War Room 26 April 2012

Government Spending:

Belt Tightening Coming?

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Government Spending: Belt Tightening Coming?

•Market Snapshot

•Trends + Policy Projections

•Outlook + Scenarios

Market Update

GOVERNMENT SPENDING:TRENDS + POLICY PROJECTIONS

HiddenLevers

US Deficit: Historical Context

Source: Bloomberg

Spending has spiked since the financial crisis, andrevenue has collapsed, exacerbating deficit trends

US Government Budget, 2011 Breakdown

Source: Budget of the United States, HiddenLevers Research

31% ($1118B):All Other Spending

25% ($905B):Defense

24% ($855B):Health Care

20% ($725B):Social Security

36% ($1300B):Borrowing / Deficit

64% ($2303B):Tax Revenue

The Big 3 now account for 70% of all government spending.

All other spending could be eliminated, and US would still be in deficit.

Defense Spending Historical Trends

Defense spending rose faster than any other category over the last decade, including Social Security and health care.

Social Security

Defense spending peaked with Iran and Afghan wars

Budgets proposals call for flat spending going forward

Social Security, Medicare, Medicaid grow while defense shrinks over time

Source: WSJ, White House OMB

Social Security vs Health Care, Forecast

Source: CBO 2010 Analysis

Long term, Social Security growth slows while health care costs explode.

Healthcare Inflation vs CPI

Healthcare inflation has consistently exceeded CPI over the last 50 years, though recent trends might be showing improvement.

Healthcare Costs: Long Term Trend

Health care = 1/3 of the economy in 25 years

Government pays 50% of health care costs today

At current rate, health care takes 100% of federal budget by 2035!

Source: President's Council of Economic Advisors

Healthcare eating up Defense Spending2011Veterans benefits = 1/6 of defense spending

Cost of Veterans health careUp 300% in past decade

2015$63.9 billion projected

Source: US Department of Defense, HiddenLevers Research

Health Care Costs Increases Wasteful

Obvious:Medicare + Medicaid will be unsustainable

Not so obvious:

80% of projected increases come from excessive cost growth.

Excessive cost growthcost of treatment growing faster than growth in per capita GDP and CPI

GOVERNMENT SPENDING:SCENARIOS

HiddenLevers

Lots of Noise from the Top

Even Top Brass not on same page

Who’s right?

U.S. Fiscal Reform – How will it go down?

No Policy Alteration

Rising Interest Rates and InflationDeflationary Spiral

Fiscal Reform Succeeds

Fiscal ReformFails

Fiscal Reform

Cost Cuts InevitableDefense Spending + Health Care

Weimar

Japan Zimbabwe

USA ?government

choices

No Policy Alteration = Status Quo

No Policy Alteration

Rising Interest Rates and InflationDeflationary Spiral

Weimar

Japan Zimbabwe

USA ?

Covered in March 2012 War RoomFixed Income Outlook

Consequences - Chaos:

1. Akin to debt ceiling aftermath

2. Equities crushed, along with faith in government

3. Bonds likely strong, yields come in – not intuitive

4. Lack of confidence hits business + personal spending

Fiscal Reform – Inevitabilities + Market Reaction

Consequences - Confidence

1. Confidence up as perceptions of govt improve

2. Equities – winners and losers, but broad rally

3. At risk – healthcare, defense, physical metals

4. Gold – investment demand decreases

5. Lowered expectations of future inflation

Conclusion

Fiscal Reform must zero in on Health Care Costs

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