US debt deal kicks spending problems down the ... cul-de-sac

So it looks as if the United States will not default on Tuesday. A deal has been brokered. And what a pathetic deal it is. Aug. 2, 2011, will go down in history as the day when the USA officially started to stop being THE global superpower.

US government debt (excluding vast off-balance-sheet items such as mortgage guarantors Fannie Mae and Freddie Mac) now stands at $14.3 trillion. The debt ceiling will now be increased to $17.7 trillion. In return, President Obama will work out how to cut spending by $1 trillion over the next decade and in December proposals to cut it by $1.5 trillion more over the next decade will be agreed.

You will note that this is not $1 trillion or $1.5 trillion a year but over a decade.

And Obama says that the deficit is under control? I am afraid not.

Even if the budget cuts are found and implemented (which is doubtful), the US will still run a vast budget deficit. The US will hit its new debt ceiling in 2013 (yes, that is just two years away, but happily for Obama and the sellouts in Congress after the election). That will mean that in just five years Mr. Obama will have taken US balance-sheet debt from $10.7 trillion to $17.7 trillion. Even George W. Bush only managed a $5 trillion increase, and it took him eight years.

So the addict that is the US government has been given another big fix. It is still an addict and a hopeless one at that.

Now to put this in perspective, we must look at official gross domestic product figures – the estimates of the nation's annual output (which is needed to support government debt). It is important to note at this juncture that these GDP numbers are overstated by politicians keen to fool you.

For instance, if an American owns his or her own home outright, no mortgage or rent is paid. But GDP accounts “impute” a notional rent for homeowner-owned properties. In 2009, this “imputed rent of owner-occupied properties” was $1.2 trillion or 9 percent of GDP. But this is money that doesn’t actually exist.

If we use the official GDP data and again exclude those off-balance-sheet items like Fannie and Freddie, then the ratio of US GDP to debt will in two years be where Italy’s is now. On the basis of real GDP numbers (i.e. money that does actually exist) the US in two years will be where Greece is now.

And yet the credit rating agencies (those chaps who as recently as two years ago rated Greek debt as AAA) still give US debt a AAA rating. Despite intense pressure to toe the line, credit rating agencies must inevitably downgrade the US from AAA to have any credibility at all.

Outside Washington, the rest of us can see that all that has happened is that the can has been kicked down the road. Unfortunately, this is a very big can, and the road is a cul-de-sac. The bright lights on the house at the far end of the cul-de-sac are now very much visible. Only those inside the beltway cannot see this.

So the date of the fudge agreement will be known as the day that the US dollar officially lost its place as the world’s safe currency.

In the absence of an alternative, the only currency whose value is not being systematically destroyed by politicians remains gold and if you think recent increases in the gold price were startling you ain’t seen nothing yet: $1,615 an ounce today; $2,100 before Obama faces the voters again next year.

A year later the US debt ceiling will have to be increased again (to $20 trillion). Two years after that, China will overtake the US as the world’s largest economy. The writing is on the wall.

– Tom Winnifrith, a top-rated fund manager with www.t1psim.com, lives on a small, almost independent, rock in the Irish Sea called the Isle of Man.