The Perfect Debt Storm

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Finanza Operativa di Finanza Operativa 26 Febbraio 2018 | 13:00

A cura di Walter Snyder, Swiss Financial Consulting

Congress has voted to spend 300 billion more. Adding this to the projected budget deficit, the Treasury is going to have to find about one trillion more to finance expenses. With the debt already at 20.6 trillion (www.usdebtclock.org), FY 2018 does not look very promising. If the Fed continues with QT (quantitative tightening) and goes ahead with three or four interest rate hikes and the trade deficit does not significantly diminish, which is unlikely, then adherents of the Doom and Gloom Club will wallow in “Schadenfreude”, which is a German word for taking pleasure in other people`s misfortunes.

Several market observers have noted the grave implications of excessive indebtedness on the part of the federal government. Dollar weakness and higher inflation are to be expected along with higher interest yields on fixed income investments. Despite central bank meddling, bond markets still react to higher yields with lower prices for long-term paper. Ten-year Treasury notes are now close to yielding 3%, which means that more people have been selling rather than buying them.

This Newsletter has espoused the proposition that bonds were a poor investment that should be avoided and that it would be prudent to short the dollar. The situation now threatens to become critical. In an environment where interest rates are rising, yields will increase, and that means that bond prices in the market will fall. At the same time rising bond yields will have an effect on the prices of equities, of which the recent correction is a reminder.

It thus becomes extremely difficult for investors to manage portfolios under these conditions. China and Japan will probably not buy much new American paper, and it will be the Fed that comes to the rescue, thereby monetizing more American debt and practically suspending QT. This means that investors will have to be careful about when they move from equities into bonds. Given the high prices for equities even though some commentators find that stock prices are not excessive, investors would be advised to take profits and diversify into commodities like uranium, which has high northwards potential. The dollar will also probably weaken further as the debt crisis develops. Shorting the dollar with Forex diversification in euros, yen and renminbi and also acquiring physical gold are two strategies that will help investors to weather the storm. Seeking a safe haven is best done before the storm breaks.

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