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Clif Droke

Clif Droke

Clif Droke is the editor of the two times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock…

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The Ticking Time Bomb Of Federal Debt

Much has been written about the various financial "bubbles" of our times, including the excess valuations in stock, bond and real estate prices. But comparatively little has been written about the even bigger "bubble" in federal debt. This enormous problem (which has now reached monstrous proportions) was lately put into even greater context by an independent study on the true nature of the federal debt with the findings presented to Congress.

The real shocker is that this study has found that the real U.S. fiscal deficit is actually 44 trillion dollars, not the much lower figure regularly discussed by the financial media. The study, undertaken by economists from the American Enterprise Institute and the University of Pennsylvania, found the fiscal imbalance of the country includes seven trillion dollars for Social Security and $38 trillion for the Medicare health program.

In March 3 testimony before Congress, Kent Smetters of the University of Pennsylvania essentially stated that the United States is faced with two possible ways of addressing the debt monster: 1.) Increase federal taxation by 69%; or 2.) Cut federal spending by 50% immediately.

Smetters framed the debt crisis in the following words in his recent testimony: "The current fiscal imbalance is so large that it needs to be put into context...the government could, in theory, put the country on a sustainable course by raising the payroll tax on all uncapped earnings by 16.3 percentage points starting in 2004 and lasting forever. That would forever more than double the amount of taxes that are already being paid by employees to the Social Security and Medicare systems and the dollar-for-dollar matching paid by their employers. But even this calculation is conservative in that it assumes that taxes are raised on uncapped earnings, which is a larger tax base than used by Social Security. If capped earnings were taxed, an even larger tax rate would be needed.

"Waiting just four years (until 2008) to implement this type of tax hike would require a permanent tax increase of 17.4 percentage points to close an even larger imbalance of $51.5 trillion. The fiscal imbalance grows by about $1.5 trillion each year between 2004 and 2008. That number is about ten times the deficit that the government officially projects for 2004. As with government debt, the fiscal imbalance grows with interest if no reforms are taken."

Smetters noted that such tax increases "would probably put our economy into a tailspin, adding that the above example is not intended as policy advice. "But," he said, "these calculations show the magnitude of the current fiscal imbalance and emphasize the need for real reform today. The longer the delay in reforming the nation's fiscal policies, the more drastic are the changes required."

Smetters further testified, "Let me describe the current $43.5 trillion shortfall another way. Instead of raising payroll taxes, suppose we eliminate half of the rest of the federal government in 2004 except for Social Security and Medicare. In particular, we eliminate half of the federal government's spending on the military, homeland security, roads, education, veteran's affairs, agriculture, labor affairs, NASA, commerce, law enforcement, Medicaid, etc. -- everything expect for Social Security and Medicare. And we do this not just in 2004 but forever. Also suppose that we don't change federal taxes so that people continue to pay taxes as projected. Now, for example, the $150 billion deficit projected for 2004 would turn to a $600 billion surplus! That sounds like a lot of money. But we would still accumulate surpluses too slowly over time. In particular, we would still be left with a fiscal imbalance of about $3.2 trillion. In other words, shutting down half of the rest of government forever is not enough to put the U.S. fiscal policy on a sustainable course."

In either case, the huge federal deficit will still remain and the economy will still be on its headlong path toward total collapse.

R.E. McMaster, editor of The Reaper newsletter, has framed the national debt problem in no uncertain terms. He observes that while total federal debt is "officially" $6.47 trillion, an estimated $56 trillion in derivatives is floating around in the U.S. financial system, which is composed of $31 trillion in total debt (300% of U.S. GDP), total non-financial debt of $20.3 trillion and consumer debt of $1.7 trillion, not including mortgages, which soars total household borrowings to $8.2 trillion. In a recent newsletter he writes, "The bottom line is that businesses must have available to them savings, profit potential incentives, technological innovation, and capital investment to prosper, for the economy to do well. These are sadly lacking in the U.S. today in large measure. As a result, consumers have to borrow to spend, but such non-productive debt is historically a form of slavery, and one of the root meanings of the word "debt" is "death." Ugh! Are we spiraling down to the bottom of the barrel? Americans are borrowing against the equity in their homes, so-called "creative refinancing," in an attempt to maintain their standard of living. That is akin to eating your arm when you are hungry. The U.S. is experiencing economic cannibalization. Moreover, not only is consumer spending prior to business investment backwards, consumer spending is 80% of the U.S. economy. Are we upside down or what? What happens to consumer confidence/borrowing/spending as increasing numbers of Americans lose their jobs, as is inevitably the case? Already, over 2 million Americans have lost their jobs during the latest Bush administration."

McMaster further points out that there are presently over 10.2 million unemployed workers in the U.S., of which nearly 2 million have been out of work for at least 6 months or more. Fully 1.4 million have stopped looking for work and half a million jobs have been lost in the past three months. Initial unemployment claims are continuing to exceed 400,000 week after week. Making matters worse, the Fed is monetizing the debt by directing purchase of U.S. Treasury securities.

Cycle expert Samuel "Bud" Kress of SineScope, has stated that the current economic long-wave (known as the "K-wave"), which is due to bottom sometime this decade, is the fourth K-wave in U.S. history. "Four in cycle theory is the number of completion, thus this fourth K-wave bottom for the U.S. should be the final one under our present constitutional form of government." The implication here is that with the K-wave leaning heavily against the U.S. financial edifice, once the economic collapses completely a new system of government will arise in place of the old one along with a new government and a new constitution. One can only speculate on its scope and nature.

Gold market observer Bob Moriarty commented on this monolithic problem recently when he said, "The recent testimony on the federal debt was essentially a declaration of federal bankruptcy. It's only a matter of time before the [economic] bomb hits, and regardless of what the 'official' reason is, the economy will collapse." Moriarty went further and established a link between gold valuations, the federal deficit, and the declining value of the dollar in stating that with the current *officially declared* holdings of gold in Ft. Knox, relative to the other factors just mentioned, gold will have to climb to considerably higher levels in coming years in response to the debt implosion.

Without exaggeration, the federal debt crisis is probably THE primary issue in the U.S. public forum. While the mainstream press may choose to ignore the issue and while mainstream Americans can ignore the problem and continue their perilous dance with death in their financially leveraged lifestyles, there is no ignoring the soon coming consequences of the debt bubble, which has now reached epic proportions. It's high time for individual Americans to get their financial houses in order while there is still a small window of opportunity left. For investors, it's time to allocate a larger percentage of capital holdings into the precious metals sector.

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