US Debt Danger as the American economy in crisis or financial trouble due to spending with a fear … More
The impact of a surging national debt will affect investors in many ways. As the federal government continues to spend more than it collects, the budget shortfall is expected to be around $2.2 trillion this fiscal year. Budget shortfalls are then added to the national debt, which is currently at $36.9 trillion. What impact will a surging national debt have on your investments? Are there steps you can take to maximize returns? Can you, as an investor, take action to protect your investments?
Investors must choose where to invest, which is a relative decision. Let me explain. Investors can choose from broad categories like stocks, bonds, cash, and alternatives. There are also subcategories to consider. For example, in the stock category, investors must decide between domestic or international, dividend paying (i.e. value stocks) or non-dividend paying (i.e. growth stocks), and by size (large, medium, or small companies). In the bond world, there are government bonds, corporate bonds, high yield or junk bonds, mortgage-backed bonds, and more. Let’s look at how the national debt could affect your investments.
Impact of Surging National Debt on Government Bond Investments
How does a high national debt affect investing in government bonds? As the national debt rises, the federal government will require more and more money to service the debt. This means the federal government will need to issue more and more bonds to finance its debt. If the need for capital becomes too great, and the federal government is forced to issue too many bonds to meet this need, demand for U.S. Treasuries could fall due to an excess in supply. If supply outstrips demand, bond prices will fall, and yields will rise. Remember, bond prices and yields move in opposite directions. The best time to buy bonds is when interest rates have peaked. The worst time to buy bonds is when interest rates are low or during a rising interest rate environment. If interest rates are headed higher, it’s best to wait to buy bonds.
Impact of Surging National Debt on Corporate Bond Investments
When a corporation needs capital, they can issue bonds, which are debt instruments. Because corporate bonds are considered less safe than government bonds, corporate bonds must pay a higher yield than government bonds. Why? If a corporate bond and a government bond were priced the same and paid the same yield, investors would opt for the safer government bond. Thus, corporate bonds must pay more to attract capital. Paying a higher rate on its bonds raises the cost of capital. When corporations have a higher cost of capital, it reduces profit margins.
Impact of Surging National Debt on Stock Investments
As interest rates rise, corporate profit margins may fall. Lower profits have a negative effect on stock prices. Moreover, as yields rise, bonds become more attractive to stock investors who opt for the less risky investment. In other words, rising interest rates will dampen the demand for stocks. As demand for stocks declines, investors will sell. If selling pressure is greater than buying pressure, stock prices will fall until they reach a point where investors find more value in the riskier stock investment.
Impact of Surging National Debt on Commodity Investments
Commodities include gold, silver, food, oil, and other investments. We’ll stick to gold and silver. Remember that investors are faced with a myriad of choices. If stocks and bonds are expected to do poorly, investors may choose commodities. Most investments in gold and silver are backed by the actual commodity. Thus, if the price of the commodity rises/falls, the price of the investment will do the same.
The price of gold has risen substantially in the past 20-25 years. Currently, the price of gold is over $3,200 per oz. However, there have been long periods when the return on the commodity was disappointing. For example, if you invested in gold in February 1979 and held it until April 2001 – about 22 years, you would have lost over 61%. Conversely, if you bought gold in April 2001 and held it until October 2012, you would have earned 570%. From December 2015 until today, you would have earned over 200% investing in gold. Gold and silver have no dividends, so your return is based solely on the change in the price. Even though gold prices are near an all-time high, is it a good time to invest in it? That’s hard to say, but many believe gold has a little more room to run. The price of gold will benefit if inflation moves higher.
Impact of Surging National Debt on Inflation and Other Investments
Why would inflation rise? There are several reasons. First, if the federal government has trouble raising enough money from the sale of government bonds to fund its operations, it may turn to the printing press. Printing too many dollars is inflationary.
Next, if the federal government continues to overspend, demand will rise, which could push inflation higher. Higher bond yields are generally not inflationary. In fact, higher yields may slow economic growth because it increases the cost of capital. This, coupled with higher tariffs, are precisely why President Trump is pushing for Fed Chair Powell to cut rates. If the Fed cuts rates, it will help stimulate economic growth and offset some of the negative effects of a surging government debt and tariffs. However, the Fed has stood its ground, resisting the president’s name calling and bullying. That’s a topic for another time.
Other investments that may do well in the coming months include TIPS or Treasury Inflation Protected Securities. Like all bonds, the price of TIPS is affected by changes in interest rates. Thus, when interest rates rise (fall), bond prices fall (rise). However, unlike other bonds, the price of TIPS will rise at the same rate as inflation. Thus, if inflation moves higher, and since interest rates are already back within a more normal range (as opposed to near zero), TIPS may be a good choice.
A surging government debt will have numerous ramifications. Investors will be wise to keep a close eye on Congressional spending as this will be like the proverbial canary in the coal mine. Unless Congress finds a way to curtail spending, the fiscal year deficits will be added to the debt and the government will need more and more money to service the debt. A surging national debt will surely have an impact on your investments. Understanding how, is crucial in your future investment decisions.
