Strategies to protect assets from debt crises

 

The world is sinking into debt. According to statistics from the Institute of International Finance (IIF), global debt rose by $1.3 trillion to a record $315 trillion in the first quarter of this year.

Strong debt growth came from emerging countries such as China, India and Mexico, while debt levels in most industrialized countries remained fairly stable. Overall, however, the unsustainable debt situation is once again becoming the focus of financial market players.

High debts after Corona

“For the finance ministers in industrialized countries, 2022 and 2023 were comparatively happy years, as national debt was reduced somewhat in the post-Corona period,” says Mark Valek from the Liechtenstein asset manager Incrementum, who is currently publishing the precious metals report “In Gold We Trust,” which has received a lot of attention on the financial market » published.

But with falling inflation and the subsiding of the special economic effects of the post-Corona period, the “gray everyday life” of structurally increasing national debt is returning. In addition, many countries became particularly heavily indebted with rescue measures during the Corona crisis.

World power USA as a bad role model

Financial market players are paying particular attention to the USA with its high refinancing needs and record-high deficits. Despite continued strong economic growth, the US budget deficit is expected to be 5.6 percent this year and 6.1 percent next year, as the Congressional Budget Office forecasts. “It is shocking that the deficits are so high even though the US economy is booming,” says financial expert Thomas Härter, who has worked as an investment specialist at various financial institutions.

According to Valek, US government bonds with a volume of $11.5 trillion will come onto the market in the calendar year 2024 – this is 50 percent larger than before the pandemic. The financing of the US national debt is likely to leave its mark on the markets. According to the “Global Debt Report” from the international organization OECD, 40 percent of all government bonds and 37 percent of all corporate bonds worldwide will have to be refinanced in the next three years, as Valek explains in his report.

By 2026, around a third of Italian, 25 percent of Spanish and around 20 percent of French government bonds will expire. For the current year, the OECD expects government bond issues worth $15.8 trillion.

Liz Truss’ misfortune with tax cuts as a foretaste?

As long as there are buyers for the bonds, the debt spiral will continue. “If not, things can happen quickly and the financial markets question the sustainability of the debt,” says Valek.

He assumes that the scenario observed in the UK in September 2022 could be repeated elsewhere. At that time, the government under Prime Minister Liz Truss announced major tax cuts, as a result of which 30-year British government bond yields rose by around 1.7 percentage points in three days. This in turn threw British pension funds into turmoil, and ultimately the Bank of England had to intervene to defuse the situation.

He cites the euro debt crisis as another negative example. When yields on bonds from the highly indebted Euro country Italy rose sharply in 2011, the European Central Bank had to buy Italian government bonds on a large scale.

“National debt not accepted indefinitely”

“The financial markets do not accept high levels of national debt indefinitely,” says Härter. “At some point investors will demand higher interest rates or force budget restructuring.” For the USA, this is not expected to happen before the presidential elections this fall. But after that it could be that time. The US government budget is in need of restructuring and if nothing happens, the risk premium for American government bonds could rise.

Is there a risk of structurally higher inflation?

“Historically, a debt cycle ends when debt overwhelms the economic system,” the Incrementum report says. The over-indebtedness will be eliminated through a deflationary debt crisis – like in the global economic crisis of 1929. The current cycle, however, lasts much longer than previous cycles because political decision-makers have access to almost unlimited debt creation. “The core of the problem is the debt-financed monetary system,” says Valek. He expects structurally higher inflation rates as the new normal.

“The high debts are a sword of Damocles that has been hanging over us for many years – but nobody knows when it will fall,” says Ivan Adamovich, head of the family office Private Client Bank. One could also discuss whether it will fall at all. But if the sword is to remain up, Western economies would have to grow much faster in the coming years.

He is also amazed that the debt spiral has continued to spiral over the past few decades and that the financial markets have accepted this comparatively calmly. As an extreme example, Adamovich cites Japan, whose national debt has been at very high levels for decades.

Phase of inverted yield curve unusually long

Meanwhile, according to the family office representative, “weird conditions” can still be observed on the financial markets. An indicator that signals exceptional conditions is, for example, the inverted yield curve that has been inverted for a long time. Since 1980, such inverted yield curves have only been observed in a few cases, and such a long phase as the current one is very unusual, says Adamovich.

He was also surprised that the significant interest rate increases by the US central bank, the Federal Reserve, were even possible in an environment of high debt. One reason why a debt crisis has not broken out so far is probably the hope for a boom era brought about by the AI ​​revolution, he says.

Recently, however, the US national debt has come into somewhat greater focus. “The debt there has risen sharply, and at the same time many countries are becoming less willing to finance the American system,” he says. This primarily refers to its rival China, which is pursuing a strategy of de-dollarization and wants to become more independent of the dollar.

The freezing of Russian currency reserves after the outbreak of the war in Ukraine also plays a role in this context. This has shown authoritarian regimes what can happen in an emergency. “The US may have to think more carefully about who lends them money in the future,” says Adamovich.

What savers and investors should do

Under these circumstances, investing remains challenging. Experts give various recommendations.

Do not use “crisis timing”: For example, Adamovich advises not to bet on the exact timing of the next crisis. This cannot be determined from today’s perspective. Anyone who has geared their investments towards a time of crisis in recent years and, for example, reduced their share of stocks in their portfolio may have missed out on massive returns.

What obligations do you have? “You should always consider what financial obligations you have,” says Adamovich. For investors who calculate in francs, this also means not taking on too much currency risk – at least not when investing in bonds or cash. The risk of losing money due to currency losses is then too high.

In this context, Härter recommends investors to critically examine their dollar quota or to hedge it. This applies in particular to investors from the Swiss franc area. Adamovich also advises not to be blinded by the higher interest rates in the USA. The yields for 3-month government securities are currently 5.4 percent, for 2 years you get 4.9 percent. The case is different with stocks, as globally active corporations are bundles of different currencies depending on their business model and the question of entrepreneurial success is the focus – and not the currency in which reports are made.

Diversification is also important: “The more uncertain the times, the more important diversification is,” says Adamovich. This means spreading your assets across various investments such as stocks, bonds, real estate, raw materials or cash.

To go into debt or not? Ultimately, the question also arises as to whether one should take on more debt in an inflationary environment or not. Ultimately, there is hope that the debt will be “inflated away” by inflation. But this is playing with fire. “When in doubt, in uncertain times, the first thing is to maintain your own ability to act,” says Adamovich. High debt limits this.

Bet on real values: If inflation increases, money and thus also nominal investments such as bonds are devalued. You are probably better off with real assets such as real estate, gold or stocks, especially in the event of higher inflation and in the longer term.