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DECEMBER 2, 2013
Columns GUARDING WEALTH
American woes The U.S. Treasury is alive and well after the truce declared on October 16, but the war is not over BY ANDREW ALLENTUCK
C
all it October madness. The rush to the cliff of default, gone for now but not really gone, pushed the world to the brink of an American financial collapse. U.S. Treasury bonds, which make up two-thirds of the reserves of central banks around the world, and an even larger share of the capital of global megabanks, are traded every business day. Banks holding the bonds sell them when they need money to lend and buy them when they have cash rattling around that can earn a little money overnight. Had the Treasury been unable to pay bonds when they were due on October 17, global liquidity would have started to run dry. Had the Treasury defaulted, banks would have run out of money to lend. Their capital would have vanished and they would have had to call loans. All this because a small rump of members of the U.S. Congress who are beholden to the Tea Party decided to imperil the full faith and credit of the United States over their dissatisfaction with President Obama’s medical and hospital cost insurance plan. The plan itself is a sort of eBay for health insurance complete with some knots. It may raise labour mobility, for workers will not have to stick with jobs just because they have good health insurance. It may cause some employers to put full time employees on part time just to avoid paying health insurance costs. The move by the radical right to push the United States to the brink of default, which was 10 hours away when the President and the Congress signed their deal to postpone the day of reckoning, amounts to sabotage of the American economy and damage to world security, says Hubert Marleau, economist and co-founder of Palos Investment Funds in Montreal. “To seek potential catastrophe as a source of bargaining power in a game of extortion is evil,” he wrote in his weekly memorandum. The consequences of default, which will return as an issue before February 7, 2014, when the present debt ceiling runs out, are to finance what a hydrogen bomb would be to land and people. It used to be reasonable to assume that the U.S. would never default. Yet in American history there are several episodes of actual default and virtual default. Two bonds issued by France to finance the colonists in their war of independence from Britain were dishonoured by the United States in 1789. King Louis XVI then called the Estates General for the first time in 150 years. A peasant revolt followed, the palace at Versailles was attacked, the king fled later to be executed and the French
Revolution was up and running. The bond default was merely a trigger. Class hatred was the fuel of the revolution. President Andrew Jackson refused to renew the charter of the Second Bank of the United States in 1836. It was a central bank which, when running, supported the credit of the fairly new federal government. With no central bank, the U.S., then a developing nation, lost standing as a borrower in global finance. Until the creation of the Federal Reserve in 1913, the U.S. had to pay higher interest rates than it would have had to pay had there be a central bank such as the Bank of England to act as a lender of last resort in liquidity crises.
far right forces lined up against President Obama and his medical care bill. The far right has shown its power, so it is possible that the Tea Party will use its muscle against other foes. In a climate of what amounts to financial self-destruction by a party that appears to think global
trade tens of billions of dollars without budging the price. However, judicious investments in top U.S. corporate debt which could become a proxy for Treasuries, in British gilts or in Canadian dollar denominated bonds issued by government backed state banks in Germany such as KfW (Kreditanstalt fur Wiederaufbau — the Bank for Reconstruction) are solid and reasonable. In the next crisis, they could flourish. Investing to beat a band of financial masochists may seem farfetched, but given the condition of the United States Congress, it is merely reasonable. The larger question is what happens to stocks and commodities.
cycle until consumers, perhaps wanting for paycheques, curtailed spending. Construction, aerospace, and electronics — industries which work on established lines of credit — might run a few weeks before shutting their doors. The safest bet would be financial instruments that must be paid, that is, bonds. Investment grade corporate bonds, federal Canadian bonds, provincial bonds and foreign government guaranteed corporate debt would be bought up eagerly by investors. Ditto the gilts and bunds, bonds from the governments of the Scandinavian countries, the Netherlands, Australia, New Zealand and Asian triple A credits like Singapore and Japan. These bonds are issued in vari-
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Crises are by definition temporary CANADIAN INVESTORS For Canadian investors, the brinksmanship forced on the Treasury by the Congressional nail biter is an opportunity to make wise fixed income investments. A default or another serious threat of default would drive pension funds, large banks and insurance companies to buy alternative bonds. That would make British sovereign bonds called gilts rise in price, ditto for German sovereign bonds called Bunds, also for the sovereign bonds of the Scandinavian countries, the Netherlands, Australia, New Zealand and Canada. Around the world, there would also be a move to top grade corporate bonds. In the U.S., there are only four non-financial companies that have AAA credit ratings: Exxon Mobil Corp., Microsoft Corp., Automatic Data Processing Inc. and Johnson & Johnson. Exxon Mobile bonds with fiveyear terms have been bought up to the point that their yield is now within a quarter of a per cent of five-year U.S. Treasuries. There are also global bond exchange traded funds that provide excellent credits with no direct U.S. Treasury bond risk. For example, the iShares Aaa-rated Corporate Bond ETF (QLTA-NYSE) has top American corporate bonds and a very low annual management fee of 15/100ths of one per cent. The iShares Intermediate Treasury Bond Ex-US ETF has no direct U.S. Treasury exposure. Each of these funds has a measure of immunity from worries over U.S. Treasury debt. Default risk will plague U.S. Treasury bonds until there is some end to the blackmail of the American government by the
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financial Armageddon would be a good idea, there is no absolute defense. Survivalists could rush to their bomb shelters, top up their hoards of gold coins and canned soup and wait for the rebirth of a global economy. That seems idiotic, for without liquidity, the world would be reduced to barter. It probably won’t come to that. Yet the U.S. dollar may be diluted as a global reserve currency to be replaced in part by gilts, bunds, Australian dollars and perhaps Swiss francs. None of those currencies and markets have the depth of the U.S. Treasuries market where one can
ous currencies. The best of the lot In a liquidity crisis, F:6.4583”companies would have trouble paying their would be in their own currencies. bills and getting paid. One would The worst would be those issued in have to assume that there would be U.S. dollars. Crises are by definition tema drop in sales and earnings. That SBC13130.Perform and any default by the is what happened in the shutdown 11-4-2013 9:28porary AM U.S. would be temporary. The Yellow, of the U.S. government which CALMCL-DMX7993 Cyan, Magenta, U.S. would return to paying its ended October 16. When compaMarsha Walters though reputanies report quarterly earnings, the bonds, ORIGINALLY the GENERATED: Oli NoneevenSPEC 100% 12.9167”tion x 8” of the Treasury and U.S. extent of the losses will become SAFETY: None TRIM: 12.916 would evident. The effects of a future financial markets Helvetica Neue LT Stdbe (65 Medium, 75 Bo liquidity crisis would depend on stained for many years. Markets its length, of course. Even with- remember. That is something out that information, it is possible that the Tea Party activists who to suggest what stocks would be endangered the credit of the hurt most. Top of the list: banks United States forgot. † and other financial institutions. Andrew Allentuck’s latest book, When Can I The retail economy could exist on Retire? Planning Your Financial Life After Work, credit cards for part of a billing was published in 2011 by Penguin Canada.