Dear Reader,

As most of you have already heard, Standard & Poor’s (S&P) has downgraded U.S. government debt from AAA to AA+. Of course, Casey Research analysts saw this coming from miles away – if not at this exact moment, eventually. With the U.S. federal government owing trillions and no end in sight for the massive deficit, this downgrade should have been a no-brainer. However, beyond the level of debt, there’s something more to it.

Regardless of one’s opinion on the debt, the coupon payments of U.S. government bonds are no longer guaranteed. Whether the U.S. defaults next year or one hundred years from now, this is still true. The political bickering has reached a stage where a constant flow of payments has been threatened. Missed coupons would surely be repaid at a later date, and probably with interest. Nonetheless, the disruption is problematic. Sure, the next time around, the politicians would probably work out a deal at the last minute again. But I can’t say that with 100% certainty… maybe with something like 75% confidence.

For that reason alone, the U.S. deserves a downgrade. Imagine this scenario: An elderly couple sits down with a financial advisor to plan their retirement. They tell the advisor that they’re only looking to earn a few percentage points on their money, nothing much. However, they need a steady stream; constant payments are very important to them. If the coupon payments don’t arrive on time, they’ll be in bad shape and won’t be able to pay the bills.

After the recent debt ceiling debate, I don’t think any sincere and half-intelligent financial advisor could tell the elderly couple, “Put your money in U.S. Treasury bonds. There’s absolutely nothing to worry about. The payments will be there every time.”

Look, S&P is not saying that the U.S. government is defaulting tomorrow. However, for a country with a large debt load and uncertain cash flows due to political bickering, it’s rational to take the rating down one notch. If the coupon payments cannot be guaranteed, then the U.S. does not deserve a “risk-free” reputation and an AAA rating. If it doesn’t pass an elderly couple’s retirement test, it shouldn’t pass the ratings agencies’ tests either. The rest of the agencies should catch up with S&P and downgrade as well.

Before we go on to the rest of the issue, let me just make it clear that I don’t see an all-Treasury portfolio as particularly wise. That was just for the sake of example. Please don’t send me angry e-mails. Next, Jeff Clark has an excellent article on gold and hyperinflation. Right now, we’re buying gold as a good investment, but things will be much different in a hyperinflation situation, where one must buy gold. In the future, it will no longer be an investment but a necessity for anyone with savings. Guess what that will do to the price of gold?

Why You’ll Still Be Buying Gold at $2,000

By Jeff Clark

I was recently asked in an interview if I thought gold was going to $5,000 an ounce. “No,” I said bluntly. “I think it’s going higher.”

“You’re that optimistic?”

“No,” I replied. “I’m that pessimistic.”

Imagine the condition of our world if gold reached $5,000 an ounce – and kept soaring. We’ll likely be in a mania if that happens – but what kind of mania will it be? There’ll be some greed to be sure, but I think there’s a good chance a deeper reason will be at play. And it’s the same reason that will drive you to keep buying gold at $2,000 an ounce.

You’ll have to.

There are 101 reasons to own gold right now. You might buy because of the debt turmoil you see around the globe. You may think it wise, like the Chinese and others, to keep some of your savings in gold. Negative real interest rates may draw you to gold. You might buy because of the mere fact that demand is overwhelming supply. Or you fear inflation. Or deflation.

But most of these factors are missing one critical element: They’re not yet personal.

Most reading this have not had to flee their country, been the victim of hyperinflation, or watched helplessly as their currency went poof! Longtime investors have made money on their gold investments, to be sure, but most of us bought the yellow metal as an investment and not because of a do-or-die situation.

It’s doom and gloom to say this, but I think it’s possible and perhaps even probable that at some point we’ll all feel forced to buy gold, almost irrespective of price, due to a sudden and rapid depreciation of the U.S. dollar.

How do we get to that point? Simple: You go to buy something and realize you’ve just been priced out of the market, not because the item is too expensive, but because you suddenly realize the money in your hand no longer has purchasing power. Your reaction to that event is predictable: You feel cornered, maybe even scared, and the urgency to seek an alternative takes over.

This is obviously an inflation scenario, but it’s not exactly a stretch to get there from where we are today. Here’s why.

The following chart tracks the dollar and gold adjusted by the CPI from 2000 to present. It catches many people off guard, once they realize its implications. Look what’s happened to the greenback in the past 11+ years:

(Click on image to enlarge)

Since the Y2K scare, the dollar has lost an incredible 25% of its purchasing power. Even adding the measly interest one would earn in a traditional savings account doesn’t make up for this loss. This isn’t a picture of the dollar since the creation of the Fed or since Nixon took us off the gold standard. This is what’s happening right now – a gross devaluation of your dollar-based savings. Gold, on the other hand, has not only preserved but increased one’s purchasing power.

Now, imagine this scenario on fast forward. Instead of a 25% loss in 11 years, what if it occurs in, say, two years? That’s what can happen in a highly inflationary environment. At some point, given the baked-in consequences for our currency and the unwillingness of politicians to effectively deal with the problem, you one day instinctively realize, as you hand money to a cashier to buy milk and she asks for more, that it is a depreciating asset and no longer a stable form of exchange.

In other words, you won’t buy gold at $2,000 an ounce because you think it’s going to $6,000; you’ll buy gold because you fear the dollar will continue losing its ability to meet basic monetary requirements and you’ll need a substitute, something that will retain its value.

Regardless of whether the downward trend with the dollar continues at the same pace or speeds up, one thing is clear: It will continue. You must portion some of your savings in gold.

Sooner or later I think we all will have an epiphany about money that pushes us to buy gold, even if it’s at levels that would seem expensive today. When that time comes, you won’t be focused on the price of gold but on the absolute need to acquire a more lasting asset.

If I’m right, $1,700 is not a high price to pay.

[For many, $1,700 at a pop is a lot of money to come up with for an ounce of gold. But Jeff found a way to buy gold and silver for $100/month, and was so impressed with the programs that he uses them himself. Check out his top two recommendations in the brand-new issue of BIG GOLD and start accumulating enough gold and silver to protect your savings from ongoing devaluation.]

Additional Links and Reads

Japan Official Warns of More Yen Selling (Bloomberg)

Japanese officials could really be setting themselves up for failure. Once again, they’re planning to intervene in the market. When the first intervention requires a second only a week later, it’s a bad sign. The Bank of Japan (BoJ) may think that it’s smart, but I certainly wouldn’t want to be intervening in this market. A flight to safety could completely overwhelm the BoJ’s actions. And once the intervention proves irrelevant, even more trades could pile on against it.

I understand Japan’s concern, but I’m not sure if they can do anything about its currency appreciating. They may just have to live with an overvalued currency until things calm down. With the tsunami, a worldwide yen intervention was one thing, but this time around the BoJ will have a much harder time fighting against the current.

S&P Explains Why the “$2 Trillion Error” Is Irrelevant (Zero Hedge)

Zero Hedge has a good explanation for the supposed error in S&P’s rating calculation. In short, S&P uses a three-to-five-year time horizon instead of the ten-year horizon mentioned by the Congressional Budget Office (CBO). Since few of the debt deal’s cuts are on the front end, this $2 trillion barely affects S&P’s original calculation. So much for the CBO being a neutral independent reporter for the public.

On a side note, the CBO and other government agencies aren’t exactly most accurate in the world; it’s pretty bold of them to accuse someone of a $2 trillion mistake. One would be amazed by the kind of mistakes in government reports. For example, I recall analyzing past editions of an annual government labor report. Since I read the earlier editions, I noticed that whole sections were copied and pasted with only the numbers changed for the latest year. In one section of about five pages, someone copied and pasted last year’s report but forgot to change the numbers to the most recent year. Whoops! I guess the government doesn’t expect anyone to actually read those reports.

Trichet Draws ECB “Bazooka” as Italy, Spain Debt Purchases Begin (Bloomberg)

Though our press is focusing on the U.S. downgrade, the European Central Bank’s (ECB) actions could be even more significant. The ECB has begun purchasing Italian and Spanish bonds. No, we’re not talking about Greece, Ireland, or Portugal; we’re talking some of Europe’s main countries. In some ways, this is the beginning of a European quantitative easing. We can pretty much forget about higher ECB rates for some time now.

That’s it for today. As of this writing, gold is at $1,716. I guess we got that right. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey Daily Dispatch Editor