What are the implications for gold in each of the debt and “default” scenarios possible after August 2nd? [Let’s take a look.] Words: 1111
So says Peter Schiff in an editorial* posted at www.TheDailyBell.com which Lorimer Wilson, editor of www.munKNEE.com (It’s all about Money!), has further edited ([ ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. Schiff goes on to say:
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 U.S. government was shrinking, that debts were being paid, that the entire U.S. 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 Balanced Budget
If the debt ceiling is raised in order to avert imminent default, and the spare time is used to truly bring the federal budget into balance, the U.S. 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 [c]ut $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 U.S. to return to solvency.[L]et’s be optimistic [here]: 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 U.S. 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. This, however, 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.
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Clearly, this is bullish for precious metals. It means more of the same – more spending, more debt, and necessarily more money-printing.
Conclusion: The Empire Has No Ceiling
Over the past 50 years, the U.S. 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 U.S. has anything resembling a “free market.” [As such,] it stands to reason that regardless of the debt ceiling increase, it is likely that the U.S. 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.
- Gold to Jump in Price With Increase in Debt Ceiling – Here’s Proof https://www.munknee.com/2011/07/gold-to-jump-in-price-with-increase-in-debt-ceiling-heres-proof/
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
- Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above