Daily Gains Letter

How the Debt Fiasco Will End for Long-Term Investors

By for Daily Gains Letter |

Long-Term InvestorsThe financial crisis struck the U.S. economy five years ago. Those who remember the collapse of Lehman Brothers know how much uncertainty was actually there. It seemed the U.S. economy was going to halt and the financial system would collapse. Ripples across the global economy were felt. Nothing looked safe—it was a total bloodbath. Investors had many questions, including if they would be able to protect their nest eggs.

As a result of all this, to fight the uncertainty and handle the issues at hand, the U.S. government and the central bank jumped in and started to spend. They bailed out the big banks in the U.S. economy to make sure everything would continue to run smoothly. We passed through that successfully, and the worst didn’t come upon us.

Sadly, as all this happened, we saw troubling trends starting to form in the U.S. economy.

Look at the national debt.

As the government started to rev up its spending spree, it posted a budget deficit and eventually borrowed money. To give you some idea, in January of 2008, when the behemoth was starting to awaken, the national debt of the U.S. economy stood at $9.2 trillion. Fast-forwarding to now, it stands at $16.7 trillion. Simple math suggests this is an increase of more than 81%. (Source: “The Daily History of the Debt Results,” Treasury Direct web site, last accessed September 20, 2013.)

Unfortunately, it doesn’t end here. Not too long ago, Treasury secretary Jack Lew sent a letter to the U.S. government saying that if they don’t increase the national debt limit currently in place by October, the U.S. economy will default; in other words, we need to increase our national debt limit.

My concern is not whether Congress will approve an increase of the national debt limit or not—they will increase it, as Congress already has done that many times in the past. No, my concern is how we are going to pay it back.

You must also realize that debt comes with an interest rate. The more national debt the U.S. economy incurs, the higher the interest expense is going to be. At the same time, the credibility of the government comes into jeopardy, which also causes creditors to ask for higher interest rates (think sub-prime borrowers).

This will also eventually affect the bond market of the U.S. economy. Currently, the U.S. economy is deemed safe, investors are willing to lend, and since bond rates are still very low, they are buying U.S. bonds. But going forward, it could get ugly.

At the end of the day, taxpayers are the ones who will pay the national debt incurred by the government. I can potentially see higher income taxes coming across the board in the U.S. economy—income brackets won’t really matter. At the same time, I can also see taxes like the “speculation tax” or “trading tax” coming into effect—a tax paid by investors when they make a stock trade, with the amount being a certain percentage of their investment.

We should be asking ourselves if we’re going down the right path. The ballooning national debt could have a huge impact on those who are saving for the long term and want to see their portfolio grow over time. If the U.S. government does say, “Sorry, we can’t pay you,” then the bond market could decline into complete chaos—yields will skyrocket, and the prices will fall. Long-term investors can save their portfolio from this situation by having exposure to hedges against uncertainty, like gold and silver.

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