I’ve thought a lot about how US government deficits are going to affect financial markets in the future, specifically the money I put aside to retire on. Here’s my basic fear/expectation: the US government will be unable to control entitlement spending and the commercial sector unable to control balance of trade, leading to more USD denominated bonds and currency being held by foreign investors. Simultaneously we’ll see a growing disparity between Americans who save and those who don’t – savers will have lots of money and non-savers won’t have much at all or have negative worth. What we’re left with is a narrow class of asset holders (foreign investors and a minority of Americans) and a large group of non-asset or net liability holders (the US government and the general public).
Since the US government controls how much currency is printed it’s pretty easy to think that they’d be willing to print more to control deficits. If the majority of voters are not asset holders, the treasury can get away with this since they’re basically ripping off foreigners and the minority of “wealthy” Americans to dig the government out of it’s spending hole (in other words, playing by the rules of a democracy).
What should you/I do to profit if this scenario makes sense? I’m kind of exploring a practical way to short-sell long dated treasury bonds (basically putting me in the same economic position as the US Government). If nothing else I’m trying to stay invested in diversified equities, which will hopefully hedge against inflation much better than holding cash or bonds.
What’s keeping this from coming to fruition? Maybe political pressure in the US to keep nominal interest rates down, which you can’t do if you’re inflating the currency printing more money. Most consumers aren’t going to be happy when mortgage and credit card rates jump, even if they profit on balance from the reduced value of their fixed rate liabilities. Another hindrance could be US political will to keep the dollar as a global benchmark currency, something it couldn’t do if it were to willfully inflate to avoid debt repayment. Finally, although probably least likely, we could see a new age of government fiscal responsibility and/or sharp organic growth in tax receipts from a strong domestic economy.
PS – if anyone has seen/done an analysis on how much of this year’s runup in stock prices is a factor of dollar devaluation I’d be interested in seeing it. I don’t know how much the S&P 500 companies hedge their forward foreign currency earnings, but assuming they’re generally unhedged (and assuming that they get 30% of their gross margin in foreign currency) it seems like 50% of the increase in large cap indexes could be from currency translation of future earnings per se rather than business fundamentals or the demand growth for dollar denominated exports.