Bond guru and DoubleLine Capital founder Jeff Gundlach says the United States is confronted with a terrible deflationary battle, one that will ultimately end in default.

“The problem for the near term is that the load of all of this debt is deflationary. We need to work through these deflationary outcomes,” Gundlach said at the recent Morningstar Investor Conference in Chicago.

“Debt growth creates a headwind where we need more and more and more debt,” Gundlach observes. “Some type of polite default, at a minimum, will happen.”

Gundlach blames government spending for the country’s current economic problems.

“Government workers are being paid with taxes on borrowed money,” he says. “If you are going to create government jobs, you are just borrowing more money.”

“Those aren’t real jobs.”

Remove government stimulus, Gundlach says, and a double-dip recession or a significant contraction or slowdown of economic growth will result.

Moreover, investors need to factor in the looming tax increase and “a radical policy shock that will affect investments in the economy.”

Municipal bonds underperformed U.S. Treasuries in the first half as default speculation drove state and local government yields to the highest level relative to government bonds in 13 months.

“The Treasury market rallied its brains out,” Brian Battle, vice president of trading for Performance Trust Capital, told Bloomberg Business Week.

“Munis haven’t followed as much.”