The much heralded "Super Committee" that was announced in August as part of the scheme to raise the debt ceiling turned out to be a microcosm of Congress -- a bunch of people that are so dug into their ideological beliefs that they are incapable of turning around the direction of our country's future.  News that the Super Committee is not so super is punishing stock futures this morning as they are set to announce they will not be able to come up with specific spending cuts before the November 23 deadline.

I've already written many articles on why this is such a big deal (click on the links for the full article as the data hasn't really changed since then).  First of all, the spending cuts that were agreed to in order to raise the debt ceiling really amount to a "Gnat on an Elephant's Behind".  Congress needs to cut much more than $1.2 Trillion from the budget over the next ten years.  If they can't come up with specific ways to cut this "small" amount, how will they ever be able to cut the amount necessary to prevent a European style collapse over the next 10 years?

The Debt Ceiling Circus was the primary reason the market broke down this year.  When they once again showed that they are nothing more than Professional Can Kickers, the sell-off accelerated.  Their inability to address the real issues (entitlement reform) and to make grown-up decisions that look out for future generations led to American being downgraded by S&P.

The market was able to eventually shake-off the downgrade, but now the possibility of additional downgrades has become very real.  The odds of a recession next year also went up as it will be increasingly difficult to get the 2% payroll tax holiday that began this year extended.  Extended unemployment benefits and other tax breaks (including the adjustment to the AMT) could also come to an end.  This will create further hardships on the already struggling middle class.  JP Morgan estimated that letting all of these items expire could subtract as much as 2% from GDP in 2012.

The other issue is what this does to the budgeting process.  Without changes, the defense department will automatically see $600B cut over the next 10 years from their budget.  The other $600B comes from domestic spending without naming specific areas.  Social Security and Medicaid, two of the bigger contributors to the deficit are off the table and any changes to Medicare (the largest deficit contributor) are very limited.  This means that the cuts will be painful to all the other areas.  Analysts expect these cuts to have a major impact on education, veterans affairs, public safety, and low income families.     

Republicans are already talking about legislation to reduce the defense cuts while Democrats are looking to reduce the domestic spending cuts. 

In other words, they got their credit card limit increased with the understanding that they will cut spending, but now are unwilling to follow through.  (Doesn't this sound a lot like what the leaders in Europe have been doing the past 2 years?)

When the deal was struck I pointed out that the only thing that this deal did was guarantee that the economy was going to have to survive with out any additional government stimulus.  25% of GDP last year was through government spending.  2011 is looking to be about the same amount.  The 2012 budget has already been agreed to, so the impact will begin in 2013.    The other thing I pointed out was that this will create 4 months of uncertainty as everyone worried about what would be cut.  Of course I forgot to factor in that the "Super Committee" took the entire month of August off for their summer vacation.  They didn't really start meeting until the middle of September and nobody really heard anything about them until a few weeks ago. 

Now their failure has created much more uncertainty as nobody knows what tax cuts will be extended, where future spending cuts will come from, or when the next downgrade will occur.

The one thing I do not hear ANYBODY talking about is how quickly we are approaching the debt ceiling.  When the deal was struck in August to raise the debt ceiling, it was assumed that it would not need to be addressed until 2013 (after the election).  Unfortunately, there was so much pent up spending to be done that there is NO WAY the U.S. will not make it that long.

There is currently $14.988 Trillion of debt that is subject to the debt ceiling limit (as of 11/16/11).  That means there is only $206B remaining.  How did we get so close to the debt ceiling in a few short months?

-The US borrowed $203B in October.

-In the first 16 days of November, the US has borrowed an additional $33B.

-The budget deficit was supposed to be a mere $1.1 Trillion this year, but due to a weaker economy (lower than expected tax receipts), the US is borrowing at a $1.4 Trillion pace.

-The budget estimates were based on an average growth rate for the economy of 3.3% over the next 10 years (with no recessions).  This includes a 4%+ growth rate in 2012 & 2013. 

If we assume that the US will get back on track for the budget, we will need to borrow $98B/month.  That means that we will be hitting the debt ceiling limit some time early next year.

Here are some numbers to put all of this in perspective.  In 2000, the amount of public debt per citizen was $20,000.  It is currently at $48,000 per citizen.  At the current pace of spending, by 2015 it will have increased to $76,000 for every man, woman, and child.  This does not include the unfunded liabilities from Social Security ($15 Trillion), the Prescription Drug Benefit ($20 Trillion), or Medicare ($116 Trillion).  When you take the TOTAL liabilities the United States has, each citizen owes $373,351.

Let's do some simple math here.  The median HOUSEHOLD income is $50,000, but let's assume that every man, woman, and child earns that income every year for the 40 years they are working.  That means they will earn $2 million in their lifetimes.  In order to cover all of our liabilities, that $50,000 income would need to be taxed at an 18.7% rate.  Some might say, "that's not too bad."  However, that would be in addition to the federal taxes the government would still have to be collecting to cover current expenditures.  Plus you'd have to add in your state and local taxes that you'd be paying (which are likely to go up as the U.S. government cuts their support of state and local governments).  If you assume a 12% federal tax rate and a 5% state tax rate, that person making the median income would be paying 35.6% of their income in taxes.

For those that believe only the "upper" income people should see their taxes go up, consider that only 53% of Americans pay Federal Income Tax.  If only those currently paying income taxes had to foot the bill for our liabilities, each would have to shell out $1,035,171.  So even if every taxpayer averaged $100,000 in earnings every year for 40 years, they would have to pay an additional 26% to cover the liabilities.  Factoring in an 18% federal tax for current expenditures, and state and local taxes, it would take a nearly 50% tax rate to get the fiscal house in order.

Obviously you can't charge a 50% tax on all current taxpayers, so the only choice is to figure out ways to also cut spending.  There are no easy choices left.

(Go to www.usdebtclock.org for some more fun facts.)

As for our portfolios, we start the week in a fairly defensive position.  EGA is 44% invested, with EPA only 12% exposed.  We will keep you posted on any further changes and developments.

The comments and posts published in the SEM Trader's Blog ARE NOT investment recommendations. They can NEVER be considered as trading calls or advices. If you decide to use the information offered here for your real trading it is at your own risk.

Investing in the stock or bond markets involves risk and may not be suitable for all investors.  Before making any investment decisions you should carefully consider your investment objectives, level of experience and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with your investments and seek advice from an independent financial advisor if you have any doubts.  All investments involve risk including those managed by Strategic Equity Management.

Opinions expressed at www.stratequity.com are those of the individual authors and do not necessarily represent the opinion of Strategic Equity Management or its management.  Any opinions, news, research, analysis, prices or other information contained on this website, by Strategic Equity Management, its employees, partners or contributors, is provided as general market commentary and does not constitute investment advice. Strategic Equity Management will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.

The use of this website constitutes acceptance of our user agreement.  Past performance is NOT indicative of future results.