Government Debt Solution Will Kill the Economy

debt problemsThe government’s poor money management is coming home to roost at the worst time. The “solution” to the U.S. debt problem will be some level of austerity and/or tax increases, both of which are sure to grind the economic recovery to a halt.

A double-dip recession is not just possible… it’s likely.

How bad could it get?

The unemployment rate could surge to 20% and mortgage lending standards may get 400% more difficult — and that’s just the beginning.

If mortgage rates rise (which they will soon) it will become even harder to get a home loan. The minimum down payment for “qualified” mortgages could increase to 20%, removing a large amount of prospective buyers from the marketplace and drive home prices even lower.

U.S. Government “Underemployed”

Because the odds of not paying their bills are much higher, individuals with poor credit must pay higher interest rates if they want a loan. High credit card, loan and mortgage rates keeps these folks locked in a vicious circle.

The government is about to find itself in this same cycle.

Right now the U.S. has a AAA credit score, the equivalent of 850 on the FICO scale (which ranges from 300-850). With that score, the U.S. can borrow money (sell bonds) at the lowest of interest rates. If the U.S. were to lose its “risk free” status and/or default, its borrowing costs would rise substantially.

Worse yet, Washington is bringing in less income now. High unemployment and underemployment mean less tax revenue. Americans are making and spending less than they were just a couple years ago.

Like so many of its citizens, the U.S. government is underemployed. This is where the cycle begins…

The U.S. dollar is the world’s reserve currency, which means our money is at the center of the world’s economy.

Take China for instance; it owns $1.15 trillion of our debt. Imagine Hu Jintao getting a notice of default from the U.S. Treasury Department… the reaction would not be good.

America’s next payment of $30 billion is due on Aug. 15 — and that’s just interest.

Here are our biggest debt holders.

Debt Holders

The federal government, like Greece, will have to back out of the promises it made. Money and government jobs will dry up, adding to unemployment and low consumer sentiment.

It’s already happening.

(Don’t forget to sign up for Smart Investing Daily and let me and fellow editor Sara Nunnally simplify the market for you with our easy-to-understand articles.)

Government Shedding Jobs

The BLS (Bureau of Labor Statistics) had this to say in its last employment report:

Employment in government continued to trend down over the month (-39,000). Federal employment declined by 14,000 in June. Employment in both state government and local government continued to trend down over the month and has been falling since the second half of 2008.

It will only get worse. Meredith Whitney, the popular banking analyst, predicted a wave of municipal bond defaults to occur this year. While this hasn’t happened yet, her warnings should not be ignored. The inevitable may be delayed.

Local governments have slashed payrolls and spending and raised taxes to reduce budget deficits. This Band-Aid may be working now, but not for long. As you cut Americans’ wages, add people to the unemployment lines and tax your working citizens whose home values are still decreasing, you eventually end up with the same problems you were trying to solve… only worse.

Can you see the cycle here? There are too many factors pointing to serious contagion in our economy. We must not get complacent.

As traders and investors, we need to put economic theory aside and look at the real ramifications of what is happening and how it will affect our investments.

Where Do You Put Your Money?

The stock market has brushed all of this aside. The reality of this perfect storm hasn’t sunk in yet. A double-dip recession is on the way. It might not be as severe as 2008, but it will be nasty nonetheless. Sara recommended silver in yesterday’s issue, which I agree is a smart place to move your money, as well as gold.

Protecting your portfolio is key to building wealth.

Another key is to find pockets of strength and stability. It won’t be easy… We saw how the last crisis knocked nearly everything flat.

Look to energy and wireless infrastructure companies like General Electric (GE:NYSE), Skyworks Solutions (SWKS:NASDAQ) and American Tower Corp (AMT:NYSE). These companies will benefit from our need to improve our wireless communication and electric grids, which are going to be in demand with increasing mobile connectivity and the evolving smart grid.

This sector has outperformed the S&P 500 over the past two years…

Just look at this chart!

S&P 500
View larger chart

Of course, this is just one pocket of strength you can put your money in.

You will also find alternative strategies and tips in our new FREE podcast series. My colleague Joseph McBrennan offered an interesting agricultural play and last Friday I demonstrated how you can use other people’s money to buy stocks at a discount in this volatile market.

Because of high rent demand and a tough housing market, apartment REITS are also still appealing — you can find more details in a Smart Investing Daily article I wrote here on June 14.

Options will become more and more prevalent as investors learn how they can greatly reduce risk and volatility in their portfolio. I think they are the only way to absolutely cap your risk.

The point is, you don’t need to be a passive, reactive investor… You can start building in defenses like gold and silver, and find those pockets of stability, to build wealth while the market’s looking the other way.

Publisher’s Note: Currencies have never played a larger role in our investing success than right now. With Europe in great flux, Uncle Sam begging for more cash and no end to this debt mess in sight, there has never been a better time to get rich from the action. Taipan’s team has proven it.

Michael Sankowski is a world currency expert. Our readers have been begging for his next report. Now they have it…

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