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U.S. Debt and Investing in 2012

Since it's a new year, I worked up my courage, and again checked the latest figures from the U.S. National Debt Clock. It's depressing. Total U.S. National debt is approaching $15.2 trillion - now over 100% of U.S. GDP. Spending is an astounding 56% higher than tax revenue.

It's difficult to relate to those, up to 15 digit, vertigo inducing, blinking red and green numbers. One commentator called them: "monopoly money" - somehow not real. Billions, trillions .... Who can comprehend it all?

What can one do about government deficits and debt anyway? You can rail against politicians, perhaps save a little here, spend a little less there. Then it's back to everyday life, trusting the government to manage things. Since just about everyone benefits from one or more government programs criticism is muted.

Below is a comparison, not new, but bears repeating as it's something everyone can relate to. Take eight zeros off the U.S. Debt Clock figures and pretend it's a family:

  • Family's annual spending: $36,240
  • Family's annual income: $23,200
  • Annual new debt: $13,040 (to pay for spending above and beyond income)
  • Total family debt: $142,710 (and rising nearly to 10% a year)

Of course, we know the above comparison isn't quite valid. Unlike the U.S. Government, our theoretical family doesn't have a printing press in the basement. Just think how nice that would be: A $2,000 medical bill? No problem, just print up 20 crisp $100's. Problem solved! 

The U.S. Federal Reserve is trying - but mostly failing - to "grow" the U.S. economy out of this "Greater Recession."  Interest rates are kept near zero. The payroll tax cut gets extended. This approach has worked in the past, but now - over 3 years after the 2008 crash - we are still in a quagmire of high  unemployment and economic gloom.

What if the Government Balanced Its Budget? 

Can you imagine the shock waves if U.S. Federal spending was reduced by over 1/3 to balance the budget? Actually, spending cuts would have to be even greater as tax revenue would also decline. The European Union is pushing austerity on its most indebted members: Greece, Portugal, Italy, and Spain. The problem is:  It doesn't work; Shrinking tax revenues outpace savings. Deficits expand rather than shrink.

So what happens next? Governments will probably respond as they always have to fund excess spending - they will use that printing press. The newly minted money will be used to pay bloated budgets and, bailing out "too big to fail" institutions. Bailouts are not always obvious. For example: Most Americans don't have a clue as to what a currency swap is, much less recognize it as the bailout of Europe which it really is.

"Extend and Pretend"- How Long Can it Go On? 

Since one bank's assets are another's liabilities any write down of non-performing assets (as large, highly leveraged European banks need to do) may precipitate counter-party bankruptcies. Bankruptcy is anathema. Everyone is terrified of  another Lehman-style global collapse. During the real estate boom a few years ago the same parties kept buying and selling houses from each other at  escalating prices. You knew it had to end eventually and it did. Now, some houses sell for 40% for what they did 4 years ago. At the time, no one forsaw this.

Warning Signs to Watch For

Markets want to delever and deflate while Central Banks fight the trend with asset purchases (printing). Who will win? I think ultimately the Central Banks will, though it will undoubtedly be a rocky road to a pyrrhic victory.

Watch inflation (or deflation) by monitoring the more non-speculative commodities such as agricultural goods. Precious metals and natural resources - having a more speculative component - are less precise in tracking inflationary trends.

Savings and Investment Implications For 2012

Central Bank policies are now the major driver of market volatility. When the banks purchase assets stocks rise, when they don't, markets stagnate or fall.

Cash is the original "safe haven" but with currency debasement it is a loser in the long run. Hold only enough to maintain liquidity. ETFs like Vanguard's Short Term Corporate Bond Fund (NASDAQ:VCSH) can substitute for cash while providing safety and income. 

Own real things. This could be real estate (preferably free and clear or with a long term, low rate, fixed mortgage). Consider investments in natural resource or growth companies such as Devon Energy (NYSE:DVN), Google (NASDAQ:GOOG), or Johnson & Johnson (NYSE:JNJ). Not good at picking stocks? Ride the coattails of master stock pickers such as Warren Buffett with Berkshire Hathaway (NYSE:BRK.B). 

I would also hold some physical precious metals. MF Global has shown that assets held in commodity brokerage accounts may only as good as the company itself -  regardless what the law says. 

Resist the urge to time the market. Sure, those leveraged ETFs will give stellar returns if (and it's a big if) your timing is right. Current high volatility and daily rebalancing can degrade your investment rapidly. I have lost more than won with these - even low tracking error inverse ETFs such as ProShares Ultra Short SP500 (NYSEARCA:SDS) or Proshares Ultrashort Financials (NYSEARCA:SKF).

Good luck investing in 2012. We  may need it. 

Disclaimer: This article is informative only - not personalized advice. Do your own research and due diligence before investing.

Disclosure: I am long DVN, GOOG, VCSH.