The Great Credit Squeeze

If you think that the sovereign debt crisis is mostly behind us … that America’s federal deficit is turning into a non-issue … or that we can just go back to business as usual … you’d better consider the drama now unfolding in the hard numbers just released last week:

February deficit: In February alone, the official U.S. federal deficit was a monstrous $221 billion, far greater than anything we have ever experienced in history.

Back in the 1980s, for example, President Reagan was plagued with the worst string of federal deficits ever recorded until that time. But with February’s deficit, Washington has managed to run up just as much red ink as it did in all of 1986, the single worst deficit year under Reagan.

Going back further, to the 1970s under President Nixon, we also had a rash of deficit spending that sent chills up the spines of economists. But last month’s deficit of $221 billion was more than TRIPLE the sum total of ALL deficits during the six years under Nixon.

Ever since America’s Declaration of Independence, deficit spending has been a recurring theme in Washington that invariably returns with a vengeance, especially during wartime. But it took 169 long years and seven major wars — from 1776 to 1945 — to rack up a cumulative deficit that matches the gaping budget hole of just 28 short days in February.

What does the government resort to in order to finance these humongous deficits? The answer is obvious …

Unprecedented borrowing: In just one week last month (ending 2/26), the U.S. Treasury issued …

• $32 billion in 7-year Treasury notes,

• $42 billion in 5-year notes,

• $44 billion in 2-year notes,

• $8 billion in 30-year TIPS bonds,

• $26 billion of 3-month bills,

• $28 billion of 6-month bills,

• $31 billion of 4-week bills, and

• $25 billion of cash management bills.

Grand total: $236 billion in government debt issued in a single week, the most in the history of the world.

This means that Uncle Sam borrowed new money — and replaced old debt — at the rate of $390,212 per second … $23.4 million per minute … and $1.4 billion per hour — around the clock!

It is a pace of debt issuance that simply cannot be sustained without disastrous consequences.

Why not? One reason is because of …

Dreadful crowding out of the private sector: As long as Uncle Sam is continuing to hog most of the available credit, it’s going to be increasingly difficult — sometimes nearly impossible — for most businesses and consumers to get their share of desperately needed funds.

Consider the fourth quarter of last year, for example. The Fed’s Flow of Funds report, just released on Thursday, tells the story …

Government borrowing was massive: The U.S. Treasury jumped into the credit markets and grabbed up new funds at an annual pace of $954.7 billion, while local and state governments raised $114.2 billion. Total government borrowing (after some reduction in gov’t agency bonds): $1,040.4 billion.

In contrast …

Most business borrowers were shoved out of the credit markets: Not only did they have a tough time getting new loans, they also cut down their EXISTING debts — either voluntarily or not — at the breakneck annual pace of $1,097.5 billion.

Millions of consumers were virtually ostracized from the credit market: They were forced to cut their existing mortgages at the annual rate of $365.1 billion and their consumer credit at the rate of $145.3 billion — a total annualized cutback of $510.4 billion.

Don’t underestimate the potential impact of this phenomenon on the economy and your investments.

Remember: We are not just witnessing a decline in new business and consumer borrowing — a trend that typically signals economic weakness. Rather, what we have here is …

• A decline to ZERO on a net basis! Plus …

• Massive pressure on consumers and businesses to actually PAY DOWN debts outstanding! Plus …

• Widespread defaults and foreclosures forcing the lenders to WRITE OFF massive amounts of debts.

My main point: It’s bad enough when you see credit flowing to consumers and corporations at a slower pace. But what’s happening now is far, far worse! Credit is actually being sucked OUT of the consumer and corporate economy at a torrid pace.

In fact, if you step back from the trees, you see an even uglier picture:

Huge amounts of credit being denied — or even taken away from — those who could fuel a recovery … plus, at the same time, huge amounts of credit being grabbed by federal and local governments to finance their giant deficits.

Now do you see why we’ve been saying all along that this recovery is bought and paid for by Washington?

Now do you see why a sovereign debt crisis — and future difficulties by governments to continue borrowing — is such a threat?

Heck! If the U.S. economy is just limping along even with massive government support, imagine the paralysis that’s likely if the government cuts back that support to curtail out-of-control deficits!

Bottom line:

First, the massive supply of government bonds on the way will drive their prices down and long-term interest rates up. Short of a miracle, we see little hope to avoid this outcome.

Second, as the federal deficit continues to grow out of control, the Great Credit Crunch is going to get even worse.

Third, don’t jump to the conclusion that the credit crunch will immediately topple the U.S. economy or stock market. With all the money that Washington has pumped in, a weak recovery can continue and stocks could still enjoy an extension of their rally.

But it cannot last. In the long term, corporate profits cannot be sustained without credit. If credit remains scarce, forget about a long, multi-year recovery … and brace yourself for a violent double-dip recession beginning later this year.

Good luck and God bless!

Martin

Warning: Enrollment to our Million-Dollar Rapid Growth Portfolio ends for good on Monday, March 22 — so that we can start allocating the $1 million the next morning, March 23. If you’re already on board, great! Or for more info, visit our brand new Rapid Growth website by clicking here.

About Money and Markets

For more information and archived issues, visit http://www.moneyandmarkets.com

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Amy Carlino, Selene Ceballo, Amber Dakar, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

Attention editors and publishers! Money and Markets issues can be republished. Republished issues MUST include attribution of the author(s) and the following short paragraph:

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

From time to time, Money and Markets may have information from select third-party advertisers known as “external sponsorships.” We cannot guarantee the accuracy of these ads. In addition, these ads do not necessarily express the viewpoints of Money and Markets or its editors. For more information, see our terms and conditions.