Debt ceiling & dumber: No safe haven for your money?

July 15, 2011

Washington is now acting out a scene from Tennessee Williams’ classic play Glass Menagerie. The ever-fragile players are about to shatter .

Yet this is not the time to turn a farce into a tragedy. A default on U.S. debt will make the 2008 debacle look like a Simpson’s episode. Interest rates will soar through the roof. Everything from mortgage rates to adjustable credit card financing will skyrocket. Payrolls may be imperiled along with Social Security and Medicare payments. Think economic crash and burn — in a big way.

If the credit rating of U.S. debt is downgraded from AAA, that will automatically signal to the global bond market that investors should demand higher yields for taking more risk. Standard & Poor’s has put the U.S. on its ominous “CreditWatch” status and will downgrade unless a debt deal is struck soon.

Money moves exponentially faster than politics these days. If bond managers get even a whiff of actual default, they will move their funds out of U.S. Treasuries at the speed of light. That tsunami may devalue anything measured in dollars, including U.S. stocks; corporations would then fire even more people and halt capital investment. Unemployment would hit Depression-era levels. Americans would wistfully recall the days of nine percent joblessness.

More importantly, a debt default will be a smack-down to the credibility of the U.S. as an issuer of the highest-quality bonds. It will also clobber the liquidity of anyone who holds U.S. paper, from Chinese banks to Europeans hoping to escape debt debacles in Greece, Ireland, Portugal, Spain and Italy. Trillions could flow out of Treasuries into countries perceived as fiscally sound.

Here’s PIMCO’s Bill Gross, the biggest bond fund manager by assets, writing in the Washington Post: “Global  investment managers have global choices these days, and a solvent Germany or Canada is just a wire transfer away for trillions of potential investment dollars looking for a safer haven.”

Gross said several weeks ago that he sold U.S. Treasuries from his PIMCO portfolio. “The debt ceiling must be raised and not be held hostage by budget negotiations,” Gross concludes. “Don’t mess with the debt ceiling, Washington. Bond and currency vigilantes will make you pay.”

Both parties have now entered the “break it, you own it” phase of their bickering. Who do you pay first in the event of a default? The military? Air-traffic controllers? Who gets burned? Social Security recipients? National Park visitors?

How do you avoid getting walloped? If the White House and Republicans can’t agree on a plan to avoid default, it would be silly to retreat into gold or other precious metals. You can’t use bullion to buy food, medicine or pay utilities.

Worst-case scenario: To protect yourself against interest rates ballooning, you could short Treasury bonds. This is incredibly speculative — and risky.

One approach is to buy leveraged exchange-traded funds such as the ProShares Ultrashort 20+ US Treasury ETF. This fund promises a return 200 percent of the inverse performance of a 20-year U.S. Treasury-bond index. So if interest rates soar, you can make a lot of money, or just offset the losses in every other part of your portfolio.

Of course, this is a money-loser if politicos come to their senses and interest rates don’t climb dramatically. A lower-risk approach may be to hold onto a high-quality money-market fund that mostly holds corporate debt. Cash would be king — as long as it didn’t involve defaulted U.S. debt.  In truth, though, no one really knows what will happen or what the safe havens will be.

There are other ways of defusing this mindless political kabuki: Take Social Security and Medicare off the table for now. Discuss them separately in a series of expert town hall forums over the next year. Besides, these programs should never have been held hostage in the perfunctory debt-ceiling passage. They are largely self-funded by payroll taxes and merit separate treatment.

The American people, who overwhelmingly support social insurance benefits, deserve an intelligent dialogue on whether all or part of these programs should be cut or privatized under the Republican template. When I talked to a packed room of fiscally conservative older Americans Wednesday night on whether they wanted to see Medicare or Social Security privatized, not one raised a hand.

Wiser heads may prevail, although it’s ironic that shorting Treasuries is not only an uber-cautionary strategy, but a portfolio position held by a key player in the debt talks — Rep. Eric Cantor (R-Va.), the House Majority Leader, at least in his 2010 financial disclosure statement.

Is Cantor merely trying to speculate on inflation returning, which countless pundits have been forecasting for years? Or maybe, since he’s at the center of this maelstrom, he’s cynically hedging his bets.

We’re not playing checkers here. The pieces can break in a disastrous way.

12 comments

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Adding another $2+ Trillion to our $14.8T Debt= greater than 110% of US GDP folks! No wonder our credit score is falling! Big government is the problem, not the answer and honesty now is the best policy!

Posted by DrJJJJ | Report as abusive

The tea party had it right all along!

Posted by DrJJJJ | Report as abusive

The TParty sound like dead-beat debtors – they want the things they can’t afford to be repossessed. What they don’t understand is that in the world of sovereign debt it’s not as easy as taking back the car or house and calling it quits… there are real consequences and Americans are going to have to pay for either with taxation or their way of life – you choose.

Posted by CDN_Rebel | Report as abusive

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Posted by GOP Freshmen Lawmakers Take on Obama Over Debt Deadline – Fox News | Report as abusive

Nationasl sales tax with no exemptions and stop all other forms of taxation at the state and federal levels!! A federal sales tax and a State sale tax and that my friend is all!! Not property,income,social security tax,payroll tax,inventory tax,school tax,road tax,pet tax,captial gains tax, no taxes other than the sales tax. Also impose a 5% or more import tax to encourage us made goods. No property sold to non-us citizens! Let us take back our counrty!! the congress and the president and stole it away from us. STOP KILLING THE USA!!!
A sale tax would create jobs and companies would be encouraged to make more money!! Right now they all spend too much time trying to find ways to hide the money from the tax man!! this will stop all of that..because we don’t tax income, only what you spend!! If you buy something over seas you still have to pay the sales tax when it shows up plus the import tax!! Don’t like it??? BUY USA STUFF!!

Lets get off our butts and get it done!!! I know too much crap to get anything done, so we’ll all go down in flames!!!

Posted by vegasmax | Report as abusive

National sales tax — I haven’t heard that one in a while. If you think you can get it through the House, it’s worth considering. But right now, the Tea Partiers are playing chicken with some nasty consequences.

Posted by johnwasik | Report as abusive

vegasmax, to substitute the revenue from other means by simply imposing a national sales tax, the sales tax rate shall be 70-80%. That is because the sales tax is an effectively a flat rate tax, i.e. the wealthy don’t consume all their wealth and will be in practice excluded from the revenue, hence everybody else will need to pay even more taxes than now. So, you are trying to increase the tax revenue from people who right now have no disposable income anyway.

I support you of course, I make a lot of money and in flat tax case I will pay much much less. My only concern is that when 98% of the population becomes really poor and really hungry, usually it tends to reposes involuntarily the wealth from the other 2% well living. This is what happens in North Africa now – the masses are hungry and they want money.

Posted by Ananke | Report as abusive

vegasmax, to substitute the revenue from other means by simply imposing a national sales tax, the sales tax rate shall be 70-80%. That is because the sales tax is an effectively a flat rate tax, i.e. the wealthy don’t consume all their wealth and will be in practice excluded from the revenue, hence everybody else will need to pay even more taxes than now. So, you are trying to increase the tax revenue from people who right now have no disposable income anyway.

I support you of course, I make a lot of money and in flat tax case I will pay much much less. My only concern is that when 98% of the population becomes really poor and really hungry, usually it tends to reposes involuntarily the wealth from the other 2% well living. This is what happens in North Africa now – the masses are hungry and they want money.

Posted by Ananke | Report as abusive

No more regressive taxes. Regressive taxes are taxes that take a higher proportion of a poor man’s income than a rich man’s. They lead to banana republics and the third world. So no more sales tax. Tax the untaxed money out there, which is the big volume money. Transaction taxes on wire transfers and the purchase and sale of blocks of 10,000 shares of stock. Taxes on first class airline tickets. Taxes on private aircraft. Contributions over $10,000. to political action committees or campaigns. Wine over $50. per bottle. Diamonds 1 carat or larger. This sort of thing. Oh yes. A tax on directors of tax exempt organizations if they sit on more than 3 boards. A 50% tax on contributions to the campaign of a candidate if a donation to the opposing candidate has been made, directly or indirectly. This is in effect a tax on bribes.

Posted by txgadfly | Report as abusive

National Sales tax = poor policy. The poor and middle would be saddled with a very large portion of the tax burden, while the rich would pay a very small percentage of their income to taxes. It is a regressive system. We have a progressive tax system for a reason. People with more wealth have the better means to pay a higher rate of taxes. A person making $30,000 is just happy to get the utilities, rent and transportation paid, then by groceries and clothes. They have little dispoable income. A national sales tax is not income sensitive, and would hit them hard. But a person making $250,000 easily pays their mortgage, bills, and has plenty of cash left over for going golfing and on vacations, ect. They have a better ability to pay taxes than the poor guy making $30,000. But a national sales tax would not hit this person as hard because they are also saving a lot of their money in retirement accounts, ect. But the poor guy would use up all of his cash paying for needs, and the sales tax would only make that burden heavier.

The only people I have heard promote a national sales tax, and eliminating all other taxes are those that have a very comfortable income, or have either not thought it through, or not educated enouph about it to understand what they are condoning. A national sales tax is a bad idea.

Posted by neeros | Report as abusive

It sounds like those who oppose a national sales tax, are saying that people who make more than $250,000 a year don’t spend money on their fair share of goods and services? Folks smarter than me have researched the NST issue and determined that a 23% NST applied to all goods and services would produce the necessary revenue to run the Govt. Check out: http://www.youdebate.com/DEBATES/TAX_NAT IONAL_SALES.HTM?survey. Sounds fair to me.

Posted by jdorisco | Report as abusive

The National Sales Tax would actually be a progressive tax – taxing the wealthy more than the avg. American. See- http://www.fairtax.org/site/PageServer

Posted by jdorisco | Report as abusive

[…] coming years and will expect the Medicare and Social Security services to which they feel …Debt ceiling & dumber: No safe haven for your money?Fiscal hawks choose wrong target for cutsDebt Ceiling: Groping for Clarity – Posted in […]

Posted by Your Share of Uncle Sam’s Debt: $534000 – NewsMax.com | Report as abusive

jdorisco, you believe the fairtax lies because you don’t understand the meaning of a progressive tax. While it’s true that a rich person under a flat tax pays more in dollars than a poor person, he pays less as a percent of his income than the poor person. Why? Because most rich people save or invest more of their income than they spend.

The true definition of a progressive tax is that the rich pay a higher percentage, not just a higher amount, than the poor.

We like to say our current tax code is progressive, and it was nominally intended to be progressive. But it’s not because there are so many loopholes for people with choices about where there money goes. (The rich have many choices, the middle class have some choices, the poor have few or no choices.) The loopholes were made (really to protect the rich, but nominally…) to create an incentive to invest. Examples of such incentives are the mortgage interest tax credit and the low tax rate on long-term capital gains. Both were supposedly created to encourage “good” investment by private citizens and small businesses. But the very rich and major corporations and hedge-fund managers and others use these mechanisms to end up mostly being taxed at 15% (capital gains) instead of 35% (marginal tax rate on personal income over about $300,000/year).

Ways to balance the budget painlessly and fix entitlements:

1) charge FICA, with no cap, on all income including capital gains, with a reasonable threshold (e.g. above 500,000) on the latter to avoid discouraging home trades.

2) Introduce another income tax bracket, taxing marginal income beyond $1,000,000 at 50%.

3) For capital gains above the $500,000 threshold, tax at a higher rate (25-20%) unless the asset is held for a significantly longer time, say five years instead of 2. The threshold could be slightly higher, like a million or two, for small corporations. Or there could be a sliding scale, where the rate continued to drop the longer the asset was held.

This would increase revenue from the wealthy without harming the middle class or small business (as eliminating the mortgage interest tax credit would do), and encourage businesses to focus on longer-term investments rather than quick profits.

What it would NOT do, despite what the wealthy SAY, is discourage investment, period. Entrepreneurs and corporations exist to invest. They will continue to do it as long as the playing field is level. Government incentives should reward hiring, not profit-taking.

Posted by martimr1 | Report as abusive