However This Debt Crisis Ends Up, It Will Be Good For Gold

I don’t know if anyone else is calling the debate over the U.S. debt that is now heating up in Washington a crisis, but, based on how the two sides have staked out their positions on raising the debt ceiling and the looming budget problems that will immediately follow in the unlikely event that the debt ceiling is raised in a timely fashion, there doesn’t seem to be any reason to delay any longer in applying that moniker.

If  the GOP caves on the debt ceiling, this will quickly turn into a sequester crisis and if the sequester crisis is somehow averted, there will be a continuing resolution crisis.

Somehow we’re going to have a crisis.

More importantly, however the crisis is resolved, it will be good for the price of gold.

Here’s why.

The only way that the U.S. is likely to avoid another credit rating downgrade is if lawmakers in Washington provide a credible deficit reduction plan while, at the same time, maintaining short-term measures to support growth.

That’s not going to happen. Fitch Ratings laid it out in this report yesterday and the last paragraph is key:

In the absence of an agreed and credible medium-term deficit reduction plan that would be consistent with sustaining the economic recovery and restoring confidence in the long-run sustainability of U.S. public finances, the current Negative Outlook on the ‘AAA’ rating is likely to be resolved with a downgrade later this year even if another debt ceiling crisis is averted.

Somehow, with or without the usual brinkmanship and/or major disruptions in the government’s finances, the debt ceiling will be raised, the sequester will be dealt with, and the government will fund itself in one more giant “kick the can down the road” and this effort will be viewed by credit ratings agencies as insufficient.

What happens then?

Well, if the reaction of financial markets is anything like the last time the U.S. credit rating was downgraded, the U.S. dollar is likely to fall and the gold price will probably surge. As shown below, credit warnings played a key role in sending precious metals prices higher in July of 2011 and, then, when Standard & Poor’s downgraded U.S. debt in August, the gold price rose to its record high of over $1,920 an ounce.

Key Dates from 2011:
July 12th - Credit warnings from Moody’s and Standard & Poor’s
August 1st - Deal reached to raise the debt ceiling
August 5th - Standard & Poor’s downgrades U.S. debt

The only important question for 2013 is whether lawmakers inject panic into financial markets by not raising the debt ceiling when needed, or not resolving the sequester in a timely manner, or not passing a continuing resolution to avert a government shutdown.

Any way these events go, the U.S credit rating will be downgraded, sooner or later - sooner if we again go to the brink (or beyond) or later after credit rating agencies conclude the nation really isn’t serious about tackling its debt problem (something that they should already have realized by now).

Per this WSJ story today, just another round of debt ceiling brinkmanship might be enough to compel Fitch Ratings to downgrade U.S. debt as David Riley, head of Fitch’s sovereign-rating team, noted the following:

If we have another one-minute to midnight deal, which we think is damaging to confidence and the recovery, and simply sets up another deadline for six months later, it’s not something which from our perspective would be consistent with retaining the triple-A.

Think about it a minute.

Given their track record of the last few years, what are the chances of the folks in Washington coming up with a credible long-term plan any time in the months ahead?

I’d say about zero.

The U.S. credit rating will be downgraded and we’ll all watch how financial markets react.

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4 Responses to However This Debt Crisis Ends Up, It Will Be Good For Gold

  1. DLP January 16, 2013 at 5:35 PM #

    We will find out soon enough.
    I think Fitch will pull the trigger by spring.
    Sentiment is so poor in PM markets right now that I don’t know if they’ll get much of a push higher, but I think we’ll get more bullish news about gold in China before long.
    This is one long correction!!

  2. BrunoT January 17, 2013 at 10:44 AM #

    One of the most useful and succinct commentaries on Financial Sense in a long time.

    • Tim January 17, 2013 at 1:18 PM #

      Thanks very much!


  1. However This Debt Crisis Ends Up, It Should Be Good For Gold | What Am I Missing Here? - January 22, 2013

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