The green ceiling: debt, the dollar, and portfolios

The green ceiling: debt, the dollar, and portfolios

US political turmoil and debt

On occasion a relatively obscure administrative matter can become dangerously politicised. The ongoing US debt ceiling negotiation is a case in point, an issue which is now beginning to hit the headlines in the mainstream media.  

To say that the United States federal government owes a lot of money is an understatement. The sum involved is so huge that it borders on incomprehensible. According to the US Treasury itself the figure is just shy of $31 trillion, a trillion is one million, million. We have now reached the point that in order for the federal government to borrow any more money, congress is required to authorise it. One can see why the situation could be emotive in more cooperative times, but in the prevailing political climate in Washington it is toxic. In addition, there is an election next year, so the stakes are particularly high.   

If the democrats and republicans cannot agree to give the government, technically the treasury, the authority to borrow more money there is a chance the US could default i.e., not pay those to whom it owes money, which is just about everyone. It is easy to see why financial markets and the Dollar in particular will react badly to this.

We have experienced this type of brinkmanship before in 2011 and ultimately it was resolved, albeit at the very last minute. It seems ridiculous that congress would do such damage to the credibility of the United States, especially at moment of such economic and geopolitical uncertainty. Nevertheless, monumental feats of self-harm are not without precedent. Whilst serious and if not resolved shortly is likely to lead to volatility, our tactical response would be to take advantage of any weakness. After all, will the competitive position of a leading US business really be impacted by whether the government pays what it owes?!

The privileged position of the US Dollar

The debt ceiling negotiation is one symptom of an underlying imbalance in the global economy that is likely to unwind sooner or later. The Dollar is very expensive in comparison to other leading currencies and has grown steadily dearer since 2008/2009. There are good reasons for this premium, including, more favourable interest rates, an explosion in global trade in which Dollars are the preferred currency of exchange and a booming US stock market. The Dollar has only been more expensive on two other occasions, and the subsequent realised returns in the following years versus other leading currencies was poor.

It is worth remembering that a currency is simply a means of exchange. They aren’t productive assets in the sense that a shares or a property is, and they aren’t generally anchored to anything tangible such as gold anymore. A Big Mac in one country shouldn’t rightfully be twice as valuable to a consumer in the next. This is a simplification of course but the general principle is sound.

The implications of a weaker Dollar for the portfolios we manage are noteworthy and it we discuss these frequently at our investment committee meetings. A weaker Dollar benefits certain investments and we will look to include these in portfolios where appropriate. In the meantime, we hope that democrats and republicans can agree a way forward sooner rather than later.

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