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The Guessing Game
The reaction to this news in the credit markets drove Treasury prices higher, which drives yields in the opposite direction. We are close to a redline zone that will make our debt less attractive. Of course, this is a depending on whom you might be talking to at the time. Some folks will take the xenophobic stance assuming that there is still no better debtor than the United States. What other country is willing to go deeper into debt today to help business tomorrow? These believers in the extended deficit are convinced, for that reason alone, that our debt, no matter how large or for what reason, will always be attractive to foreign investment. And they may be right.
Then there are those, and I admit that this school of thought looks very attractive indeed, who believe that the lack of inflationary pricing in this country may not make us as good a customer for these international purveyors of goods. Normally this would not be a problem but with so many factories now up and running worldwide, cheap labor and low cost materials make production a must. These companies are starting to sacrifice margin just to keep their foot in the door.
Currently this country's deficit is now 5% of the GDP and climbing. Long term promises by the Federal Reserve Chairman Alan Greenspan and his governors all suggest that they are comfortable with these numbers and the reports that have been signaling the economy is on the right track. With the exception of the unemployment numbers last Friday. Before bankers in Berlin on tuesday, the chairman reaffirmed his stance that weak job data has no bearing on the economic recovery because productivity was so good.
Mr. Greenspan acknowledged the growing concern about the deficits that this country seems to have no problem racking up. "There is, for the moment, little evidence of stress in funding US current account deficits," he said to those same bankers. "Inflation, the typical symptom of a weak currency, appears quiescent."
Typically, a good Greenspan watcher would look for telltale signs and phrasing in his speech and build speculation on that. For our example, we will look at "for the moment". There is as I mentioned earlier a quickly approaching redline for the amount of debt the world markets can absorb. Because the dollar has dropped so much against the Euro and the Yen, our newest best export is deflation. But don't think for one minute that the Europeans and the Japanese are going to let that happen just because Greenspan suggests that the markets will make all of the necessary corrections.
The debt that the US is asking the world to buy is wholly different than the debt the markets would like to purchase. When private corporations issue debt, it is usually the result of a need for capital to grow. Contrary to this, the current account deficit is almost entirely public sector borrowing. With yields continuing to drop, the markets will not be able to fix this problem as Greenspan believes will happen. If the dollar goes into freefall, there will be little the Fed chairman can do. Only the US, these foreign investors believe, will be able to do what needs to be done - eventually.
For investors, that view of the horizon looks very unsettled. The falling dollar has created some international opportunities worthy of a gander. This is because these funds could be considered a currency bet and popular European speculation sees the dollar falling even further. With high yield funds ending the year with a 24.37% return, the current year looks fraught with short and long term risk. But worry not, there is hope.
Inflation will not be kept at bay for long. As soon as interest rates begin to rise, inflation will follow. A diverse bond fund that buys both emerging markets and Treasury Inflation Protected Securities (TIPS) might be an excellent place in the brewing storm. Another sector worth looking into is the municipal bond funds. Some of these funds are paying a healthy return north of six percent and are tax exempt. As long as the interest rate does remain low, money will continue to be incredibly cheap to borrow for municipals in the short term.
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