Tags: US | shutdown | dollar | euro

Time to Start Thinking Outside the Box

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Tuesday, 22 Oct 2013 12:45 PM Current | Bio | Archive

As a long-term investor, it's totally impossible to overlook the short-term as well as the long-term negative implications that have been caused by the recent U.S. government shutdown.

Already, Standard & Poor's "preliminary" estimates show the shutdown probably costs about $24 billion to the U.S. economy, which translates in the fact the shutdown could have shaved at least 0.6 percent off of the annualized fourth-quarter GDP growth rate.

When we put this in context of the latest Bureau of Economic Analysis real 2.5 percent growth for the second quarter, then the government shutdown has provoked a completely unnecessary cut of about one-fifth of GDP growth. Taking that into account and honestly spoken, one could easily lose confidence for much less than that.

Maybe it's not such a bad idea for all kinds of investors to keep in mind the United States is what's called a "debtor" nation, of which international investors hold about half of all federal bonds (publically held, of course) for an amount north of the $5 trillion mark. I wouldn't take the fact of these $5 trillion bonds in "foreign" hands lightly, because in understandable English, that could mean that in the end it will be the markets and not the Fed that will set the interest rates of U.S. bonds.

Once we come to that point (although I hope we never do), we probably would have an extremely vicious crisis in the United States, but also globally, especially in the emerging economies.

Just think for a moment what an increase of the interest rates on bonds, let's say to the 5 percent zone, which by the way is expected over the next two years and that by itself would be nothing more than some kind of "normalization" of interest rates, could mean to the costs of financing the U.S. deficits, to borrowing costs for all segments of the U.S. economy and which, in turn, would negatively impact overall growth. Keep in mind sub-2 percent growth equals no job growth.

I hope Sen. Mitch McConnell, R-Ky., was right when he told CBS: "There will not be another government shutdown. You can count on that."

Fact is, the overall situation remains highly uncertain because the latest agreement reached in Congress to end the partial government shutdown was sealed in a bill that only allows government funding for three months, hoping policymakers in Washington should be able to find a much broader agreement that would finally allow to fund the government and cut the deficit on a more sustainable basis. Time will tell if that's possible or not.

Anyway, January and February could turn out to be extremely important for the implementation or not to a durable bipartisan solution. As a long-term investor, we should remain as realistic as possible and therefore always keep the worst-case scenario on our radar screen.

In case policymakers can't come to an agreement, I think we can assume there is real trouble ahead.

Countries like China, which holds about $1.28 U.S. Treasurys, could well follow the advice of David Li, a prominent economist at Tsinghua University in Beijing and former policy adviser to the People's Bank of China, who stated China's State Administration of Foreign Exchange should diversify more its reserves by, among other things, rising its investments in shares of multinationals operating in the Chinese market and increase its holdings of non-US sovereign bonds that are rated AA+ or higher.

For long-term investors, this is important and it could also be useful, in case one would like to diversify parts of their holdings in what are still considered as "good" sovereigns, to have an idea of the 17 countries that are rated AA+ or higher by Standard & Poor's. Besides the United States, these are: Australia, Austria, Canada, Denmark, Finland, France, Germany, Hong Kong, Liechtenstein, Luxemburg, the Netherlands, Norway, Singapore, Sweden, Switzerland and the United Kingdom. No, that's not a long list, and that list will probably become shorter in the near future.

Li's opinion for diversifying away in part from U.S. Treasurys is also interesting because he considers China's holdings of U.S. Treasurys as both a "hostage" situation and a "bonding instrument" for the two largest economies in the world.

Anyway, a lot of food for thought.

Besides all that and as far as the value of the dollar is concerned, these days it's certainly not difficult to make a case against the dollar.

That said, it's certainly also interesting to take notice the French Industry Minister Arnaud Montebourg said today in an interview to the French daily "Le Parisien": "The euro is too strong, and if it were 10 percent lower against the dollar we would increase our national wealth by 1.2 percent, create 120,000 jobs and reduce our deficit by 12 billion euros ($16.44 billion). If the euro went down by 20 percent, we would create 300,000 jobs and reduce our deficit by one-third."

Montebourg's comments make me think back to 2007 when the then French President Nicholas Sarkozy openly campaigned for lowering the value of the euro when it was closing in toward $1.40 per euro. To put this in context, today the euro is around $1.3675. Interestingly, the French Minister is not alone. German air carrier Lufthansa has also complained the euro is too expensive.

Notwithstanding the dollar is obviously in a weak spot, in my opinion at least, I wouldn't bet on an ominous collapse of the dollar. Instead, I would be inclined to consider accumulating dollars again when we reach, in the dollar index, prices slightly below the 79 mark line, which is an important resistance zone. I don't know if we will go that low. At the time of this writing, the dollar index is at 79.80. Nevertheless, if the dollar would weaken substantially we could expect a strong reaction from "competing" currencies. Just think about the Japanese yen and the Brazilian real. Yes, "currency wars" would suddenly come back with a vengeance.

As for Tuesday's "delayed" numbers of the September U.S. employment situation, which won't be affected by the government shutdown because the numbers were collected before that event and also it will be merely a rearview snapshot, I'd like to wait for the numbers of the month October, which should hopefully give us a better idea on where we really stand and where we are going.

Finally, and notwithstanding the topping phase in the markets continues to be frustratingly long, I'm still convinced the markets will correct over a protracted period that could easily stretch into 2015 and 2016, in what will be called a wave "C" way, down of historical proportions. Of course, I could be wrong.

In my opinion, substantially lower values that are based on sound and sustainable fundamentals will find their place back in good, not speculative, portfolios some time in the future. Of course, for buying at the right time investors will need cash that will be readily available whenever it's needed, and that probably will not be available in what's known as the "usual places."

Yes, we'll have (at least, I will) to start thinking once again outside the box.

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HansParisis
In my opinion, substantially lower values that are based on sound and sustainable fundamentals will find their place back in good, not speculative, portfolios some time in the future.
US,shutdown,dollar,euro
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2013-45-22
Tuesday, 22 Oct 2013 12:45 PM
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