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November 13, 2008

Four Words Obama Will Never Say
by Michael Pento

Will the new Obama administration offer a solution to our country's short and long term fiscal imbalances? I'm willing to bet four words you will never hear him say during his tenure are "The budget is balanced!" First, take a look at a couple of estimates regarding how great our long term debt will accrue due to the demographic challenges we face. According to estimates from a 2007 study done by USA Today, the projected debt for our country could reach $59 trillion dollars because of the unfunded mandates from entitlement programs. And if you think that's scary, Richard Fisher, President and CEO of none other than the Federal Reserve Bank of Dallas, puts the figure in a speech given May 28th 2008 at $99.2 trillion! Medicare parts A & B account for 69% of the debt, Part D for prescription drugs (thanks George W. Bush) accounts for 17%, while Social Security accounts for just 14%. As foreboding as those estimates are for our future, it appears that recent events will preclude any substantive efforts at tackling this looming catastrophe.

The election of Barack Obama coupled with the current economic crisis virtually guarantees that our collision course with the entitlement iceberg will remain unaltered. After all, Democrats have historically railed against privatizing any aspect of our entitlement programs. Not that privatization would provide a panacea for all our long term fiscal imbalances, but clearly something must be done during his new administration. But lest you think Republicans have the high road, I hasten to add the Bush administration was nothing short of a fiscal disaster. Given the recent performance (or lack thereof) from stocks and real estate, it would seem highly unlikely that an Obama administration would propose investing funds into the market. What needs to be done is a massive reduction in entitlement benefits; a phased-in reduction of expenditures until outlays equal receipts is the only viable long term solution to the problem. The problem with such harsh medicine is that it would take trillions of dollars in promises to retirees out of the economy. That would inevitably bring about a severe recession, one that would dramatically lower the standard of living for all Americans and impact quality of life for millions of our elderly population.

The bottom line is that we've made promises to future generations that we can never keep unless we print the money to redeem our obligations. But that would only be accomplished by depreciating the currency until it has lost much of its purchasing power. It isn't any benefit for retirees to send them money that has lost most its value. That "solution" becomes even less viable when you take into account that entitlement benefits are pegged to inflation.

The problems associated with our long term imbalances have been exacerbated by the reduced wealth experienced as a result of the credit crisis. The S&P 500 has lost about 35% of its value in 2008 and home prices have dropped 16% year over year. Making matters worse is the fact that bank lending has fallen sharply, and home equity extractions have plummeted as American's percent of equity in the home as fallen to just 46%--the lowest level since the end of WW ll. That situation will force the consumer to rely on those entitlement programs as a means of survival more than ever before.

According to a report from the Center on Budget and Policy Priorities, Social Security benefits account for 90% of income for 34% of our elderly, and for half of all retirees it accounts for 66% of their income. There can be no doubt how essential our nation's entitlement programs have become for the health of the country. Do you see the rub? We either have to print, tax or cut our way out of the problem but all those solutions carry an undeniable amount of dire consequences to our economy and standard of living. However, some combination of all three will most likely occur and the longer we wait, the worse the situation grows. Quoting from Mr. Fisher, "No combination of tax hikes and spending cuts, though, will change the total burden borne by current and future generations. For the existing unfunded liabilities to be covered in the end, someone must pay $99.2 trillion or receive $99.2 trillion less than they have been promised...the decision we must make is whether to shoulder a substantial portion of that burden today or compel future generations to bear its full weight."

If there is one thing investors should have learned from this credit crisis is that the United States will do whatever it can to avoid a recession. Whether it is printing money or socializing a significant portion of the economy, our government will go to extreme limits to avoid dealing with its sins, be they in the past or in the future. The unfortunate consequence of that stance is that it's unlikely the new democratic administration will do anything in a proactive measure to solve the problem. In fact,, the President-elect's proposals will make our problems much worse.

George W. Bush was about as fiscally conservative as Lyndon Banes Johnson but Barack Obama shows no signs of being any more conservative than his predecessor. His promises of "free" education and healthcare, for starters, should only guarantee that the U.S. Treasury Department's announcement that it will borrow $550 billion in the fourth quarter is just the prelude to future deficits to come. As long as foreign central banks continue to purchase our debt and keep interest rates low the problem doesn't seem acute. But net foreign purchase of U.S. debt was about $550 billion in each of the last two years. According to estimates from Goldman Sachs and Moneymorning.com, the Treasury must raise $1.4 trillion in new money in fiscal 2009, which would leave about $850 billion to be financed domestically.

Because we don't have the adequate savings, our annual deficits should lead to much higher interest rates and inflation. We Americans must hope that the Obama administration is honest with the people and makes some difficult choices early in his tenure to deal with our growing annual deficits and long term debt. But as history reveals, we have a habit of only dealing with a problem when we have no other choice.

*Please check out my podcast, The Mid-Week Reality Check

Michael Pento
Chief Economist
Delta Global Advisors, Inc.
800-485-1220

With more than 16 years of industry experience, Michael Pento acts as chief economist for Delta Global Advisors and is a contributing writer for GreenFaucet.com. He is a well-established specialist in the Austrian School of economic theory and a regular guest on CNBC and other national media outlets. Mr. Pento has worked on the floor of the N.Y.S.E. as well as serving as vice president of investments for GunnAllen Financial immediately prior to joining Delta Global.

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