Debt gridlock could rattle stock markets, push gold higher

With the risk of a credit rating downgrade around the corner, US politicians are rushing to come to an agreement on the debt limit. If an agreement is not made, then there may be many financial problems for the nation in the future.

July 24, 2011
By John Waggoner and Kathy Chu

Call it the Congressional Correction: Lack of a budget deal over the weekend points to a down market today.

Sunday night, Dow Jones industrial average futures were down 1.4%, an indication that stocks will lose ground in early trading today.

Congress has until Aug. 2 to raise the debt limit — currently $14.3 trillion — or risk defaulting on U.S. Treasury securities, considered the safest in the world. A U.S. default would crush the nation's gold-plated AAA credit rating, push interest rates up and send shock waves throughout the markets.

Before that happens, however, "The stock market is where a lot of the volatility will occur," says Bernie Williams, vice president of discretionary money management at USAA. Despite a strong earnings season, stock investors are likely to be spooked by a potential default, he says.

Even if Congress does raise the debt limit in time, the markets will likely be disappointed if the deal doesn't include significant steps to reduce the deficit, Williams says. Both Standard & Poor's and Moody's have threatened to downgrade the U.S. credit rating if Congress doesn't take significant steps to reduce the nation's deficits.

That becomes increasingly difficult as the Aug. 2 deadline approaches. "They're trying to construct something in the middle of a huge political battle, and the fear is that it's not going to be well thought-out," Williams says.

Other markets could start to sell off as the debt deadline nears. So far, the market for government debt has been relatively unfazed. But the Treasury will auction 28-day T-bills today. Any sharp rise in rates or steep dropoff in bids could signal increasing jitters in the bond market.

The value of the dollar on the world currency markets could also start to drop as the deadline approaches. The trade-weighted dollar index is down 6.6% this year, according to the St. Louis Federal Reserve Bank, but has been relatively stable the past month because of worries about the euro.

John Giuliano, owner of Vibrant Investment Group in Los Angeles, worries that the dollar could fall dramatically, and thinks gold could soar to $1,900 to $2,000 an ounce soon. It hit $1,617.50 last week. "Hopefully, the Democrats and Republicans can figure something out," he says. "It's like they're playing Russian roulette."

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