency often allows nations to
re-price exports to rejuvenate their trade sectors when
facing financial break down. Germany, Japan, Canada &
China have all traveled this road at some time.
With a Deficit/GDP ratio of 14%, Greece would be the
natural "next" candidate ... but was prevented of that
opportunity by its past decision to have joined the
EUROzone. Unable to extract itself from its
difficulties via trade rejuvenation, austerity measures
were its sole alternative, and the measure shortly
became the preferred solution throughout the EU.