Perhaps
the debt ceiling should be renamed the "national debt target," for
it seems Washington is always trying to reach it. One could say it's their
only reliable, time-tested achievement. And without fail, upon reaching their
national debt target, they promptly extend it further in order to discover
how quickly it can once again be attained!
While
I have little doubt that the ceiling will be raised, my readers have been
curious as to the implications for gold in each of the debt and
"default" scenarios possible after August 2nd. This month, I'll
outline how each outcome could affect the price of gold and silver.
BEARISH GOLD CASE #1: DEBT CEILING NOT RAISED - ENOUGH
CUTS MADE TO AVERT DEFAULT
My
readers know that this scenario is actually what the US government should
do. The debt ceiling should not be increased and massive cuts must be made.
We know this outcome is extremely unlikely - it would require not only a
resolute steadfastness to sound money, but also a 180-degree change of
philosophical beliefs by the majority of Congress (and the American public)
overnight.
Yet
in our fantasy world, if this did occur, it would be bearish for gold.
It would mean the US government was shrinking, that debts were being paid,
that the entire US economy was becoming more solvent and viable. Gold would be less important to own, as
the risk of both currency crises and sovereign debt crises would be lower.
BEARISH GOLD CASE #2: DEBT CEILING RAISED - FEDERAL BUDGET
BALANCED
If
the debt ceiling is raised in order to avert imminent default, but the spare
time is used to truly bring the federal budget into balance, the US economy
might still be saved. But when I say "balanced," I mean it. This
would mean not only eliminating the entire $1.5 trillion deficit, but also
leaving enough of a surplus to cover all outstanding debt and unfunded
liabilities. For perspective, Senator Rand Paul's proposal to but $500
billion a year, widely considered more radical than landing a man on Mars,
would only address 1/3 of the annual deficit - it would take cuts many times
that for the US to return to solvency.
But
let's be optimistic: if the budget could be balanced, then the fact
that the debt ceiling was being increased yet again would not be so awful.
Since the US government's fiscal policies would be completely reversed, we
could expect to start seeing a strengthening of the dollar (so long as
Bernanke stopped the printing presses too) and a weakening of gold and
silver.
However,
this is just as much of a pipe dream as the first scenario. No government in
history has dug itself out of the hole we now face without defaulting. If
Congress even tried to enact a plan like this, people would be rioting in the
streets over their lost entitlements. And we'd suddenly have millions of
unemployed soldiers. Not exactly a recipe for peace and prosperity.
BULLISH GOLD CASE #1: DEBT CEILING NOT RAISED - US
DEFAULTS ON TREASURY DEBT
This
is the scenario that President Obama and Secretary Geithner are threatening.
They claim that if the debt ceiling is not raised, they will have to
immediately begin defaulting on Treasury interest payments. This is rather
unlikely, as interest payments make up only 10% of spending, but let's say
they stop paying anyway.
If
they do this, market interest rates for US debt would skyrocket,
meaning the only buyer left at rates the Treasury could afford would be the
Fed. In other words, if they default on August 2nd, QE3 will start on August
3rd. Of course, a default would be absolutely devastating to the dollar and a
boon for gold and silver. Global confidence in the invincibility of the
United States would be shattered, and the underlying problem of excessive
spending would still remain to be addressed.
Another
interesting scenario would be if Congress didn't raise the debt ceiling and
the Treasury just kept borrowing anyway. It's not like the Executive Branch
follows laws scrupulously nowadays. What if they just ignored it? Someone
could challenge the act in federal courts, but the odds are often in the
President's favor. In this case, gold and silver might experience less of an
initial spike, but their long-term prospects would be elevated as the world
recognized that we were one step closer to becoming a banana republic.
BULLISH GOLD CASE #2: DEBT CEILING RAISED - SYMBOLIC CUTS IN
SPENDING
This
scenario is by far the most likely outcome of the debt talks in Washington;
they will raise the debt ceiling and make spending cuts which sound
substantial, but which only mange to slow the accumulation of new debt.
The
plans on the table suggest cutting a couple trillion in cumulative spending over
the next decade. In other words, they propose cuts that only reduce deficits
by about 10-20%; they do nothing to reduce actual debt levels. So if these
talks are successful, then instead of a $1.5 trillion deficit each year,
perhaps we only suffer a $1.2 trillion deficit. Meanwhile, the debt continues
growing. This is "success" in Washington.
Clearly,
this is bullish for precious metals. It means more of the same - more
spending, more debt, and necessarily more money-printing.
The Empire Has No Ceiling
Over
the past 50 years, the US debt ceiling has been raised over 70 times. In
other words, there is no ceiling at all - it is as fictitious as the idea
that central planning works, or that the US has anything resembling a
"free market."
So,
I guess it stands to reason that regardless of the debt ceiling increase, it
is likely that the US will be downgraded by one or more ratings agencies. The
effect will be massive because the world's largest pension, mutual, and
sovereign wealth funds typically mandate investment only in AAA-rated
securities. A downgrade of US debt means those funds must immediately sell
off their primary reserve asset. The effect of this cannot be overstated, and
gold would be the first and best refuge for an onslaught of orphaned capital.
Despite
gold once again hitting new highs, I can only recommend my readers continue
to keep a healthy portion of their portfolio in precious metals. Given the
sad realities of the US fiscal and monetary situation, it's prudent to assume
that nothing will be solved by August 2nd.
Peter Schiff
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