In prior letters we touched on the consequences of a U.S. default and some assets classes to use as safe haven investments so to speak. However, now that the possibility of a default has become very real with the August 2 deadline just a week away; delving further into the appropriate investment vehicles seems necessary.
Before we look at specific investments, I would like to present the following chart:
The last time our nation’s debt was in excess of 300% of GDP was the great depression. As you can see, the percentage is actually higher now than it was then. Disturbing? Yes, it is.
The reality is whether the debt ceiling gets raised or not, we still have long-term issues. In fact, raising the debt ceiling will actually ADD to the problem as the government will be authorized to borrow more, which is bad in the grand scheme of things.
This notion is shown in the Fisherian theory, which states that an excessive buildup of debt relative to GDP is the key catalyst in major economic contractions. This environment causes: weakness in aggregate demand, falling money velocity and underperformance of labor markets. (Any of these ring a bell in our current economy?)
Side Note: Irving Fishers’ economic principles have been around since the 1930s, and generally ignored by the masses as mainstream economists ran with Keynesian economics, which generally blames lack of demand on all economic slumps.
Now, don’t get me wrong; not raising the debt ceiling and letting a U.S. default occur is not the way to go either. The ripple effect would impact not just our economy, but the global economy as well. We just need to realize that at some point, more debt is not the answer.
Let’s now look at how to invest/hedge yourself coming into the August 2 deadline. This is kind of like putting insurance on your existing portfolio with some potential for appreciation.
The two most obvious things that will happen if the deadline passes with no deal are:
Gold (and other commodities) will likely rise as investors flock to the precious metal as a safe haven.
Yields on U.S. Treasury bonds will go up as investors demand a higher rate of return to hold debt that will likely no longer be triple A rated by the ratings agencies.
We can take advantage of these outcomes by investing in the GLD, which is an ETF that replicates the performance of Gold – I prefer this as a hedge type investment opposed to the individual gold miner stocks that can be dragged down by an overall market selloff, which is very likely come a default.
Next, for Treasury yields to rise, the price of existing bonds will have to fall. I would look at the TBT, which is the Ultashort 20+ Year Treasury ETF. This ETF aims to return twice the inverse move of the Barclays Capital 20+ Year U.S. Treasury Bond Index.
How you deploy these is of course up to you and your investment advisor. As you know, I have been long gold for a while so am just sticking with that. I used options to go long TBT in order to be positioned for a move higher in yields.
Regardless of the outcome, having a hedge on your overall portfolio during times of economic uncertainty is generally a good idea.
Your hoping Washington gets its act together analyst
Mitch Jaworski