Phorgy Phynance

Archive for the ‘US Treasuries’ Category

FT: Moody’s warns on US sovereign rating

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A while back, I was sitting in a meeting with some bankruptcy attorneys that were helping the investment group understand some new bankruptcy laws. After the meeting, I asked one of the attorneys a pretty open-ended question that tends to get surprisingly honest answers:

In the long term, what is your biggest concern for the US economy?

Her answer was immediate and without hesitation:

I can’t see how the US is going to be able to afford healthcare costs for the coming wave of retiring babyboomers.

Not exactly what I was expecting her to say, but the apparent honesty left an impression on me. That is one of the reasons why, when I began voicing my gloomy opinions for the coming credit crisis (even though I’m an optimist!), I said some fairly radical things.

I’ve quoted part of the discussion here when I first learned of the amount of US debt held outside the US.

Looking out over the horizon, say 10 years or more, it was hard to imagine the US being able to pay its obligations. On July 26, Aaron Brown said:

I’ve never understood the argument that foreign ownership of treasuries is a threat to the US. If everyone who didn’t like me lent me money, I’d be happy. I’d be even happier if I got to pay them back with paper I wrote myself. In the 60’s and 70’s, the US sold a lot of debt to foreigners and inflated its way out of repayment. In the 00’s, the US sold a lot of debt to foreigners and devalued its way out of repayment. But people keep lining up to buy more. I don’t see that changing.

I admire Aaron a LOT. He is super knowledgeable AND super helpful. He has uncanny patience and is willing to walk even thick-skulled people like me through technical explanations. What he is suggesting above is that when the US’ obligation become unmanageable, we can simply inflate our way out of it. Sure. That is one solution, but when your obligations are both internal and external, inflating your way out of an obligation to a retired senior citizen doesn’t seem to be the most politically correct thing to do.

What is an alternative?

I suggested that, since much of the US’ obligation is to its retiring senior citizens as well as foreign debtors, one solution would be for the US to default on its external debt *gasp*

Here is my direct quote on July 26:

I’m not sure I’m so enthusiastic about the idea of inflating your way out of foreign debt obligations. That wouldn’t be so great for the domestic economy. Something like what Russia did, i.e. a flat out default, as crazy as it sounds, is seeming like more of a possibility to me though.

The deep and insightful comment from Skillionaire followed:

Eric, I’ve been disagreeing with your views for the past couple of days in this thread, but I believe with this statement you might’ve officially gone off the deep end with this apocalypse stuff you’ve been pushing.

To which I replied:

The good thing about these phorums is that they have time stamps. Sure, today the idea seems crazy. It’ll probably seem crazy for the next 5 years or more. Ten years? Anything is possible. We’ll see. Care to wager on it? Wink

Wager: Within the next 10 years, i.e. before July 26, 2017, a major news source will carry a headline indicating the US may default on a foreign debt obligation.

No one took me up on it 🙂 It’s only been 5 months, but the first cracks in the long term credit quality of US sovereign debt has surfaced

This is from the Financial Times

Moody’s warns on US sovereign rating

The US is at risk of losing its top-notch triple-A credit rating within a decade unless it takes radical action to curb soaring healthcare and social security spending, Moody’s warned on Thursday. The warning over the future of the triple-A rating – granted to US government debt since it was first assessed in 1917 – reflects growing concerns over the country’s ability to retain its financial and economic supremacy. It could also further pressure candidates from both the Republican and Democratic parties to sharpen their focus on healthcare and pensions in the run-up to November’s presidential elections. Most analysts expect future governments to deal with the costs of healthcare and social security and there is no reflection of any long-term concern about US financial health in the value of its debt.

I’ll repeat, I don’t see any real threat of a US sovereign default in the next 5 years, which is probably beyond the horizon of most investors and so might be considered irrelevant. But 10 years? 15 years? 20 years?

Written by Eric

January 10, 2008 at 10:30 pm

Flight to non-USD quality revisited

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Historically, sovereign reserves were (from my understanding) ultra conservative and consisted of mostly US treasuries. Increasingly, these sovereign reserves have been managed more actively and we are hearing more and more about the growth in sovereign wealth funds. When 40% of all US debt is held OUTSIDE the US, what is going to happen in a turning credit cycle?

On July 25, I stated my opinion on the subject in the post

Flight to non-USD quality

I also suspect that a “sovereign” flight to quality will not be a flight to US treasuries and in fact may be a flight away from US treasuries into EUR denominated government bonds. So as the credit market turns, the typical safe haven will not be available as even treasuries get whacked from sovereign sellers.

I may have been wrong about the EUR (or maybe I was right… time will tell), but it made sense to me then as it does now that sovereign wealth managers will not necessary flee to the “quality” of US treasuries as the credit cycle turns. In fact, it made sense to me then as it makes sense to me now that sovereign funds will turn their backs on US treasuries causing treasury yields to rise. This would hurt US investors who typically considered the US treasury to be safe during times of crisis.

Don’t get me wrong. It is not that I WANT bad things to happen. I am an optimist after all 😉 If I do manage to get one or two things right, rest assured I am not running around in glee with my t-shirt over my head.

Mostly, my comments on this blog are driven by two things. On the one hand, I am hoping to maximize my personal learning experience so that I will ultimately become a better investor. I expect to one day to have people put their faith in me with hard earned savings. I take that responsibility very seriously and want to be the best investor I can be. For both my own sake as well as those who place their trust in me. On the other hand, I hope that something I say may help others more experienced who currently are responsible for investing other people’s money to see things in a different light. I generally have unique or unorthodox ways of interpreting things and that has often benefited me as well as those who have worked with me. If something I say manages to generate a good investment idea, I will be happy.

With all that said, I found today’s BBG article to be very interesting.

Treasury Gain May Falter; Foreign Holders Flee Dollar

Treasury investors basking in the biggest rally in four years have reason to fear for their profits: The largest owners of U.S. government debt are heading for the exit.

[snip]

U.S. long-term interest rates would be about 90 basis points, or 0.90 percentage point, higher without foreign government and central bank buyers, according to a 2006 study for the Fed by Professors Francis and Veronica Warnock at the University of Virginia in Charlottesville.

[snip]

Government and central bank holdings of U.S. government debt at the Fed fell by $46.1 billion from the week ended July 25 to the week ended Sept. 5. They climbed to a record $1.25 trillion in July from $574 billion in June 2001.

[snip]

Asian central banks also reduced Treasuries last month in an effort to curb dollar gains against their currencies. Taiwan’s central bank cut its currency reserves by $4.9 billion in August, mostly by selling U.S. bonds, George Chou, a deputy governor of Central Bank of the Republic of China (Taiwan), said in an interview.

Even before the flurry of sales, more nations were starting to shift foreign-exchange reserves away from U.S. government bonds.

[snip]

China will likely, and appropriately, “reduce its holdings of dollar assets to get higher returns,” said Ha Jiming, chief economist in Beijing at China International Capital Corp., the nation’s largest securities firm. Ha attends central bank Governor Zhou Xiaochuan’s quarterly meeting with the nation’s lenders.

The $50 billion Qatar Investment Authority said on Sept. 4 it is looking for options in Asia to counter a weak dollar.

Makes perfect sense to me. A little common sense seems like it can go a long way these days.

Written by Eric

September 9, 2007 at 9:49 pm