In response to our question, “Did the Housing Bust Fuel the Consumer Spending Binge?” Taipan Daily reader Mike writes:
Just a quick additional thought on the [consumer spending binge piece]. California actually encourages strategic default. Homeowners in California are not personally liable… So, if the house is worth only 50 or 60 percent of the amount of the mortgage, which is not uncommon, the owner just walks away. I know a couple of people who’ve done this. What is surprising is that more people haven’t done this. Of course, it eventually kills your credit rating.
Mike
Marina Del Rey
Yep. Trashing the credit rating thing is the thing. Maintaining a good credit rating used to take precedence. Now it doesn’t matter for a hill of beans.
Ironic, too, in that the U.S. government is working from the same playbook…
One of the dominant themes of the past few years has been a massive private-to-public debt transfer. When the government decided to bail out the banks, it essentially committed trillions in taxpayer dollars (via purchases, backstops and guarantees) to soaking up toxic assets. The same logic applied to propping up the housing market.
The thing is, even Uncle Sam has a credit rating to maintain. In order to keep the party going, the United States relies on hefty foreign purchases of dollar-denominated debt. The more debt that America piles on, the less attractive that debt becomes.
This is why your editor finds it sobering, and frightening, how cavalier investors seem to be when it comes to rising debt costs. It is not just strategically defaulting homeowners who have elected to “kill their credit rating” for the sake of short-term relief. The most powerful government in the world is doing it too.
Deadly Debt Service Costs
The U.S. relies on low interest rates to keep its debt service cost down to a reasonable level. (To understand what this means, imagine a household with $5,000 a month in income and $1,000 a month in interest rate charges on all their credit cards. That balance would represent a “debt service cost” of 20%.)
Once debt service cost hits a certain threshold relative to income, the heavy debtor passes the point of no return – making de facto bankruptcy all but guaranteed. This dynamic holds true for countries as much as individuals.
That’s why breakouts like the one above are no laughing matter. When government bonds fall in value, interest rates rise – and so do debt service costs.
Were foreign investors to start selling large quantities of U.S. government bonds (or simply to go on an extended buying strike), long-term interest rates would skyrocket. That would throw the economy into turmoil.
Were a fiscal catastrophe like the above to unfold, though, the United States would still avoid technical default. There is no need for that, ever, because the Federal Reserve can always technically meet U.S. obligations by printing more currency.
This is why, for countries that borrow heavily in their own currency, the real threat is not the more traditional understanding of debt default. It is outright currency collapse.
In a time of debt crisis, in other words, the logic goes like this: “So there’s a debt crisis because no one is buying our bonds? Fine, we’ll buy ‘em back ourselves with freshly printed dollars (or sterling, or euros, etc). So now there’s new panic because of all the forex paper we’ve flooded onto the market? Too bad… that’s someone else’s problem, not ours. Nobody forced them to honor ‘Federal Reserve Notes’ after all.”
Protecting Against Currency Collapse
If you live in a heavily indebted Western country, currency collapse is a genuine concern. If the private-public debt load gets to be too heavy for an economy to bear, rampant currency debasement will inevitably be the politicians’ chosen way out.
And so, whether your primary savings account is denominated in dollars, pounds, euros or something else, you have to think about the “weapons of mass financial destruction” – i.e. rows on rows of printing presses – owned by your respective central bankers, and the government’s willingness to use them.
Now, we could spill a lot of ink talking about “collapse mitigation strategies.” In fact, we could have an entire multi-day investment conference built around the theme, with multiple experts outlining the various escape routes in great detail.
Today, though, it makes sense to just cover a few basics, to help get your mind wrapped around the subject.
Collapse Avoidance Strategy #1: Foreign Bank Account
This is a very simple idea, but one that takes a little bit of doing to execute on. If your main concern is a bad currency, one direct step you can take is holding your cash in a stronger, sounder currency.
You can do this by opening up a foreign bank account and transferring a meaningful chunk of savings into it. Or, alternatively, you can make use of a bank (such as EverBank) or brokerage option that lets you manually adjust the currency mix.
Personally speaking, I bank with EverBank (among others) and trade with Interactive Brokers. I have the option of ‘$USD alternatives’ for my cash in both places. For some, though, a literal foreign bank account will be even more desirable.
Given the risk of eventual capital controls – something that any government will consider in a time of serious enough crisis – having a chunk of capital domiciled in a foreign location could be a wise thing. Our new service, Wealth Legacy Advisory, features expert advice on topics just such as these (opening foreign bank accounts and such).
Collapse Avoidance Strategy #2: ADRs (American Depositary Receipts)
Another useful collapse avoidance strategy involves the use of ADRs, or American Depositary Receipts. An ADR is basically a foreign stock traded on a U.S. exchange. For example, consider Companhia Siderurgica Nacional (SID:NYSE).
SID, which trades on the New York Stock Exchange, is the U.S.-based ticker for a Brazilian steel company.
Were, say, the USD to collapse, an investment like SID might still do very well. Being based in Brazil, with a global roster of clients, SID could see its dollar-denominated value rise stratospherically were the buck to turn to confetti.
There are a number of ADRs representing global companies, headquartered in fiscally sound jurisdictions, that would function as powerful “stores of value” were the currencies of one or more Western nations to plummet. These ADRs could function as useful proxies for cash under the right circumstances.
Collapse Avoidance Strategy #3: Hard Assets
Then, of course, there is the hard asset option. When it comes to paper currency concerns, there is a reason why gold has held its reputation as a store of value for thousands of years.
In short, politicians and fractional reserve lenders have been ripping off the citizenry since Roman times. Gold has been a worthy counterbalance for just as long. And given the right environment, many other forms of hard assets could step up as “stores of value” in the event of major currency collapse. Better to own oil in the ground, for example, than little slips of paper with Tim Geithner’s signature on them.
Collapse Avoidance Strategy #4: The Ultra-Resource Index CD
Last but not least, I would be remiss not to remind you about a special “hedge” product specifically designed to protect against currency collapse.
That hedge product is the EverBank Ultra Resource Index CD. Conceived by the Taipan Publishing Group and created by EverBank at our request, the Ultra Resource Index CD offers a basket of the following currencies:
- Australian dollar
- Hong Kong dollar
- Canadian dollar
- New Zealand dollar
- Norwegian krone
- Singapore dollar
Because all currrency trading is “relative,” the basket of currencies mentioned above will do very well in the event of a Western-debt-fueled forex meltdown. (And, in fact, this basket already has done very well by a number of measures.)
The logic is simple: Instead of owning currencies being printed en masse by countries deep in debt (like Britain and the U.K.), you want to own currencies being issued by fiscally responsible countries with a heavy backing of natural resources and surplus cash reserves.
(I am obligated to add that EverBank pays a small commission to Taipan on sales of the Ultra Resource Index CD. But given that the concept was our idea, specifically crafted to address the needs of readers like you, I think you can see how the arrangement makes sense. To find out more about the Ultra Resource Index CD, click here.)
There is much more to say on this topic, but hopefully this gets you off to a good start. If you have any specific questions or comments on currency collapse and how to avoid it, let us know: [email protected].
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pips from the day’s opening exchange rate to trade at the 1.0062 level and the pair is advancing for the first day this week. Last week, the USD/CAD fell for four out of the five days for over a 150 pip total loss.
record before emerging from the recession in the third quarter of 2009 with a quarterly GDP advance of 0.4 percent.
