Image: President Barack Obama © Chris Kleponis-Pool, Getty Images

Like Captain Kirk and the Kobayashi Maru of Star Trek fame, President Barack Obama faces his own no-win scenario with the budget sequestration due to kick in on Friday.

Created as part of the 2011 debt ceiling deal, and activated by the failure of the congressional supercommittee to find an alternative budget deal, the sequester will slash $1.2 trillion off the federal budget over the next 10 years, split between defense and discretionary spending and without touching entitlements.

It's not Armageddon: The cuts are worth an average of 7% of total spending in these two areas and are a drop in the bucket compared with the $44 trillion Washington is set to spend over the next 10 years.

But it's not insignificant, either: It'll slash at least 0.5% off growth of gross domestic product this year -- at a time when much of the rich world is falling into recession.

Unfortunately, no matter what Obama does -- and, by extension, what Congress does -- it's not going to be good. Here's why, and how investors can prepare.

Anthony Mirhaydari

Anthony Mirhaydari

Take the hit?

For Obama, and indeed for all of us, it doesn't look like this is going to end well. You can see that in the way Washington has gone from looking at ways to avoid or modify the sequester -- by, for instance, giving government agencies the flexibility to make the cuts efficiently -- to figuring out how to blame each other for what's about to happen.

Obama has held campaign-style rallies surrounded by first responders facing job cuts while members of his Cabinet, from transportation to agriculture, have been sounding dire warnings about the consequences of the cuts. Republicans' defense has hinged on the fact that the idea for the sequester came from Obama's team, and that he personally signed off on it, according to reports. (Of course, Congress approved it, too.)

That's because while spending cuts are needed, the sequester goes about them in a pretty stupid way: It freezes the way agencies allocate spending among programs, projects and activities. As a result, planned spending for the overhaul of the USS Abraham Lincoln would be cut by 72% while spending on M1 Abrams tanks would increase 442%.

If the cuts go through, they could push the U.S. economy into an outright recession. While the total size of the sequester is fairly small, its impact is anything but. With quarterly GDP growth bouncing between positive and negative territory lately, it won't take much of a push to unlock all the negative accelerants that deepen new recessions: lost confidence, reduced business spending, lost wages, fewer jobs and lower consumer spending.

In fact, research from the International Monetary Fund suggests that, if the U.S. economy is indeed already in the early stages of a new recession, the drag from the budget sequester could be as large as 1% of GDP. Combined with the ongoing economic hit from the New Year's Day fiscal cliff deal, and the higher taxes that resulted, any further Washington belt-tightening would represent a serious and growing drag on growth.

Moreover, if we do fall into recession, the budget math will deteriorate, since a weaker economy means more spending on things like unemployment benefits combined with lower tax revenues as people lose income and cut spending.

Walk away?

But Obama can't simply work toward postponing or canceling the cuts, either. For one, given that the fiscal cliff deal raised $620 billion in new tax revenues, and given that higher spending (mainly on health care) is the root cause of the terrible long-term budget outlook, it's time to look at trimming the size of government. (Of course, if you support still-higher taxes, those will impact GDP, too.)

Two, the national debt is already approaching the point of no return, with economists warning the U.S. Monetary Policy Forum that we're on the cusp of a self-reinforcing "debt trap" that would be difficult to escape. (Download that Initiative on Global Markets report as a .pdf file.) Separate research has already shown that higher government debt levels are associated with less economic vigor, slower growth and a lower standard of living. (Read the Committee for a Responsible Federal Budget's report.)

And three, it's worth remembering that the sequester is the result of Washington's unwillingness to address the real problem: underfunded entitlement programs that are overpaying, by global standards, for health care that is often mediocre. If we can't find agreement soon, we risk attracting further ire from the credit-rating agencies that unleashed the August 2011 market meltdown after Standard & Poor's cut our AAA rating.

All this represents just the latest chapter of Obama's multi-episode budget battle with Congress. A new budget is needed by March 27 under the threat of a possible government shutdown. If budgets aren't passed by both chambers of Congress by April 15, members of that body would have their paychecks trapped in escrow. And if no deal is found by mid-May, the debt ceiling -- and the risk of a default on the national debt -- would be back in play.