Investors: Three Paths Out Of The Government Debt Trap (GLD, XLF, FAS, FAZ, SLV, AGQ, TBT, TLT)

Claus Vogt:  The governments of Portugal, Ireland, Italy, Greece, and Spain have a problem very similar to the U.S. and many other countries. It’s easy to describe: Too much debt as the result of living beyond their means for way too long. So looking at the PIIGS is like opening a window to the future of the United States.

The PIIGS are at the forefront of a development that will soon reach global proportions. And there is no easy way out. But most of the voters and their leaders still don’t get it. And many who do get it simply look the other way because they don’t like what they see.

I don’t like it either. But I always knew that something like this couldn’t go on forever. There are economic laws that can’t be aborted … not by political will, not by chicanery and not by central bank arrogance. Greenspan, Bernanke, Geithner surely knew this when they made their reckless decisions.

Now it’s too late. There is no easy way out, just hardship and struggle. And the longer we wait to address the problem the harder it gets.

The way I see it, there are three possible paths governments can take …

Path #1 — Budget Cuts: Nobody likes the bitter medicine!

Demonstrations against budget cuts have spread throughout Europe. 

Demonstrations against budget cuts have spread throughout Europe.

In Spain and Greece for instance, citizens are demonstrating, striking, revolting. Think about it: Anti-government protests, publicly shouting for the economic crisis to go away.

While at the same time they’re not willing to accept the necessary steps to get the economy back on a healthy and sustainable growth path! Why? Because in the short run it would bring more hardship.

There is also an important psychological force in play …

Political leaders of all stripes have consistently told voters that it was possible to get something for nothing, to bring about growth and wealth creation by printing money and going ever deeper into debt.

Now it’s backfired! And voters are dead set against doing what it takes to make things right.

The U.S. is still behind the PIIGS. But with actual and planned budget deficits of more than $1 trillion as far as the eye can see, it will quickly catch up.

That brings me to …

Path #2 — Government Defaults: Ignite global banking crisis!

Default is an option, of course. And financial history is littered with examples of governments opting for this escape hatch. For the have-nots this solution sounds attractive.

They seem to have nothing to lose. They may think that after defaulting on its debts the government will go on exactly as before, and the world can turn back to what seemed to be normal for too long. That the lenders, such as China, who were treated badly and robbed with the stroke of a pen would quickly be back lending fresh money to the robbers.

And maybe they would. But I think it’s wishful thinking, a mirage.

They’ll likely say, “Fool me once, shame on you. Fool me twice, shame on me.”

There is another argument against the default escape hatch. Big banks and insurance companies are major holders of government debt. A default would throw us into another banking crisis, larger than the one of 2008, and possibly of biblical proportions.

Major financial institutions  could face cataclysmic losses if governments default. 

Major financial institutions could face cataclysmic losses if governments default.

The financial industry has an influential lobby. They will try everything to avoid a default and protect their interests. They stand a very good chance of succeeding, at least in the UK and the U.S.

Now, let’s look at the political favorite …

Path #3 — Crank Up the Presses: Kick the can, once again!

If the majority of voters oppose spending cuts and the financial industry exerts enough pressure to sideline defaults, there is just one option left: Money printing.

That’s exactly what Ben Bernanke has always recommended. This advice was his ticket to the Fed chairmanship. And the case for him getting what he wants seems to grow stronger by the day.

As an investor you should understand these interrelations. Inflation is not a necessity, but a political choice. To me it seems to be the most probable one. That’s why I keep recommending gold as an insurance policy against runaway inflation.

Short term I expect a price correction in gold. If this turns out to be the case, you should consider it a buying opportunity. Either coins, bars or an ETF like the SPDR Gold ETF (NYSE:GLD).

Tickers: Financial Select Sector SPDR ETF (NYSE:XLF), Direxion Daily Financial Bull 3X Shares (NYSE:FAS), Direxion Daily Financial Bear 3X Shares (NYSE:FAZ), iShares Silver Trust (NYSE:SLV), ProShares Ultra Silver (NYSE:AGQ), ProShares UltraShort 20+ Year Treasury (NYSE:TBT), iShares Barclays 20+ Year Treas Bond (NYSE:TLT).

Best wishes,

Written By Claus Vogt From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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