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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!
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).
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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The Obama Blueprint for Solving the U.S. Financial Crisis - Money Morning:
Hear the Latest Top 2011 Investing Strategies from Money Morning Financial Experts - Money Morning:
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Special Report: How to Buy Silver
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.
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
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… Read more »
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… Read more »
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… Read more »
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.
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.
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.
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… Read more »
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.… Read more »
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… Read more »
Reading these responses is sorta like the SiFi channel
Jeff, 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… Read more »
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.
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.
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.
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?"… Read more »
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… Read more »
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… Read more »
Hi,
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.
Sincerely,
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… Read more »