U.S. Debt Downgrade Points to More Currency Debasement

As debt downgrade concerns push up bond yields, metals markets are facing selling pressure.

Credit ratings agency Fitch this week issued a surprise downgrade of the U.S. government’s once-vaunted AAA credit rating. Recent political brinksmanship surrounding the debt ceiling helped prompt the move. But broader concerns about the size and sustainability of the national debt itself also figured into the downgrade.

In response, the Biden administration trotted out Treasury Secretary Janet Yellen to protest the downgrade and proclaim that federal finances are in good shape.

But Douglas Holtz-Eakin, former head of the non-partisan Congressional Budget Office, isn’t buying what Yellen is trying to sell. In an interview with Yahoo! Finance, he noted that there is no plan afoot in Washington to turn around the nation’s worsening fiscal outlook.

Yahoo Finance Anchor: Fitch downgrading its AAA credit rating on the U.S., the agency blaming rising political divisions and mounting debt. Treasury Secretary Janet Yellen denounced the move, calling it in her words, “Entirely unwarranted.” Our next guest says Fitch made the right move. Joining us now is American Action Form President and former CBO Director, Douglas Holtz-Eakin.

Douglas Holtz-Eakin: Fitch said three things, most of the conversation’s been about the erosion of governance, but they also pointed out importantly that the U.S. has a seriously unsustainable fiscal outlook, high deficits, and debts that will get higher relative to GDP as far as the eye can see, and importantly, it has no plan to deal with its fiscal outlook and so on the substance, the U.S. has a very big problem, and this isn’t news. This has been true for a while, and the fact that we continue to not deal with it, I think is the heart of the downgrade.

Investors are finally starting to demand higher yields on long-term Treasury paper. Yields may have much further to go before they adequately compensate investors for taking on both credit risk and inflation risk.

The risk to metals markets is that higher rates on debt instruments serve as competition for sound money instruments.

The national debt is currently approaching $33 trillion, whereas U.S. GDP will come in at around $26 trillion this year. It’s never a good sign for a country’s fiscal health when it owes more than its economy can produce. Worse, the debt burden is projected to grow faster than the economy for years to come.

The CBO projects Uncle Sam will run an annual budget deficit of $1.4 trillion in 2023. The deficit will average $2 trillion per year over the next decade.

In prior years, apologists for massive government borrowing could point to debt servicing costs being quite manageable in an environment of ultra-low interest rates. But the era of zero interest rate policy at the Fed is over. Interest payments on the debt as a proportion of the federal budget are now set to soar.

Interest on the debt, defense, entitlements, and other so-called “mandatory” spending will overwhelm discretionary spending. Any attempts by fiscal hawks to narrow the budget deficit will run up against these realities as well as entrenched political resistance to any spending cuts.

Instead of getting its fiscal house in order, the government will continue to rely heavily on its lender of last resort, that being the Federal Reserve. In theory, the Fed can provide Congress with unlimited liquidity through the power of the printing press.

Tens of trillions of new fiat dollars will have to be created out of thin air in the years ahead in order to supply the Treasury Department with the cash it will need to borrow into existence. That, of course, will carry inflationary implications.

Even with higher nominal rates, the prospects for government bonds or cash instruments keeping savers ahead of inflation are poor.

Inflationary fiscal and monetary policy won’t keep federal finances afloat for long if real interest rates are positive. Officials in Washington need real rates to be negative – which is to say that the currency in which their debts are denominated depreciates more rapidly than the rate of interest they owe.

Higher nominal rates may appear to make dollar-denominated debt instruments relatively attractive to hold compared to physical gold and silver which yield nothing. But precious metals markets have the potential to deliver impressive real gains in a raging bull market.

Just as there is no limit to how much U.S. fiat currency can depreciate, there is no limit on how high gold and silver prices can go in terms of Federal Reserve notes.

Of course, investors need to have realistic expectations. Gold and silver markets aren’t guaranteed to outperform bonds in any given year.

But in an environment of deteriorating credit quality and rising inflation risk, investors shouldn’t feel safe owning Treasuries, regardless of their nominal yield.

Hard money in the form of gold and silver has zero credit risk. They also have a track record for retaining their purchasing power over time that is unmatched by any government-issued debt instrument.

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