Historians will look back at December 2010 as a watershed moment. At the beginning of the month, a courageous group of bipartisan souls announced a blueprint to stem the runaway tide of red ink. A couple weeks later, Congress and President Barack Obama agreed upon extending the Bush-era tax-cut package for two more years. That took the budget deficit to a whole new level of fiscal insanity.

Progress — in reverse
Ironically, the budget deficit was actually set to shrink in 2011 as the recovering economy boosted tax receipts and the tax reductions enacted during the Bush administration were due to expire. The $1.3 trillion deficit in 2010 was expected to fall to around $1 trillion in 2011. Yet the GOP is so devoted to tax cuts, and the Democrats are so devoted to near-term fiscal stimulus to help keep the economy afloat, that neither party appears especially serious about deficit reduction.

As a result, we’ve just tacked on another $858 billion to the deficit over 10 years thanks to this tax-cut extension agreement, according to the Congressional Budget Office (CBO). The $374 billion addition to the 2011 deficit and the extra $423 billion in the 2012 shortfall likely means that we’ll be above the $1 trillion annual deficit mark until at least 2013. The proverbial ball has been kicked down the road.

The illusory benefit of low interest rates
Last week, I took a look  at how the stock market would be impacted by serious efforts to tackle the budget deficit. Up until this point, investors are tolerating the lack of action from Washington because of the very low interest rates — the government is only paying about $30 billion a year in interest for every $1 trillion it borrows. But further inaction can quickly turn the tide. If and when the government is unable to find enough buyers to gobble up its bonds, it’ll have to sweeten the yields to sustain interest, perhaps to alarming levels. Sure, 8% interest rates mean the government is only paying $80 billion in interest on $1 trillion in borrowings, but the real effect on the U.S. economy due to such high rates can be devastating. Interest rates have actually started to rise recently, and if they rise further, we must take this ticking time-bomb scenario much more seriously.

Courage when it’s needed
The change in sentiment would be a real help to the efforts of a few bipartisan legislators that plan to aggressively tackle the budget deficit crisis in 2011. Senators Mark Warner (D-VA) and Saxby Chambliss (R-GA) have been holding quiet discussions since this past summer with about 20 across-the-aisle colleagues to identify ways to jointly promote deficit reduction, without the usual rancor that invariably dooms bipartisan attempts at progress these days. Warner recently told reporters at a press conference that the group has “a cease-fire on immediately criticizing each other’s ideas.” At that same event, Chambliss said the truce is  due to the make-up of the group: “We’re starting with a group that’s in the middle and we’re growing out,” he declared.

Other members of the group include:

• Bob Corker (R-TN)
• Amy Klobuchar (D-MN)
• Jeanne Shaheen (D-NH)
• Roger Wicker (R-MS)
• Ron Wyden (D-OR)
• Mike Johanns (R-NE)

Action to Take –> Investors who live in one of those states, should write to their senator to let them know how much this issue means to the future of their investment portfolio.

2011 will be a crucial year for the budget deficit issue. By the end of the year, politicians will begin campaigning for the 2012 elections and the odds of bipartisan collaboration will greatly diminish.  If we wait until after the elections, then we may well find ourselves with far higher interest rates and a greatly constrained economy.