As the nation comes down to the wire on the debt ceiling spending fight, I
thought these two charts, were interesting and perhaps, a provocative mind
tease.

Since the national debt is owed in dollars, and since the dollar does not
have a fixed value, it is hard to know what the " real"debt burden really
is.  IF the dollar was defined as it is in the Constitution as a certain
weight of gold, the chart above shows the debt burden, if it was defined and
payable in gold.  What we find is the real dollar debt burden (defined in
gold) has actually been declining over the past decade.  The debt burden in
gold adjusted terms, actually peaked at the end of the much heralded
fiscally sound Clinton Administration, and has been declining over the past
decade.  Huh?  How is that for starting your head to spin!

Incidentally, if it was payable in gold, US gold reserves (unaudited) that
we presume to have, would only cover about 1/42 of the national debt.  In
addition, we are talking about the "national debt", which is the funded debt
represented by bonds outstanding, not unfunded liabilities on Social
Security and Medicare/Medicaid, student loans, loans to farmers, guaranteed
mortgages, etc.,  which are about 5 times the official debt.

You might respond by saying, that debt reduction can only be the case
because gold has been on a tear for the past decade. True.  But saying gold
has been on a tear is like saying the dollar has been in a free fall.  If
you depreciate the currency, you reduce the over all debt burden because you
are paying creditors back with a currency that has considerably less value
than when you originally borrowed it from them.

If you reduce the value of money at a faster rate than new debt is taken on,
you can actually reduce the real debt burden , while at the same time you
are increasing debt and spending. This essentially is what the US has done
over the past decade.  If that is true, than why can't this fiscal insanity
continue for a lot longer than any of us currently think?

Above we see the basic concept we just examined, put a different way.

The greater the US debt limit, the greater the gold price.  Or, if you will,
the greater the debt limit, the more the dollar has lost value.

So, raising the debt limit (which I am convinced will be done) means a
weaker currency and higher gold prices, in the longer term.  In the very
short term, the "solution" to the current political stand off may come as
release of market tension about the matter, and cause gold to temporarily
weaken. But longer term, this latest failure to control spending is ominous.

What seems clear is the nation cannot simultaneously continue to spend and
borrow, and maintain the value of the currency.  So, if we keep this up, the
value of the dollar goes down.

After the prior experience with spending caps on Congress, Graham-Rudman and
the like, it is clear Congress will simply break out of any restraint on
spending and borrowing.  Likewise today, using the debt ceiling as a threat to control
spending looks to end in failure.  If the spending cuts are mostly in the out years, future
Congresses can simply wriggle out of the limitations as they did when they
repealed Graham-Rudman.

A Constitutional Amendment to balance the budget will require years to
implement.  In addition, it could be used simply as a justification to keep
taking more money from citizens through taxes.  Congress will spend too much
money, and then say the only way to " balance" the bloated budget is to
close the fiscal gap through taxation. Amendments don't say how "balance" is
to be achieved. We see this contention repeated over and over in the "shared
sacrifice" argument.  We, the Congress and President, spent too much, so now
you must sacrifice through higher taxes.  You will have less to spend, and
we the politicians have more to spend.  They win, you lose.  And if you
don't give sanction to crazy spending, you are bad person and selfish person
who lacks the national spirit of compromise.

It could well be that our political system will never be able to deal with
spending excess because of the tilted playing field in terms of political
incentives.  One party gives stuff away, promising benefits that a narrow
few of the rich must fund, while the other party has to take back the stuff
having been given away, and wind up appearing to defend the relatively few
"rich". People don't like giving back stuff they were once given, even if it
was stolen.  They get used to receiving it and it soon morphs into a sense
of entitlement. And most people envy and dislike people who have more than
they do. Guess who wins under those assumptions.

But there is hope, but it involves a lot of pain and disruption for
investors.  The market place may well have to exercise the discipline that
the political system cannot deliver.

This could come in several forms.  Bond holders could recognize they are
buying something that will lose value and demand higher interest rates.
This is the so called "bond vigilante" theory.  It does seem to work at
times.  It worked in the 1980s in the US and it currently is working on
European countries in debt excess like Greece and Portugal.  The news
stories you read about the "interest rate spread" is evidence the vigilantes
are mounted and riding their horses.  However, so far in the US, the fear of
recession and asset price decline, leaves the US able to fund itself at
rates well below the official inflation rates of 3.6%.

For reasons of safety, bond holders appear willing to make negative real
returns.  And Japan seems able to do the same.  In short, bond vigilantes
are undependable as a restraint on government at some times, but do awake at
other times.

The loss of the US dollar as the reserve currency would prove to be a very
powerful discipline, and very painful.  The US remains the only country that
can depreciate both internal and external debt, by printing money. This is a
subsidy only the US enjoys.

But with the Euro in chaos, and China suspect, there does not appear right
now any sounder currency with a large enough supply, to finance world trade,
available.  So for the time being, the dollar will remain the reserve
currency, because as one wag put it, the dollar is the tallest midget in the
room.  Our foreign creditors will howl, but they really have no other place
to go, at least right now.

So for the intermediate future, the spending and debt cycle lacks both
internal and external controls, and hence will likely continue.  This would
argue for a currency that will progressively lose value and is a strong
positive for gold and other hard to extract commodities,  and a strong
justification for holding a healthy percentage in any portfolio.

Neil and Norm