Wednesday, August 3, 2011

Where Is Financial Safety?

The debt ceiling deal was, more than anything else, an agreement to disagree. It had commensurate impact on the financial markets (i.e., nada). Because the deal resolved very little, Congress will continue to convulse over budget deficit issues. The stock markets, which are driven by politics as much as economics, will convulse synchronously.

Meanwhile, across the pond, the Euro bloc sovereign debt crisis is all the rage again, with Italy getting smacked around by the bond vigilantes. The EU doesn't seem to understand that its strategy of solving debt problems with bailouts that, net net, increase the amount of its debt will only lead to more instability. Because the EU has, in effect, collectively assumed liability for all of the debts of all Euro bloc members and all of their banking sectors, the aggregate amount of continental debt is what matters. The EU's relentless expansion of its liabilities, with each bailout diminishing its capacity for further bailouts, guarantees that the bond bandits will have a never-ending stream of dominoes to knock over. The average citizen, working on a brown bag lunch in a cubicle, will opine that reducing debt is the way to get out of financial trouble. But the hoi polloi, lacking sophistication, just don't understand that these things are complicated.

So, we can look forward to more stock market volatility. Where is there financial safety?

Swiss bonds have risen in popularity. But they don't have the liquidity of U.S. Treasuries. If you buy Swiss bonds, you had better like them because they won't be that easy to exit.

Japanese debt has also gotten attention, even though Japan's sovereign debt is about 200% of GDP, well above American levels. With almost all of Japan's debt held by its own citizens, it isn't likely to face serious capital flight. Indeed, the Japanese government seems to prefer a little capital flight. With the popularity of the yen pushing up its price, Japan's export-based economy is at risk. Even as we write, the Japanese government is intervening in the currency markets to push down the yen. If you buy yen-denominated debt, understand that you'll earn almost no yield and be at risk of currency losses from Japanese government yen smackdowns.

So what's left? Well, oddly, U.S. Treasuries. At least until the current debt ceiling is reached, probably in early 2013, U.S. government debt is safe. You may face some moderate inflation risk. But the long term picture for U.S. Treasuries--which isn't pretty--won't emerge for the next year or two. So, if you're worried about the stock market swan diving into a correction or bear market, Treasuries may be a safe place to hit the mattresses, at least for a while. Money market funds invested solely in U.S. Treasury securities are comparably safe, albeit exceptionally low-yielding.

FDIC insured bank accounts are also safe. The European debt crisis, in the worst case, could hit the U.S. banking sector pretty hard (because of interbank lending, derivatives exposures, and other bank interconnectedness). But the FDIC, with the backing of the U.S. Treasury, will protect insured deposits come hell, high water, plagues, swarms of locusts, loathsome diseases, or anything else. One hard lesson the government learned from the thousands of bank closures leading up to and during the Great Depression is that the loss of bank deposits wallops consumer confidence more than anything else. People don't look to their stockholdings or the equity in the house to cover next month's expenses. But if you take away their bank deposits, you create immediate household crises on a wholesale level. Make sure your bank deposits stay within insured levels (for more detail, see

We also discuss safe investments at

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