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Farrell: Dancing the Potomac Two Step

Friday, 5 Feb 2010 | 8:37 AM ET

Why would you ever want to be President?

Everyone who comes to the job does so with some vision and dream and quickly has to learn how to dance the dance if anything is to be done.

It's harder now than ever with the accumulated debt we have built up.

Consider the following (all compiled by my good friend, Michael Farr, of Farr, Miller in Washington, D.C. - there are good guys in D.C.). Gross government debt at the end of fiscal 2009 was $11.9 trillion with $7.5 trillion held by the public- you, me, the Chinese, etc. The other $4.3 trillion is debt issued by the government to other government agencies - like Social Security. The government has loaned itself money in other words. Gross debt was 83% of GDP and public debt was 53% of GDP.

Exactly how much is $1 trillion?

My other pal, Art Cashin (yes, I have two) quoted a buddy of his (sorry, I forgot who) who figured if you wanted to spend $1 trillion at the rate of a million a day and just be finishing, you would have to have started in 728 BC, or 2738 years ago. That was just before Babylonia made its move for independence from Assyria and about the time Greece emerged from its Dark Ages after those guys in the Mycenaean civilization lost control (more about Greece slipping back in a moment.)

Based on the Administration's own estimates, net debt will increase to 77% of GDP by 2020, and gross debt will be 107% of GDP. If that is correct, the government will need to borrow an additional $11 trillion by 2020. Interest expense alone will be $840 billion a year by then, or 15% of all government spending. And here is where the Potomac two step dance comes in. This assumes the economy will grow 3.8% a year and the ten year bond will not exceed 5.3%. These are not outlandish estimates, but certainly aggressive. If the economy were to grow at that strong a rate, interest rates would certainly be higher. If interest rates were lower, it would imply a slower growth rate.

Keep dancing...

It's no wonder that Moody's shot a warning across the bow and said the AAA rating of the US Government could be in danger (which would, of course, drive interest rates much higher). The projected 2011 deficit is $1.5 trillion which would be more than 10.5% of projected GDP. I was about to launch into a criticism of Greece but the mess they are in is because their debt is 13% of GDP.

Give us a little time and we will be there.

It was hoped the EU's qualified endorsement of Greece's budget cutting plan would calm the situation. But Greece's largest union (GSEE) is planning a mass protest against budget cuts. And then the Portuguese government failed in its attempt to sell 500 million of euro bonds and the Spanish government raised estimates of its 2010 through 2012 deficits.

So, and here's an old expression, the "contagion" seems to be spreading.

It is assumed the EU must, in the end, rescue Greece (Portugal, Spain, Italy as well ?) but the London Telegraph newspaper is saying Germany is sticking to its "no bail-out" stance. Will northern Europe really bail out southern Europe? Will France and Germany partner up in such an endeavor? Didn't these guys fight a few wars about such matters?

Can the euro survive centuries old rivalries?

The euro is only ten years old and has not lived through a major crisis yet. I find it hard to be bearish on the dollar since you have to be bullish on some other currency. The euro zone is in a mess and Japan is still fighting the deflationary wars. By default if nothing else, the dollar benefits. I expect the dollar to strengthen considerably against the euro and somewhat against the yen. I was talking with my partner, Will McDermott (head of sales), and we both recall when the "Asian contagion" started in 1998 with the collapse of the Thai baht, money flowed to the dollar and then to US financial assets in a big way. We both expect the same to happen here, hopefully in a lower key way than that disastrous time.

Between now and then, I still believe we are in a normal correction and we will fall to the 200 day moving average on the S&P, about 1017. The average closed on Wednesday at 1097. The 200 day would also be about a 10-12% correction off the high which feels right to me. One man's opinion.

I will be leaving this weekend for a marketing blitz in Europe. A zillion cities in a half a zillion days. To be followed by a vacation in Rome with my wife. I will be in email touch but will not be writing. Won't have time the first week as we really are moving rapidly. The second week is vacation and "she who must be obeyed" would have my head if I tried to work. This is a smart woman. I'm going to sit in the Coliseum and play gladiator.

Talk again in two weeks.

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Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.

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