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Debt Reduction and Economic Growth

Are debt reduction and economic growth compatible? Many believe that this is a valid concern for investors today. At the last minute the US congress appears ready to pass legislation temporarily increasing the debt ceiling. This will be coupled with substantial reductions in social and military programs. The staggering multi-trillion dollar US debt has been a drain on the US economy and a threat to economic growth. The prospect of a debt reduction is encouraging for US investors. However, an abrupt decrease in national cash flow could lead to economic contraction. Here is where the concern about debt reduction and economic growth lies for many investors. Fundamental analysis of the situation starts with defense stocks as the president has promised troop withdrawals from Iraq and Afghanistan. No new military involvement is on the immediate horizon. That will likely mean fewer bullets and, probably, a reduction in manpower. It may also mean a reduction in research and development for new weapons systems as the nation attends to concerns at home. Stocks of defense contractors will likely feel the pinch of reduced military appropriations. The reductions in military spending will likely also have a ripple effect throughout the economy. Less money spend on military salaries or on paying engineers to develop high tech weapons means reduced spending throughout the economy. In this regard there will be an inverse relationship between debt reduction and economic growth.

Social programs, debt reduction and economic growth are also related. Every dollar in social programs is eventually translated into spending for housing, groceries, food, and other necessities. The weak real estate market may well become weaker in the inverse relationship between debt reduction and economic growth. Picking new winners in this brave new world of investing will require a little thought and stock by stock or equity by equity analysis. Even in weak economies consumer goods manufacturers tend to do well. The next cancer cure, stem cell miracle cure for diabetes, Alzheimer’s disease, Parkinson’s disease, or treatment for any other major malady will likely make investors rich. If the threat of fixing the US debt structure turns into a reality Gold Bugs may well want to hedge their bets in investing in gold . The primary argument for buying and holding gold is that the dollar will perpetually lose its value. If the US puts its economic house in order we could possibly see the same sort of precipitous fall in gold prices that happened in early 1980! Investors in gold stocks and gold ETF’s can hedge their risks quickly by selling stock. It may take a little longer to remove gold bullion and coins from a depository, transport, and sell in a falling market.

The bright side of debt reduction and economic growth is that eventually the relationship will reverse. A less debt ridden government will require less money to finance its ever-growing national debt. If a combination of spending reduction and tax structure modification succeeds in reducing the national debt, stocks will likely go up. For those who invest in US stocks at the bottom of the trough it could be a nice ride to prosperity.

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