This is an issue I have been looking into for a while. How can the
US ever manage to to payoff its debts ($12.7 trillion and counting) and continue to run trillion dollar deficits for the foreseeable future. This year the national debt to
GDP will equal 100% and could hit 150% in the next 7 years. The historical method for managing the national debt has been to debase the currency by 3-4%(official numbers) through
inflation. This technique has worked very well over the years as most people lack a general understanding of
inflation. However the sheer amount of debt and the rate it is piling would require
double digit inflation for years. Below is a chart of the best case estimate of how the national debt will increase over the next few years.
Remember this is an optimistic projection and likely underestimates the true numbers.
Marc Faber estimated that the
US will run trillion dollar deficits forever. Why? Because
Social Security has now fallen into deficit. This means that for the first time in history, the
government is paying out more in benefits than it takes in from payroll taxes. The
US government has used
Social Security as a piggy bank for years in order to finance the government. It was a great racket while it lasted. But instead of being able to freely spend
Social Security's surpluses, the Treasury now has to make up the deficit by borrowing billions more.
This brings us to the next problem: servicing the interest on the national debt. The
US will spend north of $400 billion during 2010 to just pay the interest on the debt. And this is with historically low interest rates. At a certain point interest rates will rise and the cost of servicing the debt will skyrocket putting more pressure on federal budget.
Solutions
Historically there are only four solutions to the current debt problem.
1.
Grow your way out. If the
US could grow at 6-7% for the next 20 years without a single recession we could theoretically grow our way out of this problem. Yes the debt would still increase but it would represent a smaller percent of
GDP and thus more easily serviced. If you believe in this scenario all I can say is good luck.
2.
Simply defaulting--This is not a possible outcome as it would have devastating affects for the
US. It is also politically unacceptable and could spark riots and even a revolution. I highly doubt the
US will ever officially default.
3.
Reduce Government Spending--HA HA HA!!
4.
Print Money and lots of it--This in my opinion is the most likely scenario because it is so easy. The only problem is that the US would likely have to print $1-1.5 trillion a year to achieve the desired outcome.
Printing this amount of money would lead the
high rates of inflation in the future. The only downside to this is the potential for a large backlash from the general public who become unable to afford their lifestyle. Imagine having to pay $10 for milk $14 for a gallon of gas while your wage stays relatively flat. This is the conundrum facing the
Federal Reserve central planners. The people are oblivious to 3-4%
inflation but become enraged at 10-30% because it is more easily recognizable. Another problem with
high rates of inflation is that the bond market will simply refuse to purchase government bonds (except at egregiously high rates). This in turn forces the
Federal Reserve to print even more money which creates a viscous cycle of ever increasing
inflation.
How to protect yourself
Since
inflation is the most likely scenario, you have to find a way to protect yourself from this eventuality. It is really simple--you have to get your money out of paper assets. Paper assets include bonds, stocks, money markets, etc. I know most people will tell you that stocks protect you from
inflation but this is somewhat misleading. Stocks do well during periods of
low inflation (around 2-5%), but do poorly during periods of
high inflation(above 10%). This is especially true during
hyperinflation. Take a look at the following chart which shows the nominal price of the Dow between the
Great Inflation between 1966-1980.
At first glance it does not look so bad--the market was roughly flat over this period. But remember that this does not include
inflation. When you
adjust for inflation the market lost over 50%. Not very good it is.
The only way to protect yourself is to have hard assets which retain their value in real
inflation-adjusted terms. It does not matter which hard asset you choose, be it
gold, silver,
oil, copper, etc. All commodities will hold up under
inflation.
Good luck
Black Swan Insights
