Thursday, May 5, 2011

Can you protect your portfolio against a U.S. debt default?

Thursday, May 5, 2011

You can guard against some catastrophes. If you want to avoid being bitten by a rattlesnake, for example, you can wear sturdy boots, spray yourself with Snake-B-Gon, and limit your visits to snake dens. If you do get bitten, you can carry a cellphone so you can tweet about it.

  • The Treasury Department is urging Congress to act soon on the debt limit ceiling before the nation defaults.

    Karen Bleier, AFP/Getty Images file

    The Treasury Department is urging Congress to act soon on the debt limit ceiling before the nation defaults.

Karen Bleier, AFP/Getty Images file

The Treasury Department is urging Congress to act soon on the debt limit ceiling before the nation defaults.

A default on U.S. debt would be a catastrophe. Can you protect your assets against it? Somewhat. But it's not easy, and the best protection would be to avoid it entirely.

The debt limit sets the amount that Congress can borrow, and it's determined by adding the amount we owe in Treasury securities the public debt and the amount owed to the Social Security and Medicare trust funds. The public debt is $9.65 trillion. The intergovernmental debt is $4.65 trillion. The total is $14.3 trillion.

When the nation hits the debt limit, it can't borrow new funds. This is problematic, because Congress has approved, and the president has signed, legislation that requires spending more money than we take in. In other words, the debt limit is a limit on spending that Congress authorized when it passed the budget.

Those obligations are substantial. According to the Congressional Budget Office, the deficit the difference between revenue and outlays was $830 billion from October through March.

The Treasury estimates the nation will reach the debt ceiling on May 16. By doing some fiscal juggling, it can continue operating until July 8. If Congress doesn't raise the debt ceiling by then, Treasury will face some tough choices indeed.

Without the ability to borrow new funds, Congress would either have to slash spending or increase taxes. Neither option is particularly appealing in a weak economy.

Of the total $1.85 trillion in government outlays so far this fiscal year, $1.07 trillion, or 58%, was for defense, Social Security and Medicare/Medicaid. An additional $123 billion has gone to interest on the public debt. The remainder about $588 billion funds all other government activities, from NASA to janitorial service at the Capitol.

Cuts would have to be so deep that eventually even Social Security recipients and the military might have to go unpaid. In the worst-case scenario, the U.S. would not pay those who own its $9.6 trillion in public debt a group that includes not only foreigners, but U.S. savers, mutual funds and pension funds.

How bad would it be? "Horrible. There's no other way to put it," says Jonathan Lemco, principal and senior analyst at Vanguard. "It would be a tremendous embarrassment for Americans as a whole we'd be seen as deadbeats."

The financial reputation of the United States is a valuable asset. For one thing, it allows us to borrow short-term money for virtually nothing: The yield on a three-month Treasury bill is 0.04%, vs. 12.05% in Brazil.

"We'd lose our status as a reputable place to do business," says Axel Merk, manager of the Merk Hard Currency fund and no fan of U.S. fiscal policy. "And we'd have no access to money." When you have restricted access to money, you have to pay up for it. Merk figures short-term rates would soar to 20%.

The nation's spotless credit record also allows us to be the world's reserve currency the currency that is used in the vast majority of international transactions. Oil, for example, is priced in dollars. If we had to pay for it in, say, euros, we'd not only have to bear the burden of fluctuating commodity prices, but fluctuating currency values as well.

Higher interest rates would mean a slower economy, crushing the already weak housing industry and pushing up the cost of doing business for corporations. "The spillover would be tremendous," says Lemco. "Anyone who suggests it's no big deal just doesn't understand."

What can you do to protect yourself? You could buy foreign currencies, because the value of the dollar would plunge on the world markets. You could avoid Treasury securities and funds that invest in them. You could hoard gold or silver and hope that your local grocery store will exchange canned goods for them. (It might be more efficient to hoard canned goods.)

We can only hope that Congress does, in fact, understand what's at stake. The place to have a national debate on the budget is at the ballot box and during the budget process, not by playing chicken with the nation's good name. The World War II generation dealt with a larger debt relative to gross national product without threatening default. It's the adult thing to do.

John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays; for more of his columns go to His book,Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. John's e-mail is Twitter:

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