Dr. Marc Faber, author of the Gloom, Boom and Doom report, suggested in a recent CNBC interview that the debt in the Western world will continue to increase, leading to a "Colossal Mess" over the next five to 10 years.
Dr. Faber is also of the opinion that there will be no fiscal cliff. Instead, according to Dr. Faber, there will be a "fiscal grand canyon." I had discussed the reasons for a lack of a fiscal cliff event in one of my earlier articles. In this article, I will discuss the reasons for believing that the West is, indeed, in a "Colossal Mess."
Starting with the United States, the government debt to GDP is already at 102% as of second quarter of 2012. In a sluggish growth environment, it is very unlikely that the fiscal cliff will come into effect in 2013. Instead, tax cuts will be extended until more stability is witnessed in economic growth. According to the Congressional Budget Office (CBO), if the tax cuts are extended, the U.S. will witness budget deficits of $10 trillion over the next 10 years. The CBO does expect budget deficits to fall below $1 trillion on an annual basis between 2014 and 2018. I personally don't see that scenario panning out, and budget deficits should remain over $1 trillion over the next 10 years.
This is in line with Dr. Faber's statement in the CNBC interview, linked above:
"I think the deficit here (in the U.S.) -- irrespective of who is in the White House -- will stay above a trillion dollars per annum for at least as far as the eye can see."
Clearly, there is no possibility of a decline in debt to GDP over the next decade. Further, if interest rates do start trending higher, the debt servicing cost will increase, leading to an increase in deficits. I do see a scenario where more debt is needed in order to service existing debt.
The problem for the U.S. does not end there. The present value of the Social Insurance programs (Social Security and Medicare) for the next 75 years is estimated at $34 trillion, according to the 2011 annual financial report from the U.S. Department of the Treasury. These are an off-balance sheet item, and more money printing might be the only solution to fund the programs. Certainly, the entire security program is not due over the next decade or two. However, it ensures that the debt will keep climbing amid a weak economic scenario and unfavorable demographics.
The scenario in the eurozone is no better. Government debt as a percent of GDP has increased in the 17-member eurozone from 69% at the beginning of 2007 to 89% as of first quarter of 2012. The chart below shows the government debt to GDP for the euro area and other countries as of 2011. For several countries, the problem is much more intense than that in the United States. I personally do believe that the U.S. looks relatively better than the eurozone, and that the dollar should do relatively well.
With the eurozone already in a recession and with the unemployment scenario looking gloomy, the government debt will continue to rise in the foreseeable future for the eurozone countries. The unemployment rate for the 17 euro countries currently stands at 11.4%, which is much worse than that of the United States. Spain and Greece deserve special mention, with an unemployment rate at 25%. Therefore, Spain's government debt, which is relatively lower, will in all probability increase going forward.
Further, even for the eurozone countries, the NPV of healthcare and pension spending from 2010-2050 (as a percent of GDP) is significant. This will necessitate further government borrowing, or creating money out of thin air.
Given these factors, it is nearly impossible to visualize a scenario where the government debt will decline for the Western economies over the medium to long term. Also, from a historical perspective, the current debt level in the advanced economies is at near record highs. In previous instances, such a high debt level has been followed by periods of defaults, financial repression and inflation. I did discuss the probability of a financial repression in one of my earlier articles. Going forward, one might witness a flurry of defaults and high inflation due to governments trying to inflate their way out of debt.
From an investment perspective, high levels of debt and continued expansionary monetary policies will favor hard assets. Gold and silver should be an integral part of an investor's portfolio in such a scenario. Besides physical gold and silver, investors can consider exposure to these precious metals through the following ETFs:
SPDR Gold Shares ETF (GLD) - The ETF seeks to replicate the performance, net of expenses, of the price of gold bullion. The ETF has an expense ratio of 0.4%, with net asset holdings for the fund at $65.26 billion.
iShares Silver Trust ETF (SLV) - The ETF seeks to reflect the price of silver owned by the trust, less the trust's expenses and liabilities. The ETF has an expense ratio of 0.5%, with net asset holdings for the fund at $8.78 billion
Also, equities will trend higher in an inflationary scenario, and as such, investors can consider exposure to the SPDR S&P 500 ETF (SPY). The ETF provides exposure to the S&P 500 index, with ETF returns generally corresponding to the price and yield performance of the S&P 500 Index. The ETF has a low expense ratio of 0.09%, and is a good index investing option.