Monday, May 3, 2010

We Are All Greeks Now

To paraphrase Maggie Thatcher, "the problem with socialism is that sooner or later you run out of other people's money."  Over the weekend the EU and IMF decided to bail out Greece to the tune of $146 billion dollars in exchange for the pledge of strict austerity measures by the Greek government.   Greek labor unions and citizens took to the streets to protest their impending loss of benefits.  Waiting in the wings are the other PIIGS, Spain, Portugal, Ireland and Italy.  It remains to be seen whether the EU and IMF will put together a loan package to bail all of these countries out of the economic messes their governments have created by promising the citizens generous social benefits and putting off the costs of paying for them.  Does the story sound familiar to anyone who lives in the US?

The modern day Dr. Dooms-- Marc Faber, Peter Schiff, and Nouriel Roubini-- have been sounding the warning on a looming Sovereign debt crisis throughout the world that the heavy borrows will either default on their debt or debase their currencies by printing money.  Greece is the first domino to fall, with others likely to follow.  The EU countries have a unique disadvantage in that they do not control their own currency.  The US is, of course, the largest debtor nation in the world with few backstops other than to inflate its way out of debt through printing money or to cutting benefits (highly unlikely) or substantially raising taxes (more likely). 

If the US government, whose debt is rated AAA by all the rating agencies, were to get a credit score like the average citizen where would they rank? has already taken on this task.  I can't vouch 100% for its accuracy, but given the state of the country's finances, the chart looks reasonable to me.

Even in the Berkshire Hathaway annual shareholder meeting this weekend, Buffett and Munger warned of higher inflation ahead due to the unprecedented government deficits. What's an investor to do in this kind of environment?   In an inflationary environment, with the expectation for higher interest rates, the worst places for cash are in the mattress, in low-yield savings accounts, and in long bonds, all will lose value.  Since I'm a believer in balanced investing, the best places to be are in short-term bonds, inflation-protected bonds (especially in retirement accounts), domestic stocks that can pass inflation through with higher prices for their products, international stocks of countries with sound currencies, and commodities.  The investor has more investment vehicles available to them today than ever before to prepare for a world with higher inflation.  For example, in the area of commodities they can choose from broad commodity futures baskets such as PowerShares DB Commodity Index Tracking (DBC), iShares S&P GSCI Commodity-Indexed Trust (RJI), and ELEMENTS Rogers Intl Commodity ETN (RJI).  Or for those who prefer owning a physical asset, there's SPDR Gold Shares (GLD), iShares Silver Trust (SLV), ETFS Physical Platinum Shares (PPLT), and ETFS Physical Palladium Shares (PALL).

Whether the inflation scenario due to high deficits plays out or not only time will tell.  But in my opinion, investors should hedge for the possibility.


  1. I love the quote by Thatcher in your opening. It appears to be sadly true.

    I wonder how the Chinese will react to the US devaluing its currency. And I wonder if the EU will end up doing so as well--how could they keep a strong currency if the dollar is devalued??

  2. Thather's right of course but it takes a long time when you can print money out of thin air. The Greeks don't have that option. The U.S. has dodged a bullet thus far because of low interest rates keeping the interest expense on the national debt fairly low.
    If the Fed keeps holding rates low the blow-up will be swift and massive and sooner than expected I think.