4 reasons why this may be the worst crisis since the 1930s – and 4 projections for what’s going to happen. I identify the foundational forces now driving our economy to establish a basis for the investment recommendations you’ll read in this advisory in the months to come. The role of the U.S. as the world’s dominant economic superpower is now challenged by an out-of-control growth in debt and a deterioration in its reputation as a financial haven.

The dollar is losing its special status as the global “reserve currency,” is leading, in turn, to higher inflation, higher interest rates, weakening financial assets (stocks and bonds) and runaway prices for commodities.

Let’s look at the data and let them speak for themselves, with some interpretation along the way:

1. U.S. Government Deficits: From Bad to Worse

Government deficits are the root source of the creation of money… and its eventual debasement. Simply, when the federal government spends more than it raises in taxes, it eventually has to create more money (in complicity with the Fed) in order to pay the bills.

Of course, it can borrow the money, but that often includes borrowing newly created money from the Fed. The deficits remain and they accumulate and in time. They must be resolved, either by payment or default, either overtly or covertly through the mechanism of inflation.

While some level of government deficits may be acceptable over modest periods of time, the U.S. deficit is now well past the point of being acceptable. The deficit will soon grow to monster proportions as the baby boomer retirement obligations exceed the ability to tax the declining number of workers contributing to the Social Security and Medicare funds.

Projections of the likely deficit compared to GDP growth make it clear that the government is faced with hard choices. The easy path of just letting the dollar fall is the most likely.

2. The Expanding U.S. Trade Deficit

It is consumers who primarily receive the money provided by U.S. government deficits. In this globally interconnected world, they then spend a portion of that money on foreign goods. An unintended consequence of the ballooning government deficits, therefore, is a large and growing trade deficit.

The foreign recipients of those dollars – whether Chinese manufacturers or Middle Eastern oil sheiks – have, in recent years, turned around and reinvested those dollars in U.S. Treasuries. They have done so because of the perceived safety of those instruments, and because of the sheer volume of the dollars they have to invest. In addition, it has been in their commercial interest to help finance the U.S. deficit.

With the trade deficit now running at $750 billion per year, and much of that money coming back into U.S. Treasuries, the U.S. government has grown dependent on foreigners to sustain the continuing deficits.

That level of debt would normally cause extreme weakness in a currency – just as it would in the value of debt owed by a deeply indebted individual. However, the sheer magnitude of the foreign holdings provides something of a bastion against a total collapse in the dollar.

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