Friday, July 15, 2011

Can Your Protect Your Savings in the Event of a US Debt Default?

Debt ceiling & dumber: No safe haven for your money?

By John F. Wasik (Reuters)

Washington is now acting out a scene from Tennessee Williams’ classic play Glass Menagerie. The ever-fragile players are about to shatter .

Yet this is not the time to turn a farce into a tragedy. A default on U.S. debt will make the 2008 debacle look like a Simpson’s episode. Interest rates will soar through the roof. Everything from mortgage rates to adjustable credit card financing will skyrocket. Payrolls may be imperiled along with Social Security and Medicare payments. Think economic crash and burn — in a big way.

If the credit rating of U.S. debt is downgraded from AAA, that will automatically signal to the global bond market that investors should demand higher yields for taking more risk. Standard & Poor’s has put the U.S. on its ominous “CreditWatch” status and will downgrade unless a debt deal is struck soon.

Money moves exponentially faster than politics these days. If bond managers get even a whiff of actual default, they will move their funds out of U.S. Treasuries at the speed of light. That tsunami may devalue anything measured in dollars, including U.S. stocks; corporations would then fire even more people and halt capital investment. Unemployment would hit Depression-era levels. Americans would wistfully recall the days of nine percent joblessness.

More importantly, a debt default will be a smack-down to the credibility of the U.S. as an issuer of the highest-quality bonds. It will also clobber the liquidity of anyone who holds U.S. paper, from Chinese banks to Europeans hoping to escape debt debacles in Greece, Ireland, Portugal, Spain and Italy. Trillions could flow out of Treasuries into countries perceived as fiscally sound.

Here’s PIMCO’s Bill Gross, the biggest bond fund manager by assets, writing in the Washington Post: “Global investment managers have global choices these days, and a solvent Germany or Canada is just a wire transfer away for trillions of potential investment dollars looking for a safer haven.”

Gross said several weeks ago that he sold U.S. Treasuries from his PIMCO portfolio. “The debt ceiling must be raised and not be held hostage by budget negotiations,” Gross concludes. “Don’t mess with the debt ceiling, Washington. Bond and currency vigilantes will make you pay.”

Both parties have now entered the “break it, you own it” phase of their bickering. Who do you pay first in the event of a default? The military? Air-traffic controllers? Who gets burned? Social Security recipients? National Park visitors?

How do you avoid getting walloped? If the White House and Republicans can’t agree on a plan to avoid default, it would be silly to retreat into gold or other precious metals. You can’t use bullion to buy food, medicine or pay utilities.

Worst-case scenario: To protect yourself against interest rates ballooning, you could short Treasury bonds. This is incredibly speculative — and risky.

One approach is to buy leveraged exchange-traded funds such as the ProShares Ultrashort 20+ US Treasury ETF. This fund promises a return 200 percent of the inverse performance of a 20-year U.S. Treasury-bond index. So if interest rates soar, you can make a lot of money, or just offset the losses in every other part of your portfolio.

Of course, this is a money-loser if politicos come to their senses and interest rates don’t climb dramatically. A lower-risk approach may be to hold onto a high-quality money-market fund that mostly holds corporate debt. Cash would be king — as long as it didn’t involve defaulted U.S. debt. In truth, though, no one really knows what will happen or what the safe havens will be.

There are other ways of defusing this mindless political kabuki: Take Social Security and Medicare off the table for now. Discuss them separately in a series of expert town hall forums over the next year. Besides, these programs should never have been held hostage in the perfunctory debt-ceiling passage. They are largely self-funded by payroll taxes and merit separate treatment.

The American people, who overwhelmingly support social insurance benefits, deserve an intelligent dialogue on whether all or part of these programs should be cut or privatized under the Republican template. When I talked to a packed room of fiscally conservative older Americans Wednesday night on whether they wanted to see Medicare or Social Security privatized, not one raised a hand.

Wiser heads may prevail, although it’s ironic that shorting Treasuries is not only an uber-cautionary strategy, but a portfolio position held by a key player in the debt talks — Rep. Eric Cantor (R-Va.), the House Majority Leader, at least in his 2010 financial disclosure statement.

Is Cantor merely trying to speculate on inflation returning, which countless pundits have been forecasting for years? Or maybe, since he’s at the center of this maelstrom, he’s cynically hedging his bets.

We’re not playing checkers here. The pieces can break in a disastrous way.

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