Monday, April 23, 2012

U.S. Debt is a safe haven?

Stocks are stagnant, oil has settled below its recent high of $107. Even gold and silver seem to have run out of steam. The debt is approaching $16 trillion dollars with no plan to even address the deficit on the horizon. So why are Treasury Securities (U.S. debt) trading at historically low interest rates? Why the big global demand for more U.S. debt? They call it a flight to safety, but what's so safe about it? Why is it more attractive than other investments or other country's debt? Well, it's not because anyone's excited about the prospects for a solution any time soon. It's about our political system and our capacity to get things right, eventually.

 People and companies with large sums of money on hand have to store it somewhere. They want to make sure it's safe and ready to use in better times. Putting it to work right now is not all that attractive as governments are in over-regulation mode at the moment. European countries with debt issues similar to ours are faring much worse in the credit markets. There are several reasons for this.

For one, European countries generally are governed by a parliamentary system. There is no clear separation of the legislature and executive. The executive branch comes from the legislature. They also have multiple parties as opposed to the two main parties in the United States. At first blush, this might seem like it would provide better, across the board representation. That's the theory. In practice it usually means no party gets a clear mandate from the people. A party can come to power with say 30% of the public behind them. Now they have to ally themselves with one or more other parties to form a majority government. This is not a recipe for bold or quick changes.

We also have a Constitution and a an independent judiciary charged with ensuring that legislation adheres to it. It is not their function to decide whether or not the intention of a law is good, but to decide if the mechanism for achieving the intention is permitted under the Constitution. Other countries are bound only by majority vote. Ideas and programs that are short-term popular and long-term disaster have a much better chance there.

What investors are betting on is that the U.S. system will eventually produce a plan that works. There are really only two conceivable outs for our debt problem One is hyper-inflation. However, even if that's allowed to take hold, the American public will not tolerate it long enough to bring the debt down to manageable levels. Inflation may make the math work, but it's also devastating to a large portion of the population. More likely, we will go with a version of cut, cap and balance. Maybe next year; maybe in four years, but we'll get to it. As the saying goes, the government will inevitably do the right thing, but not until all other avenues have been exhausted.

The plan doesn't have to bring the budget to balance immediately. In fact it can be a 20, 30, 40 year or more plan. The only essentials are that the math works, it's feasible and there's reasonable expectation that it will be adhered to. The only way to achieve that last bit is with a Constitutional amendment. Congress can not bind a future Congress. Only the Constitution can. That's another reason the Constitution gives us an advantage over other countries. Even if Europe came up with a grand, bold plan, it can be undone at any time with a single vote.

As messy as our political system is, we are fortunate that our Founders realized that a vibrant economy must be based on free individuals and a government accountable to them. They laid down some absolute rules designed to limit the damage a government can do. We've had bad times, corruption, scandal and gone down some dead ends over the last couple of centuries, but on a net basis, you must admit, it's worked pretty well. It seems global investors agree.