Too Much Hope and Audacity: Obama's Budget is Worse than You Thought

By Andrew Mickey   Mar 9 2010 10:28AM

Too Much Hope and Audacity: Obama’s Budget is Worse than You Thought

Forget the current estimates, the deficits are going to be much, much worse.

Just a few days after Senator Jim Bunning was labeled a “lunatic” for trying to enforce the recently enact Pay-As-You-Go laws, the Congressional Budget Office (CBO) releasted its analysis of the Obama Administration’s federal budget proposal.

The CBO forecast the massive deficit spending to add $9.7 trillion to the U.S. government debt. That was $1.2 trillion more than the administration had forecast.

The CBO expects the government debt to increase to 90% of GDP.

The thing is though, these dire estimates are extremely optimistic.

The reason is because the assumptions the projections are based on are absolutely ludicrous.

The generous assumptions include NO recession in the next 10 years (it’s the 90’s boom time all over again! What…nobody told you?), record low inflation, and businesses across the country going on an unprecedented hiring spree, just to name a few.

When these hopeful assumptions never materialize, the ramifications will be widespread. And, as you’ll see in a few moments, we believe even more strongly in our statement our complime ntary gold report  issued last March:

“Every few decades though, the right conditions come along to make an absolute fortune in gold and gold stocks. Right now the conditions are right.”

Although only time will tell how bad the deficit/debt will actually be, we can be pretty sure it will be far worse than both the White House’s and the CBO’s estimates. The reason is because they are based on five assumptions which, quite frankly, just aren’t going to happen.

Unemployment Rate:

Assumed: 6.68% 10-year average

Reality: The current headline unemployment rate is 9.7%. The last time it reached this high was in 1982.

Back then the government was cutting taxes and deregulating businesses. They were making mostly right moves. But even making the right moves still led to an average headline unemployment rate of 7.04% for the following decade.

The booming 80s couldn’t even bring unemployment down as fast as the Obama administration expects over the next 10 years.

As long as the economy fails to ever truly recover, unemployment benefits keep getting extended, and the cost of employment (taxes, mandatory healthcare, higher minimum wage, etc.) keep going up, the next decade averaging 6.68% unemployment is nearly impossible.

Inflation

Official Assumption: 1.61% annual average

Reality: We hear all the regular talk about how inflation isn’t a problem and how the Fed – despite its entire history - will know just the right time to start hiking rates. But if you take a look at the budget assumptions, you can see they truly believe the right moves will be made at just the right time that will lead to the lowest inflation rate in 70 years.

The budget assumption is for inflation in the next decade is lower than any decade since the Great Depression. It’s lower than the 40s, 50s, 60s, and on and on. It’s lower than the long run annual average (1913 to current) of 3.4%.

It’s not impossible, but it hasn’t happened in the past 70 years and none of those decades started off with near-zero interest rates and trillions of freshly printed dollars handed over banks.

10-year T-bond Interest Rate

Assumed: 5.06% average annual rate

Reality: Despite a deficit (as a percentage of GDP) nearly tripling the GDP growth rate and a debt that’s working its way to 100% of GDP, the administration believes it will still be able to borrow money very cheaply.

The assumption, however, is more than 20% below the 57-year average 10-year treasury interest rate of 6.35%.

Unless the government will be able to borrow money at lower rates as its creditworthiness deteriorates, the government’s ability to borrow at the rate of 5.06% is highly doubtful.

Average Interest on 3-Month T-bill

Official Assumption: 3.42% 10-year average

Reality: Same situation as with the 10-year T-Bond. As borrowers credit risk increases, the cost of borrowing does NOT go down.

The assumed 3.42% rate is one of the lowest decade-long average rates in the history of the 3-Month T-Bill.

And to give you an idea of the economic conditions necessary to create such a good environment, you have to go back to the decade between 1997 and 2006. The 90-00s boom years, when population demographics and low inflation were supporting strong GDP growth and low rates, the 3-Month T-Bill yielded an average 3.42%.

Right now, none of those pillars of economic growth are present. But the budget proposal is based on the presumption they are.

Real GDP Growth

Official Assumption: 2.5% annual average

Reality: This is probably the most plausible assumption, but it’s still very optimistic. A quick look at history shows why.

During the stagflationary years between 1972 and 1982 real GDP only grew at a 2.4% annual rate. So 2.5% seems realistic. However, the boom years between 1998 and 2008 was led by 2.66% annual growth in real GDP.

Right now, the government is expecting a return to prosperity despite a massive credit contraction, increased regulation, higher taxes, etc.

Clearly, 2.5% is very optimistic.

The budget proposal, which assumes such a strong recovery and an era of unprecedented economic growth, is presenting a “best-case” scenario. And it is still expected to increase the federal debt level by another $9.7 trillion.

It’s yet another case of great expectations. And as we say in our free e-letter, the Prosperity Dispatch, great expectations inevitably lead to great disappointments.

When it comes to the budget, the disappointment will have a widespread impact.

Just think…What happens when the best-case scenario doesn’t materialize, the coming higher tax rates reduce tax revenue, additional entitlement programs get added to the mix, or the economic consequences of a random event like a natural disaster or another major terrorist attack are added into the mix?

None of the answers are good.

For anyone interested in maintaining and growing their wealth in the years ahead, the options will be limited in this kind of environment.

When interest rates rise, the government takes resources away from the most productive areas of the economy, and consumers are paying down debt, it’s going to be a tough run for the most popular investments over the past three decades – stocks and bonds.

The markets may look good for a while longer and this rally will last just long enough for most investors to get sucked into it, but now is the time when investors look to the classic stores of wealth – gold and silver – to help insulate themselves from the consequences of the ballooning government debt which, even under the best-case scenario, are not good.

Good investing,

Andrew Mickey
Chief Investment Strategist

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Andrew Mickey is editor of the 100% free daily e-letter Prosperity Dispatch. The goal of the e-letter is to help individual investors become better investors and to single out investment opportunities in any market environment. Whether that’s convertible bonds, gold, farmland, or any other asset class, if people are making money in it, you’ll learn about it in the Prosperity Dispatch. See www.q1publishing.com for more information.