Real Wealth #260 05/18/2010
Financial Markets Still Impacted By Legitimate Fear
The U.S. stock market struggled yesterday to stave off another 100 plus point drop to finish the day positive by a few points. Meanwhile the Euro hit a fresh 4 year low against the U.S. Dollar. (See my update #879 on the dollar, Gold and Oil from earlier today.)
Fear over a possible collapse and or breakup of the Euro remains of great concern to investors, bankers, investment managers and for that matter, governments and the central banks worldwide despite the Greek bailout and the $1 Trillion European rescue fund agreed to last week by Europe's dominant powers. The bailout wasn't so much about saving Greece but saving banks all over Europe that would be hit hard by a Greek, Spain, Portugal and other European Union defaults.
Don't let anyone tell you these events in Europe aren't important; they are. A collapse or breakup of the Euro would be an enormous financial setback and would likely disrupt the financial markets all over the world, much like they were disrupted the world's markets back in October of 2008 and March of 2009. Yet, while the danger for the Euro is tremendous, the danger here in the United States, despite the rally in the U.S. Dollar, is much greater going forward.
The International Monetary Fund released a report showing that under the Obama administration’s current fiscal plans, the national debt in the US (on a gross basis) will climb to above 100% of GDP by 2015 – a far steeper increase than almost any other country.
The impending sharp rise in debt around the world and here in the United States is enough to scare any clear-thinking investor; but it gets worse. One of the International Monetary Fund key findings in today's report is that the government financing needs of many advanced economies not only “remain exceptionally high” but the need to refinance maturing debt is imminent. Japan will have to sell debt equivalent to 64% of GDP this year in order to rollover maturing debt (54% of GDP) and finance new deficits (10% of GDP). The United States comes in second, needing to sell debt equivalent to 32% of GDP in order to rollover maturing debt (21% of GDP) and cover new deficits (11% of GDP).
While the troubled economies of Great Britain and Europe are in the spotlight today, the truth is our enormous debt has a much shorter average maturity. According to the IMF, the average maturity of US debt is only 4.4 years. Portugal, Italy, Ireland, and Spain have maturities that are about 50% greater (from 6.2 to 7.4 years), and the UK is almost three times as long at 12.8 years.
The short maturity of US debt is a blessing in the short run, since we can finance at lower interest rates. But it also poses two risks in the long-run: greater exposure to interest rate increases (if and when they materialize) and a relentless need to ask capital markets to rollover existing debts.
In short, the credit crisis and resulting economic crisis is not over. This may well explain why the price of gold continues to rise, hitting new historic highs in recent days, even as the dollar has been rallying. It is also the reason I recommend holding at least 15% of your investment portfolio in physical gold.
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