By Denny Gulino

WASHINGTON (MNI) – The Treasury Department and the Office of
Management and Budget Friday made it official, the deficit racked up in
the government’s just-ended fiscal year totaled $1.08 trillion, slightly
less than expected, underlining the challenge that faces the nation as
big decisions on fiscal policy are forced on Congress in the months
ahead.

The latest fiscal year’s deficit was $207 billion narrower than
last year’s, an improvement buried by the reality it was the
fourth-straight annual trillion-plus total of government red ink.

Around the edges, AIG’s repayment of bailout funds during the year
made the deficit $13 billion less. September’s deficit alone was turned
into a surplus, mostly by some calendar shifts that accelerated
recurring payments into August. Otherwise somewhat higher tax receipts
and lower government expenditures.

Payment of interest on the national debt actually was a little less
than in 2011, which did almost nothing to reduce the threat that
category poses for the future. The annual deficits and the national debt
they’ve fed have not yet ratcheted the government’s debt service up into
crisis levels. Higher interest rates in the future, though, would boost
that government spending on interest a great deal.

In nominal dollar terms the fiscal 2012 deficit is the fourth
largest since World War II, but in debt-to-GDP terms is much smaller,
about 7% vs. 113% right after the war ended, in 1947. When Pres. Obama
took office four years ago, the debt was 10.1% of GDP.

In the year just passed Social Security spending rose about 3% and
Medicare spending rose about 6%.

If the deficit stays stable in nominal dollars while the GDP avoids
recession and keeps getting bigger, that deficit-to-GDP ratio will keep
falling all by itself. Long before it gets down to reasonable levels
decades from now, the payments on that debt may have consumed almost
every dollar of tax revenue. And long before that happens markets will
have marked down the dollar severely and the world, depending on what
else is happening at the time, could shun U.S. debt.

How long that would take is anyone’s guess but if U.S. debt keeps
growing, the analysts say, the path to crisis is inevitable.

Any improvement elsewhere in the world, for instance, should there
ever be a perception that Europe has begun an authentic rebound from its
problems, makes the clock tick faster toward a U.S. debt payment crisis.
Meanwhile, as long as the world needs a safe haven and the U.S. needs
the support of quantitative easing, a debt payment crisis is put off
longer into the indefinite future.

As CBO Director Doug Elmendorf showed a University of Michigan
audience in September, the portion of all government spending to be
devoted to debt service begins to show up as a little green patch on his
charts in the middle of this decade and quickly expands from then on. By
2020 debt service alone becomes a sizable chunk of GDP.

The debt service load will not be appreciably changed in the next
few years regardless of what Congress does. Later on it becomes an
existential threat if it is not controlled now.

Next up is the “fiscal cliff,” a still ill-defined collection of
events that it seems the smart money is betting won’t happen. That’s not
because Congress is seen capable of assuming its responsibility for
fiscal policy and overcome paralyzing polarity, but because lawmakers
will be forced into budget decisions by grim alternatives and coalescing
interest groups.

Already top bankers Jamie Dimon and Lloyd Blankfein have made
high-profile appearances this week on behalf of fiscal sanity. More
bankers will follow, as well as appearances by members of a new
coalition of top business CEOs who have been organizing a media campaign
to commence shortly.

Defense contractors have been spending PR money for months, even
sending young representatives house to house in Washington suburbs
talking about the threat of major job losses should defense spending be
cut as drastically as scheduled.

One by one interest groups on opposite poles of the political
spectrum are expected to become strange ideological bedfellows as they
respond to a common threat, severe cutbacks in government spending.
Whether their constituents are defense industries or social lifeline
groups, the threatened cuts will raise the alarm level week by week.

The “Gang of Eight” bipartisan group of lawmakers on Capitol Hill
have been meeting in Northern Virginia and other combinations of
lawmakers have been talking of compromise despite the pressure not to,
and so some estimates are that perhaps three-fourths of the fiscal cliff
fight has already been resolved on a theoretical basis.

When it comes to counting votes, this and forthcoming efforts on
Capitol Hill could count for nothing. Votes are controlled by the
leadership and both parties know it is their leadership in the House and
Senate that is at stake in the coming battle.

Election Day may heighten the paralysis or lessen it to some
degree, but both sides have powerful strategies of obstruction to bring
to bear whether in the majority or minority. Should President Obama lose
the election, he might become even less inclined to compromise in the
lame-duck months.

Whether the fiscal cliff turns out to be more of a bumpy and
bruising trip down a ramp of obstacles that takes months to complete, or
whether Congress is galvanized into rapid action, late 2012 and early
2013 will be a time to remember for budget wonks and possibly a much
wider swatch of the citizenry.

Aside from the dreaded sequester, the national debt subject to the
congressional limit on Treasury borrowing, as of Thursday, was $16.13
trillion. When it gets to $16.39 trillion late this year the debt limit
will have been reached, but not yet breached. That “drop-dead” date
won’t arrive until sometime in the spring, Treasury officials have said,
after all of the department’s “extraordinary measures” to prevent
default have been exhausted.

Bush era tax cuts are set to expire along with 2012, a factor that
could cut consumer spending in the New Year.

As if the bundle of uncertainty needed to be stuffed with anything
else, analysts are pondering what effect the expiration of the FDIC’s
TAG program will have. If unlimited deposit insurance is allowed to
expire Dec. 31, a massive amount of uninsured deposits, up to $1.4
trillion, will have to find a new home in a matter of weeks.

The CBO concludes — and Federal Reserve Chairman Ben Bernanke
appears to agree — that currently scheduled sequester levels would
trigger a new recession after the 90 days pass it would take the Office
of Management and Budget to put them into effect next year. Higher taxes
and a possible impasse on raising Treasury’s borrowing limit wouldn’t
help.

But if the sequester did go into effect as scheduled, cutting
government spending by large amounts, the threat of a debt payment
crisis would recede. Fiscal policy would have been strengthened and the
long-term future would look better. The U.S. could even get its triple A
sovereign rating back.

Such a sudden improvement in the nation’s fiscal future would leave
many victims, a higher unemployment rate and an angry electorate looking
for scapegoats. The generation not yet old enough to vote might have a
happier long-term future — at the expense of their parents.

** MNI Washington Bureau: 202-371-2121 **

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