John Mauldin‘s latest newsletter, entitled This Way Be Dragons (Thoughts from the Frontline), tackles the big problem that the bulls don’t want to think about yet: How will the $1.2 trillion deficit we’ve got in the oven ever be paid off?
While Obama gives lip service to cutting the deficit in half, his actual budget increases it over the next 10 years. As I have been writing for some time, this is a very dangerous path. And it is one that the bond market seems to be concerned about, as interest rates are rising, even on mortgages that the Federal Reserve is buying in massive quantities in its effort to hold down rates and stimulate the housing market.
He lays out three basic scenarios, none of which are very encouraging.
On the table, Mauldin observes, we could see anything from a Value-Added Tax (call one of your European friends about that), a huge tax on the rich, health care benefit taxation, and even a little help from massive inflation. Certain items are virtually certain to be eliminated, like the Iraq War‘s annual expense and the Bush tax cuts.
Unfortunately, the Democratic-controlled congress has major health care initiatives and programs in the works that, as Mauldin posits, are almost certain to run over their budgets.
Under almost any of the plans laid out in the article, investing in growth-ier foreign economies or companies that don’t rely on US consumption and reducing exposure to the US Dollar seem like a good idea. A glance at the performance of gold over the last 2 weeks will show you that Mauldin and Stanford professor John Taylor, whom he quotes, are clearly in the majority in terms of their vision.
Will taxes be raised to growth-crippling levels? Will the Obama administration embrace the VAT concept? Has the trashing of the dollar we’ve seen simply been an appetizer before the main course is served?
Too early to tell which road we’re headed down, but the good news, according to Taylor, is that all is not lost yet:
“The good news,” Taylor concludes, “is that it is not too late. There is time to wake up, to make a mid-course correction, to get back on track. Many blame the rating agencies for not telling us about systemic risks in the private sector that lead to this crisis. Let us not ignore them when they try to tell us about the risks in the government sector that will lead to the next one.”