Protection in a weakening economy

October 5, 2009 5:16 AM

Our deficit and our debt are at record levels, even compared to WWII. Then, the debt was financed internally, not by other countries, so the interest we could pay was lower and the money was recycled in the U.S. Now, the debt and deficit are mostly financed by other countries through bond offerings and the like. And as they grow, those debtor countries will want higher interest rates on repayments, which drains money out of the U.S.

Does anyone know of, or can anyone suggest a position to take in-case our national financial fortunes deteriorate slowly? A crash, understandably, wouldn't offer much safety for anyone except the very rich. And I'd expect social unrest would threaten even them at that point. But in general and for the average investor, are there any suggestions for investment or money/asset movement strategies that can protect one in an economy with (a) increasing foreign debt payments in the short term, (b) potential significant interest rate increases in the medium term and (c) lessened national economic influence on the international currency markets in the long term? I just can't seem to find any financial wonk willing to speak plainly on this.

posted by CollectiveMind to work & money (4 comments total)

Any non US dollar denominated assets in general, those of developing nations specifically.

The reason is simple: most developing nations run trade and budget surpluses. By contrast, pretty much the entire G20 has problems at this point, with some countries worse off than others.

If "speaking plainly" to you involves recommendations of specific instruments or trading strategies then I can't help you and pretty much anyone who will tell you what to buy is either trying to sell you something, or doesn't know what they are talking about.

Anyway, from the details of your question it's clear to me (a self-confessed "financial wonk", although I prefer the phrase econometrician) that you've already thought through the general topic very well, you're aware of timeframes and possible outcomes; you just needed a nudge in the right direction.

And that direction is - developing nations.
posted by Mutant at 6:11 AM on October 5 [2 favorites has favorites]

I think you're a bit muddled.

First, a little perspective. The US economy is much bigger than it was in WWII. The capacity to service debt is now much higher. If - and it is a big if - the US can achieve fiscal consolidation after the current difficulties, there is no particular reason to worry about official US debt.

Secondly, given that official debt is mainly in the form of bonds, servicing costs for existing debt are fixed. That's kind of the point of bonds. Granted, it may become more expensive to issue new bonds, but if foreigners want more return per bond on existing bonds it costs the government nothing.

Thirdly, I suspect you're conflating official, government foreign debt with foreign debt overall -which is the accumulated difference between domestic saving and investment. Escaping the burden of the former is difficult: in the absence of government default, taxpayers are liable. Escaping the latter is a matter of having low debt exposure yourself and being in an industry not exposed to exchange rate depreciation (import-competing and export-oriented sectors being obvious examples).

Fourthly, with regard to point (c), it is important to distinguish between the role of the US as a reserve currency prior to the 1970s and since. Under the Bretton Woods fixed exchange-rate world, countries held big currency reserves and they were mostly $US. The US got revenue from this ("seigniorage"). These days, not so much: just because a contract is specified in $US doesn't mean that anyone's holding $US. Worries about US national influence on world currency markets is mainly a matter of prestige these days.

My only advice would be to be careful of risks you don't understand and to remember that one symptom of not understanding is not understanding that you don't understand.
posted by hawthorne at 6:11 AM on October 5 [2 favorites has favorites]

While I agree with much of Hawthorne's comment, if you reasonably account for our Medicare and Social Security funding shortfalls, it isn't out of line to say that the US government is more indebted than ever before.

That said, many of OP's concerns are a bit off-base.

At least for the moment, our funding costs are quite low. They may well go higher, but it seems unlikely that they would get to recent-historical averages, to say the least of above them. (I am not a Treasury strategist, to say the least of yours, of course.) Foreign lenders are, by all appearances, less likely to demand higher interest rates than domestic lenders.

While we have more foreign bondholders as a percentage of the whole than we used to, our obligations are denominated in U.S. dollars, which removes most (if not all) of the classic pitfall in foreign indebtedness.

The "recycling" concern shouldn't be much of one. All capital flows to its best global investment opportunity: foreign recipients of U.S. Treasury principal and interest are no more, or less, likely to re-invest them in U.S. public or private obligations or equities than domestic recipients.

No future is assured or truly secured, of course, but in terms of long-term trends and global influence, it's important to remember that the U.S. is and for quite some time likely will remain: (1) the essential market for virtually all goods and services produced worldwide, (2) the dominant producer of advanced degrees and the dominant recipient of highly-skilled immigrants, (3) absolutely dominant in military force projection and untouchable by conventional attack, (4) less bollixed by demographic and legacy liability problems than western Europe and arguably less so than China, and (5) possessed of massive reserve resources of arable land, natural gas, coal, theoretical alternative energy capacity (biofuel production, sunny days in deserts for solar, windy days for windmills, etc.)
posted by MattD at 7:07 AM on October 5 [1 favorite has favorites]

Just a minor point- most of the US debt is still held internally.

And, to the other points, you can't compare debt in dollars to some other time. The dollar was worth more, and/or other curriencies and commodities were worth less or more in comparison. A more apt comparison is percent of GDP. (Worth noting, though I have no idea what the cause or importance is, is the correlation of low debt to unpleasant financial times. Depression era, Carter era Stagflation, the drop in debt leading up to the 2000s.)

As earlier stated, currency flows to the best investment available. And similarly, interest rates only go as high as they need to in order to satisfy demand. If boogyman foreign investors started "demanding" higher returns, they would invest elsewhere. Our interest rate would only go up to the point it had to in order to be able to sell those bonds. If one set of parties quit buying, someone else might start. Things would seriously have to go out of whack for the US to have to markedly raise interest rates in order to sell debt.

Or, look at the interest rates right now- low. There is plenty of money out there looking for safe investments, and the US is still pretty darn safe.
posted by gjc at 8:09 AM on October 5