Protect Yourself: Why The U.S. National Debt Could Drain Your Savings (GLD, SLV, EWS, AUY, FXF, EWY)

David Zeiler: Now that Congress has allowed the U.S. national debt to grow bigger than the American economy, it won’t be long until the American public suffers the consequences by losing most of its savings to inflation.

Figures for last year show the national debt officially exceeded 100% of the nation’s gross domestic product (GDP). According to government figures, the national debt stood at $15.23 trillion at the close of 2011, compared to a GDP of $15.18 trillion.

“The 100% mark means that your entire debt is as big as everything you’re producing in your country,” Steve Bell of the Bipartisan Policy Center, told USA Today. “Clearly, that can’t continue.”

Government overspending has grown the federal debt at an alarming rate. As recently as 2010, the Congressional Budget Office (CBO) had projected this milestone would not be reached until 2020.

“Congress is doing everything it can to make sure the national debt grows,” said Money Morning Capital Waves Strategist Shah Gilani. “Republicans want more tax breaks for the rich while they appease the middle class by considering extending the payroll tax cuts and unemployment benefits. The Democrats want to hire voters as government employees, a la Greece, to not only expand their base, but prove that big government can indeed be friendly. It’s sickening.”

According to projections in the latest budget submitted by U.S. President Barack Obama, the federal debt will soar to $26 trillion over the next 10 years. At that pace, the economy would need to grow at a 6% pace to stay even. The historical average for the annual GDP growth since 1948 is only 3.25%.

Unless Congress acts – and its recent track record of bickering while doing nothing to shrink annual budget deficits is not encouraging – this crushing debt will soon start inflicting serious pain on the American public.

Headed the Way of Italy and Spain

Although Congress could choose to tax its way out of debt, it would need to go far beyond the millionaires the Democrats want to tax. Fear of voter backlash will dissuade lawmakers from imposing the sort of taxes on the general public that could make a dent in the U.S. national debt.

Instead, Gilani sees the United States following the path of such troubled Eurozone countries as Italy and Spain.

“Greece, and more precisely Italy and Spain, are our ghosts of the future past,” Gilani said. “The Fed will print more money. That’s what they do. They work for the banks.”

When countries print money to pay off debt, it typically leads to inflation. In such a scenario, the middle class loses big time as their savings lose value.

“The government’s strategy appears to be some kind of “repression,’ where you keep rates low and figure out a way of forcing domestic investors to take government bonds at very low interest rates,” said Money Morning Global Investing Strategist Martin Hutchinson, noting that British bonds lost 90% of their value from 1945 to 1975.

“Repression’s main effect is to solve government’s problem at the expense of the middle class — it’s effectively a very nasty extra tax,” Hutchinson said.

The Lessons of Weimar Germany

One extreme case of damaging inflation took place in the German Weimar Republic of 1920-1923. By 1921, prices were already 15-times what they had been in 1914 at the beginning of World War I.

What followed was a period of “hyperinflation” that in 1914left the German mark worth only one-trillionth of its value.

“The Weimar hyperinflation wiped out the entire savings of the German middle class,” Hutchinson said, noting that current U.S. policies of low interest rates, low taxes, deficit spending and an expansion of the money supply have mirrored those of the Weimar Republic.

“U.S. authorities probably won’t pursue expansionary monetary policies with quite the dogged Germanic persistence that caused the mark to fall to one trillionth of its former value,” Hutchinson said, “but the turnaround needed to stop a Weimar repetition will be very unpleasant, so there will undoubtedly be considerable denial and fudging of the figures as inflation begins to take off.”

Although Congress can still prevent a national debt-induced disaster that would destroy much of the savings of the middle class, time is running out.

“Congress has until 2013 to start doing something, maybe through the first or second quarter of 2013 at most,” said Gilani. “After that, if the world is growing and the U.S. is back on a growth trajectory, commodities will spike and inflation will start its inexorable, ineluctable rise.”

Protect Yourself

There are several things investors can do to protect themselves from inflation. Hutchinson recommends:

  • Investing in Gold: Gold is still the best hedge against inflation. The SPDR Gold Trust ETF (NYSEARCA:GLD) is a good option. Alternatively, you could go for a solid gold mining company such as Yamana Gold Inc. (NYSE:AUY). These tend to move somewhat independently of the gold price, but also become more valuable through earnings as the period of high gold prices lengthens.
  • Investing in Silver: Try to work silver into your portfolio, as well – specifically the iShares Silver Trust (NYSEARCA:SLV).
  • Investing in Asia: A third option is to invest in Asian stocks – especially South Korea and Singapore. Two strong prospects are the iShares MSCI Singapore Index Fund (NYSEARCA:EWS) and the iShares MSCI Korea Index Fund (NYSEARCA:EWY).
  • Fleeing the Dollar: With damage sure to be inflicted on the U.S. dollar, the Rydex Currency Shares Swiss Franc Trust (NYSEARCA:FXF) also is a good choice. It tracks the performance of the Swiss franc and has an expense ratio of only 0.4%.

Written By David Zeiler From Money Morning

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