President Barack Obama © Zuma, Rex Features

Now that the inaugural balls are over and the speeches and celebrations are finished, Washington returns to the task it's been struggling with for years amid partisan rancor and brinkmanship: how to solve the budget mess.

Our leaders have had little success in addressing the problem, so the debt load is now larger than the economy's annual output, at roughly $52,000 for every man, woman, and child in America.

There's a reason that the problem seems never-ending. And President BarackObama touched on it in his inauguration speech when he said that he rejected "the belief that America must choose between caring for the generation that built this country and investing in the generation that will build its future."

The problem is, we can't do both. Not so long as we hitch the government's finances -- via Obamacare, Medicare and Medicaid -- to a bloated and inefficient health care system. Not while making needed investments in education and infrastructure, and providing for the national defense. And it can't be done while keeping taxes reasonable.

Thus, the bickering. The deficit commission. The congressional deficit committee. The fiscal cliff. The debt ceiling. The fact that the government hasn't operated under an actual budget since 2009. The recent flirtation with the "trillion dollar coin" idea. There is a real and growing threat that our fiscal procrastination will damage an already fragile economic recovery via a government shutdown, a debt default or a credit-rating downgrade.

Anthony Mirhaydari

Anthony Mirhaydari

So now, with the economy faltering again, continental Europe and Japan in new recessions and the United Kingdom slipping into one, too, we have politicians focused not on making hard choices to solve the problem but on finding ways to pin the blame on the other side. And it's going to get worse before it gets better.

 A tough nut to crack

The political reality is that no one wants to be the bearer of bad news. No one wants to spell out the cuts that are needed. Part of the reason the Republicans lost the presidential race was because of their plan for Medicare vouchers and deep spending cuts. Even though the GOP approach would have taken a decade to balance the budget, even this fiscal tonic was too harsh for the electorate. Voters instead preferred Obama and his call that the rich "pay their fair share."

Americans want to believe that the days of ample spending, low taxes and easy credit can continue -- and they will punish anyone who tells them otherwise.

While Obama talked in his inauguration of making the "hard choices to reduce the cost of health care and the size of our deficit" -- which has been $1 trillion or larger for the past four years and likely will be for at least two more years -- no one wants to put pen to paper to outline the reforms that are needed.

Obama's 2013 budget proposal, the only working budget document we have from the Democrats, did nothing to address the long-term debt, as the chart below, lifted from that proposal, shows. That's because it doesn't propose the structural reforms that are needed to control costs associated with the aging of baby boomers.

Chart 5-1. Publicly Held Debt Under 2013 Budget Policy Extended


In 2011, the three major entitlement programs -- Medicare, Medicaid and Social Security -- accounted for 44% of non-interest government spending, up from 30% in 1980. According to Credit Suisse estimates, the way things are going, by 2025, spending on these programs, plus interest on the debt, will take up 100% of tax revenues.

Mostly, it's health care. Over the past two decades, annual health care cost inflation has been running at 150% of the underlying inflation rate. Asa result, despite mediocre scores on measures of the quality of care (such as infant mortality), we pay far more per capita than anyother developed country.

What's really scary is that the chart above assumes the economy will grow at a 3.7% average annual pace through 2018 (which is doubtful), interest rates will remain near zero and that the cost-control efforts in the Obamacare legislation -- such as the tax on low-deductible health care plans and the Medicare payment advisory board that opponents have dubbed "death panels" -- will actually work as planned.


If any of these assumptions is incorrect, the long-term outlook will be even worse.

What will it take?

To really wrap your head around the scale of the problem, I recommend trying the Committee for a Responsible Federal Budget's budget simulator tool, which allows you to pick and choose ways to close the deficit and stabilize the country's debt load by 2021.

The tool was designed before the fiscal cliff deal -- which the Congressional Budget Office says will increase the deficit by $4.6 trillion over the next 10 years -- was done. So be sure to factor that in.

It also doesn't account for the impact on growth of things like tax hikes (negative) or short-term stimulus (positive). Indeed, Merrill Lynch believes the various tax hikes associated with the fiscal cliff deal will reduce disposable income by 2.1% this quarter and will drag down first-quarter growth of gross domestic product. Consumers are already expressing displeasure, with the Consumer Sentiment Index recently falling from a post-recession high all the way down to levels not seen since late 2011.

But as an illustrative tool, it's just fantastic.

The first thing you'll realize is that the only easy options big enough to move the needle on the spending side are related to health care -- like block-granting Medicaid to the states, raising the Medicare eligibility age to 67 (to match Social Security's full retirement age) and raising Medicare premiums.

Then, the hard choices kick in. Do you roll back the Obamacare expansion of health coverage or establish a new surtax on the rich (beyond the surtax that's already part of Obamacare)? Do you slash spending on the Navy, given the rise of China, or do you enact a cap-and-trade carbon tax? Do you create a new source of taxation via a federal value-added tax or cut funding on highways, schools and food stamps?

And before you assume the rich should just pay more, know that we've already got one of the most progressive income tax systems in the world. As a percentage of the federal tax burden, the rich's share has grown from 55% in the 1970s to 70% now (as their share of income went from 45% to 51%). Yet over the same period, the middle class' share of taxes has fallen from 14% to 9% (as their share of income went from 16% to 15%).

And before you assume we can just continue to neglect our infrastructure and education system, know that lower reading and math scores and failing roads and bridges hinder the economy's ability to grow -- which will weaken our ability to repay our debts in the future. Already, consulting firmMcKinsey estimates that road congestion costs the country more than $100 billion a year in fuel costs and lost time, and the American Society of Civil Engineers says infrastructure woes could cost us 3.5 million jobs by 2020.

The blame game

Given the difficulty of the task at hand, and the ongoing public preoccupation with low taxes and unhindered government largesse, it's no wonder we are now barreling toward a government shutdown at the end of March.

House Republicans today passed a measure that would suspend the debt ceiling through May 18. Senate Democrats and Obama have indicated they would go along. But that still leaves open the question of an actual budget accord to keep things running beyond March 27.

One intriguing part of the debt ceiling suspension: If either the House or Senate doesn't pass a budget, members of that chamber don’t get paid. No budget, no pay. It’s a jab at Senate Democrats, who haven’t passed one in years, but Democrats seem willing to accept the provision. Perhaps they’re worried about the visceral satisfaction many Americans would feel about the idea of pulling Congress' pay? (And why not their health benefits, too?)

It's about showmanship, not statecraft.

It's political jujitsu. It shifts the dialogue from whether the GOP will push the country into default or stop payments for seniors on Social Security to why Washington can't pass a budget and whether elected officials should get paid if it doesn't. And it also shifts the playing field from the debt ceiling to the budget, turf the GOP believes is friendlier.

But, like the fiscal cliff deal, this merely postpones -- yet again -- the tough political decisions over issues like taxes on the rich, entitlement reform and reducing health care cost inflation.

Remember, what lawmakers are avoiding is the debate over how much damage to do to the economy via tax hikes and spending cuts. There is very little appetite for or discussion of short-term stimulus. And thus, no good economic news can come out of all this once the posturing and delays are finished.

It's like this: The outcome of all of this budget drama will be a drag on the economy. The fiscal cliff deal alone will trim 1.5% off GDP growth this year. The only question is how large that drag will turn out to be. The bigger the drama, the greater the hit will be due to the shock to investor confidence.

As the bad news comes out, the stock market won't be able to ignore the downside risks to still-elevated economic growth estimates on Wall Street. That's why I continue to recommend that investors stay cautious, sell into current strength and batten down the hatches by moving into defensive assets like Treasury bonds and gold. Examples include the Market Vectors Junior Gold Miners (GDXJ) exchange-traded fund and Yamana Gold (AUY).

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At the time of publication, Anthony Mirhaydari did not own or control shares of any company or fund mentioned in this column. He has recommended Market Vectors Junior Gold Miners and Yamana Gold to his money-management clients.