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Financial Musical Chairs

|Includes:GLD, iShares Silver Trust ETF (SLV)

Anyone who has an understanding of how our government works knows deep down that the game is over... the clock is ticking down and it is just a matter of time before the game of financial musical chairs is k-a-p-u-t. That's right... done: stick a fork in it. A lot of us are familiar with the argument which generally sounds something like: The federal government is bankrupt and quantitative easing will cause inflation. However, one rabbit trail not explored appears to be: What will be the immediate effect on government at the state level when (and not if) the federal government financially implodes?

Feds Will Cut State Funding... Eventually

State governments are highly dependent upon the federal government for funding to the tune of 30% to over 40% for most states. That is massive!

"They (the states) have become the third largest category in the Federal budget, trailing only Social Security and national defense."

"According to the Congressional Research Service, there were 1,724 grants in fiscal year 2011, paying for things such as bridges, teachers, Medicaid, farm subsidies, and abstinence programs. The total cost of these federal grants was $515 billion, up 160 percent in real terms since the beginning of the 1990s and nearly 60 percent since 2000."

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The federal government will eventually have to drastically reduce its expenditures and with that comes cuts to the states' budgets. Once the states' budgets are cut, they will have to axe or reduce many programs and employees.

Who Will Be Affected Directly?

How many people work directly for the federal, state, and local governments? The answer is on average 17% according to a 2010 Gallup poll.

"Seventeen percent of U.S. workers say they work for federal, state, or local government, ranging from 38% in Washington, D.C., to 12% in Ohio. More than a quarter of workers in Washington, D.C., Alaska, Virginia, and Maryland work for government, as do upwards of 15% in the vast majority of states."

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The article goes on to report:

"Alaska and Hawaii, along with South Carolina, have the highest percentages of state government workers (11%). In general, however, the percentages of state and local workers are in the single digits. State workers vary widely by profession, and include, for example, correctional officers, while local government workers include teachers, firefighters, and police."

What is not included though are the workers who support state projects such as sub-contractors or the businesses that supply steel to a state-construction project. Think about the tangled web of economic consequences. The state cuts funding for a construction project and thus an iron worker does not drive his truck and consume gas; he does not buy a lunch... use your imagination. Like a spider web the economic pangs spread out. Businesses are impacted and the incidious cycle spins larger and larger.

When the music stops and the federal-money spigot pressure is reduced, the states with the highest funding will be the states who suffer the most. The lack of funding will result in a loss of jobs. As more and more jobs are lost, a snowball process will roll downhill which will further depress the local economies of the states and result in yet lower tax revenue. Guess what... This means the federal government will then collect less taxes and the vicious cycle then continues with more cutting of state funding. It is unlikely that the federal government will slowly reduce funding, allowing the private sector time to adjust. Like a credit-card addict, the federal government will keep raising the debt ceiling in an attempt to prolong the game of musical chairs.

What Can You Do?

Rest easy, all you have to do convert some of your fiat currency to real solid assets such as gold or silver. If you are not comfortable holding physical, then you can invest in a metals ETF or even mining stocks. It is always a good idea to hedge your bets, and the metals offer a very attractive hedge in these turbulent economic times.

Investing in Gold and Silver

We would recommend that you hold (at the very least) 10% of your investment assets in physical silver and gold. The only downside to holding gold and silver is that you have to store the metals in a secure location, and they can be illiquid compared to holding a stock or an ETF. If this is a problem for you, you may consider investing in a Gold ETF like the SPDR Gold Trust (NYSEARCA:GLD) or ProShares Ultra Gold (NYSEARCA:UGL).

Another option for investors would be the iShares Silver Trust (NYSEARCA:SLV) or Physical Silver Shares (NYSEARCA:SIVR). Both would be a good choice to capitalize on silver while maintaining liquidity through the stock market. Now let's look at some reasons to invest in gold and silver.

Conclusion

Is this situation going to play out tomorrow or next week? Probably not, but just like in every musical chairs game, eventually the music box ceases. Is it going to end next year? Five years? Ten? Whatever the time frame, when the currency issues come to a head we do not want to be holding a bag full of paper money.

Stocks: SLV, GLD