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S&P Downgrade Shows U.S. Debt Crisis Could Have Dire Consequences

[Editor's Note: Standard & Poor's yesterday (Monday) downgraded its outlook for U.S. debt to "Negative" from "Stable."; To read more about the downgrade in a separate story that appears elsewhere in today's issue of Money Morning, please click here.]

The latest development in the U.S. debt crisis came yesterday (Monday) when Standard & Poor's finally downgraded its outlook for U.S. debt to "negative," from "stable."

That's right: Of the 17 countries that S&P has rated AAA, the United States is the only sovereign that carries with it a negative outlook.

This merely confirms what we've been saying all along about the complete lack of fiscal discipline on display in Washington – and it has potentially dire implications for the U.S. economy.

Fortunately, as an investor, there are steps you can take to safeguard yourself against the abhorrent fiscal and monetary policy that has resulted in this U.S. debt crisis.

I'll get to that later – but first, let's examine how we got to this point…

The Nexus of the U.S. Debt Crisis

First, the obvious: Deficits are a lot harder to get rid of than they are to incur.

That's particularly true in the United States, where spending cuts and tax increases are very hard to enact, and spending increases and tax cuts virtually enact themselves.

Remember, the $787 billion U.S. Recovery and Reinvestment Act was passed in a couple of weeks in 2009, whereas it took Congress three months and a near-shutdown of the government to agree on a mere $38 billion of 2011 spending cuts.

Of course, it wasn't always like this.

Traditionally, governments thought they had little alternative but to balance the budget, or risk an economic collapse. The required self-discipline was best demonstrated by Lord Liverpool's British government, which in 1815 inherited the largest public debt that any country has successfully conquered – about 250% of Britain's 1815 gross domestic product (GDP).

Even back then, there were voices like Henry Brougham advocating a loose monetary policy that would reduce the real value of the debt, satisfying the government's obligations by cheating the bondholders. Liverpool's government, however, was made of sterner stuff; it raised taxes on imported food through the notorious Corn Laws, took the country back on the gold standard – which involved a price deflation of about 20% — and cut public spending to the bone.

The short-term result was a huge economic boom, which within a decade produced substantial budget surpluses and reduced the debt's burden to manageable levels. The long-term result was a century of stable prices and prosperity, at the end of which the debt was lower in nominal terms than it had been in 1815, and GDP was about 10 times higher.

The blame for eradicating that admirable attitude towards deficits and debt can be laid squarely at the feet of John Maynard Keynes. His spurious justifications for increasing government spending in depressions and reducing it in booms were used to create deficits, and never surpluses (except accidentally, as in 1998-2001).

When Britain in 1945 was faced with a similar but smaller debt problem to that of 1815, it increased public spending rather than decreasing it, and sorted out the debt by creating inflation. Thus it balanced the government's books by robbing bondholders like my Great-Aunt Nan, who was reduced to penury before her death in 1974.

It is now very clear that the approach of U.S. President Barack Obama and Federal Reserve Chairman Ben S. Bernanke to public debt is similar to that of the British leaders Clement Attlee and Hugh Dalton after 1945. They created a huge wave of unproductive spending when faced with recession in 2009, most of which became locked into the "baseline" expenditure for future years – thus preventing the budget from ever approaching balance.

Their strategy for tackling the resulting debt is the same as that of Britain after 1945: Create inflation and watch it magically melt away, becoming a smaller and smaller percentage of a GDP that is inflating in nominal dollars.

Of course, there are two problems with that approach. One is that there are no longer sweet old ladies like my Great-Aunt Nan that can be leveraged to absolve the U.S. debt crisis. Instead, much of the debt is held by Asian central banks and the Middle Eastern ultra-wealthy. They probably won't like being swindled in this way, and will find some way of getting revenge.

The second problem is that the policies of ultra-low interest rates, huge public deficits and increasing inflation are very bad for the real economy. They encourage banks to engage either in speculation or to simply buy government bonds and finance them short-term. Neither activity directs money to small businesses, which create jobs.

Companies also are encouraged to invest in new factories, mostly outside the United States, while cutting labor forces to the bone – since capital is cheap and U.S. labor is relatively expensive.

Those two factors explain why GDP growth in this recovery has been sluggish and high unemployment has been so persistent. Indeed, long-term unemployment is almost half total unemployment at present, far above its level in previous post-war recessions – and that's not counting those who drop out of the workforce altogether.

Worse, years of ultra-low interest rates are as bad for the nation's social fabric as they are for the economy as a whole, because they produce a huge pool of unemployables, encourage gambling, and discourage true entrepreneurship and hard work.

Liberals inclined to doubt my analysis should reflect on one thing: What kind of society do we have when Donald Trump is leading the polls for the Republican Presidential nomination? If the Fed had maintained normal interest rates following the recent real estate crash, that overleveraged real estate and casino speculator would be too busy fighting for his financial life to finance a run for high office.

The Bottom Line: Liverpool's budgetary austerity was rewarded by a massive economic boom, which was the core of the first Industrial Revolution. And the United States would see similar results if it made that approach its own.

Of course, that is hopelessly unlikely in the near term, so buy gold and sell Treasury bonds. It won't entirely mitigate the economic unpleasantness ahead, but it will help you avoid the sad financial fate of my Great-Aunt Nan!

Action to Take: The U.S. Federal Reserve's loose monetary policy and the Congress' inability to rein in the U.S. debt load have undermined both the dollar and the economic recovery.

There is no safe place to hide, but owning gold and other precious metals like silver could go a long way toward preserving your wealth.

In fact, I would recommend you have at least 15% to 20% of your portfolio in gold and silver, the traditional inflation hedges. For detailed instructions on how to stock up on these metals see Money Morning's special reports: "How to Buy Gold" and "How to Buy Silver."

Of course, the short story is that both metals have exchange-traded funds (ETFs) that track their price fluctuations: The SPDR Gold Trust (NYSE: GLD) and the iShares Silver Trust (NYSE: SLV).

[Editor's Note: Earthquakes and nuclear meltdowns in Japan, soaring food-and-energy prices, a numbing federal debt load and savings-account rates that make your mattress an alluring place to stuff your money … it's enough to make the typical investor surrender.

Not so fast.

There is a way for you to double your money in the next 12 months – and you don't have to hire a Swiss banker to do it. All you need is the right blend of high-yielding investments. You can find out the details by clicking here. Or you can sign up for The Money Map Report, which each month details the very best profit opportunities you'll find anywhere.]

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Join the conversation. Click here to jump to comments…

  1. db | April 19, 2011

    Really Mr. Hutchinson, Are you advocating wide-spread starvation, essentially eliminating defense spending, and a limited franchise, as the answer to the US budget problem?

    Try reading Charles Dickens, not Jane Austin for your social commentary.

  2. Werner Strohmeier | April 19, 2011

    Thank you Martin, for reminding people of what happens. There is far too much complacency on the subjet both in the US and abroad. As a Swiss citizen I am particularly appalled at the size of the country's holdings in US bonds. If you list were classified in per capita holdings Switzerland would probably show up at a much higher level, and that is far from reassuring me!
    Carry on your good work and please let me know if I may use your listing to send it to Swiss National Banks president to tell him off!
    Many thanks again.
    Werner Strohmeier

  3. Jeff Pluim | April 19, 2011

    db, Hutchinson has it right, as do the IMF and S&P. Unless the USA takes the same approach that Britain did in 1815, THEN you WILL see widespread starvation. The USD will be worthless, and like in Germany in the earlier 20th century, it will take a wheelbarrow full of money just to buy a loaf of bread. The same mental freeze that makes people stay on the beach when the tide has gone out too far because of a forthcoming tsunami, is the same type of brain freeze that db is guilty of when it comes to the forthcoming economic tsunami. Just because you have never seen it personally, in your lifetime, does not mean that it won't happen.

  4. kelly cranston | April 19, 2011

    The housing boom and subsequent bust were caused entirely by artificially low interest rates enacted after 9-11 in a lame effort to stimulate the economy by getting people to spend the equity in their homes. The other fuel to the fire encouraging speculators into the housing market were the Bush tax cuts which lowered capital gains from 30 to 15%, giving house flippers (I was one) an almost free ride where up to 40% of all houses were owned by speculators. Just check the figures, 2/3 of the budget deficit are caused by Bush tax cuts and Bush wars The other third is of course due to the recession caused in part by the preceding factors. Of course cuts need to be made, but lets be honest about the causes of this mess.

  5. Elaine Carrington | April 19, 2011

    Kelly – aren't you sick to death yet with the blame game – it's time to move on and be smart as to how our economic woes are resolved. Former president Harry Truman had to make the most serious decision regarding "to drop or not drop the bomb" during WWII, later it is told he suffered all kinds of criticism for that decision. I love his response to his critics – "you make the best decision you can at the time with the information you have – that's the best you can do – if later others see another way then that's just the way it goes" Until we have a crystal ball in the bottom drawer – we make decisions with the information we have, we do our home work – seek counsel of those we perceive as wise and experienced, take action, and pray the most good will come from those actions.

  6. David | April 19, 2011

    Kelly, what a simplistic view of a complex issue.I am not rep. or dem.Read the book The creture of jekyll isalnd.It has been the same mantra fiat money/fractional reserve banking,debt enslavement,too big to fail,bailout.Rinse repeat.Fiat money will always revert to its intrinsic value….zero.

  7. jj | April 19, 2011

    I think db is in the majority in this country.I'm not optimistic after decades of the U.S. being a welfare state,with so many dependents.I remember when Meg Whitman ran for governor,here in California,and she pronounced,"California is a welfare state".She was correct and that fact is also the reason she lost her bid.

  8. DrQuien | April 19, 2011

    Yes DB…personally I would advocate cutting (not eliminating) defense spending. in the 21st century superpowers will be created by economic might, not weapons arsenals. Its a new paradigm the world is moving into and we (the USA) unfortunately are not getting the message.

  9. chan | April 19, 2011

    The US is not in reality.They don't earn instead the Americans will spend others money by borrowing and also they are so arrogant and definitely they don't deserve the standard of living in the US.All immigrant have to abandon to stay in US and they have to make arrangements to return to their own respective countries as soon as possible.The fancy of living in US has gone and one cannot have any descent life any more that too particularly after 9/11 and the US people including the politicians are continue to lead a responsible life and the Americans out of mind.It is not believable that such a high industrialized nation is becoming a bankrupt country. US do not have financial regulation from 1837.
    By complaining that there is no financial regulation in the country everybody cheated others in America is all possible manner.Besides the America is the hosting country for WHO, UN and IMF and the Americans are the officers of IMF and controlling all this still the US in financial crisis is seriously to be dealt with and if they continue like this god only have to save the US nation.Such a shameful Americans.

  10. Ian Shearer | April 19, 2011

    An interesting and accurate comment on Britain's economic history.

    And as for db's comment: Yes, if the USA virtually eliminated defence spending the sum of misery in this world would diminish. The US military complex seems to scour the world looking for somebody to fight. But not to beat quickly or they would drop a nuclear bomb, just a nice little pot-boiler of a war. The UK has not yet rid itself of the urge to tag along.

    Loose money and ultra low interest rates are pernicious evils which encourge investments in projects that do not generate an economic return. Such as housing bubbles which are vulnerable to the first ill wind. During the most succesful period of the UK economy the Bank Rate was fixed for 200 years at 5%. That is where it needs to return in USA and UK.

  11. frank saia | April 19, 2011

    I propose a separate dedicated transfer tax of 2% on all Buyers and 2% on all sellers, payable to each country to be used solely to pay off that country's debt. For Example: Walmart bought stores in S. Africa for $2 billion. If the transfer tax were in place 2% would go to So. Africa and 2% would go to the USA.
    In 25 years or less the DEBT would be paid off. It is not likely that the deficit will go to s urplus of 1/2 trillion per year to pay off the debt in 30 years. We need to vote for a special dedicted tax on all transactions to accomplish the elimination of each country of the World's Debt. Inflation and interest rates are threatening to cost that 2% and we will have to pay it, but the difference is inflation and interest rates will not eliminate the debt. With this 2% solution, confidence will improve, and inflation and interest rates will stay down since we will have put in place a direct reduction method to pay off the onerous debt threatening us all. We need to do so now to prevent other countries from following Portugal, ireland, and Greece
    What do you think of this idea?

  12. Les Jones | April 20, 2011

    Reading these responses is sorta like the SiFi channel

  13. db | April 20, 2011


    There have been Right Wing "Pundits" promising the collapse of the dollar because of the US debt, and resulting hyper-inflation, since at least 1980. I've heard it all once too often."Fool me once…"

    If you want to put on your tin hat, buy your "Survival Seeds", and watch Glenn Beck reruns from your mountain hide-away, blessings upon you. If you'd care to make an intelligent contribution, lose the sloganeering.

    My point was & is that the UK in the 1820s launched a number of policies that would be totally unpalatable, & nearly unthinkable, for the US today. It is easy to look back nearly 200 years with rose colored glasses (Jane Austen). The reality was much less pleasant (Charles Dickens).

  14. Michael G Angstreich | April 21, 2011

    Kelly C. is right. If we're honest about the causes we can find the cures. Chronic ailments often require painstaking recoveries. The pain, like the fault, in the US is,however, unjustly shared and largely borne by the majority least able to suffer it.

  15. Walter Mitchell | April 24, 2011

    I guess those of you with school age children and college dependents will have to force them off the gov't./family dole. If none of them can make it on their own they will just have to eat less and wear hand me downs.
    This is the way it will be with Obama Care/Gov't. Care. Off course maybe we should have the politicians live off of what they earn.

  16. Roger | April 24, 2011

    Dear Dr. Quien, You are clearly an apologist for the Communist Republic of China : how else could you spout such Geo-Political nonesense? Any intelligent observer can see the Military/Economic strategy of China…..not Obama or Carter or Clinton of course. Actually, both Clintons could and did….but could not resist the massive bribe that went with the sale of the Panama Canal. Do you personally think you and your family will survive WW111? Kindest regards, Roger.

  17. publius | April 24, 2011

    Tax cuts are NEVER a cost to the taxpayers, or to the economy. Tax cuts are only a "cost" to ever-growing government. The truth is that only spending is a cost. So you can say the costs of the "Bush Wars" after 9/11 outweigh the benefits of those wars. That's a legitimate argument, whether you agree with that position or not. But to say the tax cuts were a "cost," or that "we can't afford tax cuts," as liberals do, is ridiculous.

    Does your family ever say, "Keep the tax rates nice and high – we can't afford tax cuts?" Of course not.

  18. cristhian pirazzoli | April 24, 2011

    USA no esta muerto ni en peligro, domina el 50% del comercio mundial más las nuevas tecnologías.
    Estoy de acuerdo que es un momento difícil pero no para alarmarse ni darle en el gusto a los especuladores, ésto es un puro juego económico ya que el déficit lo tendremos que pagar entre todo el mundo ya que USA no puede caer, solamente esta licuando su deuda. Ya verán y establbishment económico sabe lo que esta haciendo. Ahora están sufriendo los Estado Unidences, los Europeos etc. pero nosotros paíces emergentes como los Sudamericanos que estamos haciendo las cosas bien, más temprano que tarde nos tocará.

  19. Paul Maloney | April 24, 2011

    Until America is truly honest with itself and admits what the real problem is, the problem will never be solved. Unfortunately, the truth is that Reagonomics, as preached by the Republicans for the past thirty years, is, and always was, a ponzi scheme! It gave us the excuse to lavish ourselves with tax cuts, but we never cut spending. Instead the solution was to use credit to expand our standard of living instead of paying cash. However, like any irresponsible household that abuses credit, the U.S. will soon face our own day of reckoning. Then, all of the gadgets, baubles (and McMansions) we bought ourselves with our tax cuts just won't look so wonderful and important any more.

  20. Ed K | April 25, 2011


    Kelly- I agree with you. I think that it is important to remember how we got into this mess. Didn't W bankrupt every company that he ever ran as well? Yes, we need to move on, but let's be honest about how we got here.


  21. Tindle Ramon | April 28, 2011

    Martin, Jeff, Kelly, Dr Quien and Paul are right on track.

    A country is no different than a household when it comes to money management. If you do not pay for most things as you go, save for a rainy day and keep your debt small, short term and manageable the buzzards will eventually come home to roost. Oh yeah, out of that same household budget should be our giving to help others that are less fortunate than us.

    OK, enough euphemism. We have to cut spending AND raise taxes if we want our country to become fiscally responsible. I have seen presentations by several reputable economists, democrat and republican alike, and the numbers just do not work if we do not do both. Yes, we need a strong military but we need to walk softly and carry a big stick. (Oops) Wars for profit and without an attainable goal have wasted billions. ($900 billion as of 3/31/2011 in Iraq alone) Unnecessary military bases in the USA and around the world are costing us billions every year. Yes, we need to cut entitlements but mostly on those that can afford it, of which I would be one. Yes, we need to raise taxes on the wealthy and the group Patriotic Millionaires for Fiscal Strength agree. (

    No one is advocating starvation and that is why we need some of the social programs we have. We do need better regulation and stiffer laws to prevent the power players from pushing all the pain to, as Michael put it, “the majority least able to suffer it”. And lastly, we must recognize and accept that it will be painful for all of us.

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