Flickering but not flashing

The US have a unfunded pension and health-care obligations problem.

In a couple of years when the economic recovery is likely to sputter out, as in any economic slowdown, service and refinancing of debt will become an issue. We saw with the GFC in 2008 that too much debt and slowdown don't get along.

It won’t just be a debt problem this time around but rather a story about unfunded pension and health-care obligations. To address that looming crisis, the U.S. will need to ramp up issuance of U.S. Treasuries. The Federal Reserve will have to sell more Treasury bonds to make up for the deficit, and as Americans won’t be able to buy all those Treasury bonds, foreign investors will have to step up. The first consequence of this increased issuance could be a depreciation in the value of the dollar (this, from a European perspective, does not take into consideration a coincident crisis in the Euro area, weak and internally divided).

The exorbitant privilege

The term, coined in the 1960s by Valéry Giscard d'Estaing, refer to the privileged position of the United States of being able to borrow in their currency because they have the world's leading reserve currency. The idea that the U.S. dollar would lose its status as the world’s reserve currency is an unlikely existential threat, a talking point that encourages debate until people realise something else would have to fill that void. Moody’s Investors Service recently confirmed that: "The U.S. dollar will remain the dominant foreign reserve currency for the foreseeable future”.

The analysis of the unfunded pension and health-care obligations is not easy, but it is an important one as the total amount of US debt outstanding is $15.3 trillion while was $4.9 trillion ten years ago. The recent fiscal stimulus, positioned toward the end of an economic cycle is not ideal, in theory. However, time and again, the bond markets, have shown that deficits do not matter. For all the hand-wringing about the increasing size of Treasury auctions, the 10-year yield is still below 3 per cent. Inflation is rising but appears contained.

The caveat in Moody’s report is that reserve currencies should be stable and the issuing country should be “highly unlikely” to experience a financial crisis.

As Ray Dalio says, his seven indicators of bubbles are “flickering but not flashing,” and his depression gauge, which sent out an alarm before the 2007-09 financial crisis, isn’t glowing red. Receive a free PDF of latest Ray Dalio' s book HERE.

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