Investment Contrarians

How Debt Created an Artificial Economy

By for Investment Contrarians |

Artificial EconomyThe money printing presses appear to be in jeopardy. The amount of liquidity that has been pumped into the U.S. economy and other global financial systems has been superlative; and as I’ve said before, it would only be a matter of time before the massive national debt levels accumulated by the governments in the U.S. and Europe would wreak havoc with the economic recovery.

Yet, it may have finally clicked for the Federal Reserve, as comments made Wednesday questioned the central bank’s $85.0 billion in monthly bond purchases and suggested that the buying be reduced or stopped to avoid facing losses. Could you imagine losses for an already cash-strapped central bank, given the national debt?

What has been happening is the Fed’s bond-buying provided the mechanism to pump hundreds of billions of dollars of liquidity into the economy; it was meant to keep it going and avoid a worsening of the recession, but it added to the national debt. Not isolated to the U.S., other central banks around the world have been pumping cash into the fragile global economy. In the financially distressed eurozone, the European Central Bank (ECB) bought bad debt and provided easy monetary liquidity, in order to avoid a financial Armageddon. But this added to the national debt of the countries. Yet here we are: Greece is in shambles; Spain, Portugal, and Italy are broke; and the eurozone’s two powerhouses, Germany and France, are struggling with their own growth issues.

The problem is that the super loose monetary easing in the U.S. created an artificial economy that has been supported by the free-flow printing of money and the subsequent rise in national debt. As long as there’s paper to print on, there will be money. This kind of monetary strategy makes no sense. Just take a look at the national debt.

The government was saying the economy was improving with the recovery in the housing market, jobs growth, and manufacturing. The problem is that if you take away the near-zero interest rates and other accommodative monetary easing, I doubt the recovery would be here. The economy has strengthened and is showing positive signs, but I feel it is nowhere near what the government estimated, given the influx of liquidity into the system.

So, with the central bank looking at the current quantitative easing programs, you’d understand why there is nervousness surfacing in the equities market. Take away the money, and I doubt the economic recovery will continue at the same rate; albeit, with gross domestic product (GDP) growth only in the two-percent range for this year, it also hasn’t been a total success.

Congress and President Barack Obama continue to debate over budgetary cuts and the national debt limit. The statutory national debt limit of $16.4 trillion has already been passed, as the running balance stands near $16.54 trillion (Source: USDebtClock.org, last accessed February 22, 2013.) The deadline to reach a deal has been extended to May, but I would question if a valid resolution will surface.

Again, the problem is that a cut in fiscal spending at this stage, given the fragile economic recovery, is a major risk for the country, and it could drive America into another recession. On the other hand, if cuts aren’t made and costs aren’t curtailed, the country’s national debt will continue to spiral out of control; and it will just be given to the next generation to deal with.

The reality is that the national debt is accelerating fast; it’s not going away anytime soon. The only plus here is the country’s low bond yields; albeit, a rating cut won’t help. If the U.S. had to pay out the same high yields as Spain or Italy, the U.S. would be broke, given the massive interest payments on the national debt.

With the possibility of further financial distress down the road for America, you will need to be proactive and look for ways to help shelter your investments. My favorite holdings for if the U.S. falters include gold and silver, dividend-paying blue chip stocks, T-bills, and “AAA”-rated bonds from America’s top companies.

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