US government debt is at a level compared to gross domestic product higher than during the second world war or any time thereafter. Similar situations are repeated in governments across the globe. What does this have to do with your investment choices and how can investors protect themselves from a potential economic meltdown? This issue came to mind while reading a thoughtful article by Michael Bloomberg about government “debt messes” and the potential for devastating consequences.
Is There any Likelihood of the US or Other Government Reducing Their Debts?
It is instructive to look at the top items in the US budget when considering if the US can reign in its debt. The top budget item is social security. Social security was less than a percent of US spending during the world war two era but broke above 20% at the turn of the century. Today it accounts for 22.5% of Federal spending. When the system as set up by the Social Security Act in 1935 life expectancy was less than today. By 1960 a 65 year old retiree could expect between twelve and thirteen years of life. By 2000 that increased to sixteen years and by 2023 to eighteen more years of life on average. People are living longer and collecting Social Security benefits longer than in the early days of the program. As better health care and medicines are likely to continue to allow us to live longer Social Security is likely to cost more every year unless cuts are made to the program. Making significant cuts will be difficult for legislators who are fully aware that the most likely people to vote are those receiving or about to receive monthly Social Security payments. So don’t for a quick fix in this area. Where else can the government look to decrease spending?
Time Running Out to Fix US Debt Courtesy of Bloomberg
Where Else to Look to Save on Government Spending
After Social Security, Medicare, directly funded health care, interest on the total debt and defense are costliest items in that order. With the country locked in a war with Iran and in need of replenishing stockpiles of expensive weapons, defense is not likely to be a place in the short term to look for savings. As buyers of US treasuries become leery of the US being able or willing to pay its debts, they will demand higher interest rates in order to purchase bond, especially on the longer term issues. This will increase the debt burden as we go forward. That only leaves medical and social programs to cut which will also not be popular are people lose health care and health problems mount across society.
How About Taxes as a Cure for the US Debt?
Taxes are never popular but today the fact that many in the highest earning groups are paying a lower portion of their income in taxes than those with lower incomes is making folks angry. It remains to be seen if enough legislators could be elected to significantly raise taxes and if doing so could make a meaningful difference in regard to the massive US debt.
Reduction of Immigration and US Debt
In the 1980s Social Security was in trouble like it is today with the trust fund running out. At the same time there was a national debate about immigration and how “no county with two languages ever survived.” Behind the scenes the US opened the flood gates and had the most immigrants in a century. These folks worked, paid taxes and paid into the Social Security system and rescued the system for decades. A side eforfect of the current war on immigrants is that the Social Security system will not be rescued and with the US having such a low birth rate there will be fewer and fewer young workers to pay taxes, support government programs and pay the massive US debt.
Worst Case Scenario for US Debt
JPMorgan published some useful information about possible outcomes of the current federal debt dilemma. The suggest five possible outcomes:
- Steadily rising debt-to-GDP with rising borrowing costs
- Slowly rising debt-to-GDP with little market reaction
- A fiscal crisis
- Slower growth in federal debt via spending cuts
- Slower growth in federal debt via higher taxes
The worst case would be a fiscal crisis. Possible instigators of such a crisis would be the Congress refusing to raise the debt limit, another government shutdown, unwise tax cuts or extension of current tax cuts when revenue is needed, or total loss of foreign investor confidence in US debt!
It remains to be seen if the government and the American people will be able to cut spending and pay more taxes while finding a way to stop getting involved in expensive wars.
What Are the Risks of So Much Debt for the Average Investor?
The slowly evolving case is higher interest on debts, and depression of economic growth. The fast and lethal case is when over extended traders and investors using derivatives or shorts to enhance their profits. When these folks get caught in bad positions they need to liquidate and that can cause market panic and crashes inflicting harm to investors who had nothing to do with derivatives, shorts, etc. If the government decides to print money to pay the debt the dollar will devaluate making imported goods more expensive for individuals as well as businesses.
How Can an Investor Prepare for a Debt Crisis?
We are seeing investors like Ray Dalio suggesting that people start hedging with gold and Bitcoin against a debt crisis. Alternatively, one might follow a useful approach in a recession which is to invest in companies that produce what people want or need no matter how the economy is doing. We wrote years ago about investing in beer in that vein. Other choices include utilities, retailers that cater to folks with less money. Holding on to cash may seem counter productive if the value of the dollar is falling but folks with cash on hand are better able to take advantage of opportunities when they arise. The most important part is to get rid of any high interest debt such as with credit cards and have at least enough cash on hand for six months of expenses.