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Thursday, 15 July 2010

US Debt Downgraded

 China just kicked the U.S. in the proverbial nuts. I hate to say it but we had it coming.

Last month China played the U.S. into leaving it off its list of “currency manipulators.” To show just how grateful they were, yesterday China unveiled its first report on the debt risks of 50 countries. And guess who was ranked below China?

The U.S. of A.! In fact our government debt was knocked down from the best in the world to a pitiful 13th place.

Was it self-serving? No doubt about it. But it’s the truth.  The only thing that’s surprising is that it took this long.

I saw this day coming. I’ve already talked a great deal about the U.S.’s runaway debt with you. Many will say it’s not a problem now. It’s in the future. To them I say the future is now.

The report was a warning to all investors: THE U.S.  government debt market is NOT the safe haven you think it is. The Dagong Credit Rating Company, a professional rating agency in China, says US debt is more risky than Singapore’s, New Zealand’s and Norway’s.

But this is China know, the county that executes a couple of dishonest businessmen a year in the futile effort to tamp down corruption and bribe-taking.
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Can you believe a Chinese credit rating agency?

Or would you rather rely on Moody's, Fitch and S&P? These are the same head-in-the sand agencies that slapped triple-A ratings on subprime mortgage loans. They continue to rate US government debt AAA. Despite the deplorable state of our fiscal situation.

Me? I'm on board with Dagong. And I’m not the only one. In a recent survey of 440 executives from around the world commissioned by Royal Bank of Canada's capital markets unit.... 40% said they expect debt issued from companies will be considered safer than government debt.

Corporates safer than governments? I never thought I’d write those words. But think about it. Would you rather lend your money to a bankrupt organization (the US government) or a company with a strong balance sheet (like J&J for example)? I know where I’d rather invest. You need to take a look at corporate bonds.
More on that later.

Meantime, Dagong was founded 16 years ago to rate Chinese corporate debt. It is privately owned. But Dagong made its announcement on Sunday at the headquarters of the Xinhua News Agency. This is the ruling Communist Party's main propaganda outlet.

Make no mistake. The downgrade of US government debt was made with tacit approval from the Chinese government. Consider it an admonition from our biggest creditor to get our fiscal house in order.
Will we? Not with the pandering politicians we currently have in Washington DC.

One nation under debt

China’s concerns are legitimate. Consider

Our national debt currently stands at $14 trillion. But $14 trillion is just for starters. According to the Federal Reserve we have another $2.5 trillion in state and local debt. Mostly municipal bonds. And according to Institutional Investor magazine nearly every state's pension fund is on the verge of running out of money. A federal bailout is all but inevitable. So tack on another $3 trillion.

But things really get ugly when you add in the government's obligations under Social Security and Medicare. The government doesn’t even take these obligations into account.  They should. Right now those entitlement programs consume around 14% of tax revenues.

In just 10 years these programs will consume almost 1/3 of revenues.  And if things don't change by 2030 it will be close to half. To meet these obligations the US government would have to have $106 trillion on hand right now. How much do we have? Not a penny.

So add on another $106 trillion unfunded liability. So while everyone thinks about our debt as $14 trillion.  The real number is more like nine times that amount.

Consider the words of the former Fed Chairman Alan Greenspan in a recent essay “The federal government is saddled with commitments for the next three decades it will be unable to meet.”

China gets it. Greenspan gets it. 40% of executives around the world get it.

So it’s come down to this. Lined up on one side are global executives and China deeply worried about the debt hole we’re digging. On the other side is the US government (with its deeply indebted European fellow-travelers) still believing that government spending is a good thing

And don’t expect this credit downgrade to change the government’s tune. They’ll call the Dagong downgrade politically motivated. They’ll continue to insist the only way out of this hole is to dig it deeper…more stimulus. 

But the handwriting is on the wall. Interest rates will move up.  Maybe not tomorrow or next month. But the stage has been set. Inflation will be making a big comeback.
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What to do now

Can you take advantage of the growing confidence in corporate versus government debt? Sure. Add corporates to your portfolio. Stick to short maturities and don’t consider anything less than investment grade.
If you’d like help selecting the right bonds I highly recommend Steve McDonalds Bond Trader service.

Finding the best corporate bonds is what Steve does best. He already has an impressive winning percentage of over 97%. Click here to find out how Steve can get you off the stock market rollercoaster and into the new “safe haven” of corporate bonds.

Source: Investors Daily Edge

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