Global insiders are starting to gather in Davos, Switzerland for this week's World Economic Forum. JPMorgan Chase's Jamie "Obama's Favorite Banker" Dimon will be there, as will be Treasury Secretary Geithner.

When attendees arrive and check in, they will be given their badges and a copy of a special Davos magazine, prepared especially for the event. In the magazine will be an article by Robert Rubin. He is an insider's insider. Participants will read the article. Rubin is so wired in that when insiders think of the people who are operating behind a president, it is names like Rubin's that come to mind. Jacob Lew the new director of the Office of Management and Budget is connected to Rubin. The old director of OMB, Peter Orszag, was connected to Rubin. The new head of the National Economic Council, Gene Sperling, is connected to Rubin, as was the previous NEC head, Larry Summers. It goes on. Rubin served as Treasury Secretary under Bill Clinton. He was former co-CEO of Goldman Sachs. He is co-Chairman of the Council on Foreign Relations. Got the idea? Insiders will read what he has written.

The first part of the article is about what the United States needs to do to get the economy going. It is a desperate shot taken at the buzzer from beyond half court. Rubin knows this. He is also a Keynesian, so his recommendations call for more spending that he hopes can be reversed in two or three years, once the economy "gets going". It won't work. The shot will fall short of the rim.

The second part of the article is much more significant. It is the breakdown of what is going wrong in the United States.

The risks of our fiscal position are serious and multiple. And while these risks become more severe over time as our debt position worsens, all of these either have begun to materialize or could do so in the near term, so we should act now.

What multiple shapes could the crisis take? Rubin writes to the Davos insiders:

"To be specific about the risks, deficits could crowd out private investment, which could choke off a private investment recovery. Moreover, the capacity for public investment is already diminishing, and could be exacerbated by growing entitlement costs and mounting interest payments...

"Most dangerously, there is a risk of disruption to our bond and currency markets from the fear of much higher interest rates due to future imbalances or from fear of inflation because of efforts to monetize our debt. The result could be significant deficit premiums on bond market interest rates, seriously impeding private investment and growth or, worse, acute bond market declines that cause an economic crisis. This could also start in the currency markets.

"While the likelihood of major market disruptions is greater in the intermediate and longer term, the shorter-term risks are also real. Market psychology can change unexpectedly and dramatically -- either on its own or because of some catalyst -- when underlying conditions are unsound. Possible catalysts are a debt ceiling confrontation, currency market problems, and state deficits..."

For emphasis, I remind you this is a former Treasury Secretary of the United States writing. One of President Obama's top outside advisers. So does Rubin think there is an easy solution to the debt problem? He writes:

"Growing out of our fiscal morass over time without policy action would require inconceivable rates of growth. Muddling through with unexpectedly favorable developments is extremely unlikely. The strong probability is that either we make the hard decisions so vital to our future, or we will be forced at some point to act more harshly and with less time to thoughtfully set priorities. Our long history of political and economic resilience should augur well. But these decisions are extremely difficult, and the question is whether we have the political will to face up to what we must do."

There you have it, from a man as inside as you can get:

"...our structural fiscal trajectory is unsustainable with multiple, serious risks (while at the same time, our large cyclical deficits are exacerbating debt levels and interest costs)..."

Bottom line: The United States is in serious financial and economic trouble. It is only a matter of time before the crisis explodes. Don't take my word for it, just re-read what the former Treasury Secretary has to say. It's all there.

CBO Report of July, 2010

The non-partisan Congressional Budget Office (“CBO”) released a very troubling report in the last week of July of last year. The report was entitled Federal Debt and the Risk of a Fiscal Crisis and warned that we will face financial calamity if we do not get our massive budget deficits under control.

The CBO report pointed out that the national debt, which was 36% of the gross domestic product three years previous, was projected to be 62% of GDP at the end of fiscal year 2010 on September 30. And it continues to ratchet up every year thereafter, even in the CBO’s “baseline” (more conservative) projections.

The CBO specifically warned that our out-of-control deficits could lead to the ultimate debt crisis when buyers of Treasury securities lose faith in the government’s promise not to default on these most trusted financial instruments. No kidding!

Many people in the know have been writing about the perils of increasing our national debt year after year since back in the 1980s when they criticized President Ronald Reagan for doing so, and every president since him. The concern was that in 20-30 years, the ultimate debt crisis would come. Guess what: it’s now been 20-30 years, and even the CBO warned that the day of reckoning is on the horizon.

We will summarize the CBO report that came out last July. But before we jump into this troubling CBO report, let’s take a quick look at the economic reports, most of which have not been favorable.

The Economic Recovery is Faltering

The report on the 2Q 2010 Gross Domestic Product was weaker than expected. The Commerce Department reported the 2Q GDP rose only 2.4% (annual rate). That was well below the pre-report estimates of 2.5% to 3.0%. In fact, some forecasters had predicted growth well above 3.0% in the 2Q.

The news was not all bad, however. The Commerce Dept. revised its estimate of 1Q GDP from 2.7% to 3.7%, which was considerably better than the consensus estimate. Still, the trend was not good: 4Q +5.0%, 1Q +3.7% and 2Q +2.4%. With most of the economic reports looking negative, growth in the last half of the year, however, stayed in positive territory.

The Index of Leading Economic Indicators (LEI) fell 0.2% in June of last year and was down in two of the previous three months. However, the LEI was still well above its recession low in early 2009. It remained to be seen if this was merely a pullback in the LEI, or if it was rolling over to the downside ahead of a double-dip recession.

Consumer confidence remained in a free-fall. After plunging sharply in June, the Consumer Confidence Index fell from 54.3 to 50.4 in July. Here is the official statement that accompanied the release of the Conference Board’s confidence index on July 27:

“Consumer confidence faded further in July as consumers continue to grow increasingly more pessimistic about the short-term outlook. Concerns about business conditions and the labor market are casting a dark cloud over consumers that is not likely to lift until the job market improves. Given consumers’ heightened level of anxiety, along with their pessimistic income outlook and lackluster job growth, retailers are very likely to face a challenging back-to-school season.”

The Reuters/University of Michigan Consumer Sentiment Index also fell sharply again in July. The index fell from 76.0 in June to 67.8 in July. This report also cited the weak employment situation and continued weakness in home prices as the primary reasons for the fall in sentiment. They also warned that consumer spending could fall even more as a result.

Rasmussen reported: “Following the release of Friday’s government report on unemployment and job creation, consumer and investor confidence has fallen to the lowest level of 2010. Just 21% of Adults nationwide now believe the economy is getting better. That's down from 30% on Friday morning. The number who believe the economy is getting worse is now up to 54%.”

The Commerce Department reported that consumer spending remained low in June. Personal spending was unchanged in June, reflecting a third straight month of lackluster consumer demand. Incomes were also flat, the weakest showing in the previous nine months.

Not surprisingly, the US personal saving rate continued to rise. The government reported that the personal savings rate climbed to 6.4% of disposable income. That was the highest rate since the early 1990s. Most Americans were clearly concerned about another recession, so they were saving more even if they were not making more. On a related note, consumer credit continued to be in free fall. It’s no wonder then that retail sales fell 0.5% in June.

On the manufacturing front, the ISM index fell to 55.5 in July, down from 56.2 in June. Durable goods orders fell 1% in July, when forecasters had expected a gain of 1%. The government reported that factory orders fell 1.2% in June. On the positive side, industrial production rose a modest 0.1% in June.

The unemployment report for July was dismal, to say the least. While the official unemployment rate remained at 9.5%, the internals of the report were considerably weaker than had been expected. The economy lost another 131,000 jobs in July, and the June report was revised from 125,000 jobs lost to 221,000 according to the Labor Department report. The unemployment rate held steady mainly because 181,000 people stopped looking for work the previous month, and were no longer counted as unemployed.

On the housing front, the news was mixed. New homes sales beat expectations in June with 330,000 units sold according to the Census Bureau. Sales of existing homes fell, however, in June to 5.37 million units, down from 5.66 million units in May. And the number of buyers who signed contracts to purchase homes fell in June, down 19% from a year ago. Housing starts were also weaker than expected in June at 549,000 units.

While the Gross Domestic Product increased to 3.2% in the fourth quarter of 2010, the housing and job markets are mired in the doldrums with no improvement in sight. Ordinarily 3.2% would be a solid number, but after a recession that so far has eliminated more than 8 million jobs, "it's sub-par," according to California State University economist Sung Won Sohn. In December the number of housing starts nationwide fell to a seasonally adjusted annual rate of just 529,000 units -- a 14-month low and not much above the 477,000 recorded in April 2009, which was the lowest level in decades.

Economists continued to adjust their forecasts downward for the second half of last year in light of the latest mostly disappointing economic reports. Congressional leaders in Washington started talking about more stimulus (read: pork-barrel spending), and President Obama seemed more than willing to go along -- surprise, surprise.

CBO Warns of a Debt Crisis on the Horizon

As we have seen, on July 27 of 2010 the non-partisan Congressional Budget Office issued a new report entitled Federal Debt and the Risk of a Fiscal Crisis. The report warned that we will face financial calamity if we do not get our massive budget deficits down in the years just ahead.

The CBO report pointed out that the national debt, which was 36% of the gross domestic product three years previous, was now projected to be 62% of GDP at the end of fiscal year 2010 on September 30. And it goes up every year thereafter, even in the CBO’s “baseline” (more conservative) projections.

Most Americans glaze-over when they hear numbers about the debt-to-GDP ratio. Perhaps the following chart from the CBO will put it in some better perspective. We have been warning about this problem for years.

Tracing the history of the national debt back through our history, the CBO finds that the national debt did not exceed 50% of GDP, even when the country was fighting the Civil War, the First World War or any other war except World War II. As you can see in the chart, the national debt declined sharply after World War II as the nation began paying off its wartime debt when the conflict was over.

By contrast, our current national debt is still going up and may end up in “unfamiliar territory,” according to the CBO, reaching “unsustainable levels.” They spell out the following economic consequences -- and it is not a pretty picture:

“Although deficits during or shortly after a recession generally hasten economic recovery, persistent deficits and continually mounting debt would have several negative economic consequences for the United States. Some of those consequences would arise gradually: A growing portion of people’s savings would go to purchase government debt rather than toward investments in productive capital goods such as factories and computers; that ‘crowding out’ of investment would lead to lower output and incomes than would otherwise occur.

"In addition, if the payment of interest on the extra debt was financed by imposing higher marginal tax rates, those rates would discourage work and saving and further reduce output. Rising interest costs might also force reductions in spending on important government programs. Moreover, rising debt would increasingly restrict the ability of policymakers to use fiscal policy to respond to unexpected challenges, such as economic downturns or international crises.

"Beyond those gradual consequences, a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates. It is possible that interest rates would rise gradually as investors’ confidence declined, giving legislators advance warning of the situation and sufficient time to make policy choices that could avert a crisis. [Emphasis added.]

"But as other countries’ experiences show, it is also possible that investors would lose confidence abruptly and interest rates on government debt would rise sharply. The exact point at which such a crisis might occur for the United States is unknown, in part because the ratio of federal debt to GDP is climbing into unfamiliar territory and in part because the risk of a crisis is influenced by a number of other factors, including the government’s long-term budget outlook, its near-term borrowing needs, and the health of the economy. When fiscal crises do occur, they often happen during an economic downturn, which amplifies the difficulties of adjusting fiscal policy in response. [Emphasis added.]

"If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation. A sudden increase in interest rates would also reduce the market value of outstanding government bonds, inflicting losses on investors who hold them. [Emphasis added.]

"That decline could precipitate a broader financial crisis by causing losses for mutual funds, pension funds, insurance companies, banks, and other holders of federal debt -- losses that might be large enough to cause some financial institutions to fail. Foreign investors, who owned nearly half of U.S. debt held by the public in May 2010 (or about $4.0 trillion, $1.7 trillion of which was held by Japan and China alone), would also face substantial losses.” [Emphasis added.]