>Hi Won,
>
>In January 2004 the IMF sent a letter to theUS warning it that it was
>nearing insolvency; so I think that's the first step in prevention as
>you pointed out. I'm not suggesting that we'll get to the point that
>the US can't pay it's loans, but it will get to the point where the US
>has to make it's bonds more attractive to buy since we don't save
>enough money to operate ourselves.
I was not aware of this. There is maybe 20 days top out of the whole year
that I don't at least read the front page of the WSJ. I'm surprised this
has not come up as a topic of conversation with my co-workers or friends.
*I just googled this and read that the IMF asked the US to tighten
budgets. I agree that the budget needs to be balanced. But borrowing
rates are really low right now and the US is over borrowing. The analogy
that I use is that a someone goes to an all you can eat buffet. Perhaps
the smart thing to do is eat a normal amount of food. But the best
cost-value is to eat as much as you can while you are there and then go on
a hardcore diet and exercise regiment the next day. The US has typically
always borrowed heavily in economic downturns and reduced the debt during
upswings. This administration might be taking that model a little too far,
but I'm not too concerned.
>As the lender's population ages, and they need more of their own
>money, and they'll decline to lend it to the US. That means the $2 -
>$4 billion per day that we borrow will get a heck of a lot more
>expensive, right? That would mean high inflation.
>
>I think this is what Paul Volcker, former Chairman of Fed, was
>referring to a "crisis" that he predicted would happen within 5 years.
> That is, he thinks monetary policy will have to be significantly
>tightened and than means that US currency will be devalued relative to
Monetary policy has been good. Some people might argue that the rate
increase has been a quarter slow. I don't think Volker would criticize
monetary policy since he was a former Fed Chairman. I think you mean
fiscal policy, which is set by the President. Fiscal policy is how we use
the money. I think President Bush has guided the US out of the recession a
lot faster then was expected. People will moan about deficit but no one
has told me concretely why deficit is bad. Once we hit the good times
again we can pay off the low interest loans.
>say the Yen, Yuan, or Euro. In fact we've already lost about 40% of
>value against the Euro since 2000.
Well, according to currency traders the EURO was undervalued when it was
first adopted.
The USD->EURO rate was .97510 on 1/4/00. Todays rate is .82280.
That means in 2000 $1 qould have bought you .9751 Euros, without conversion
costs.
Today that same dollar would buy you .8228.
That is not 40% but it is a significant amount. I've been tracking the
EUR/USD (for some reason everyone lists it EUR/USD and not USD/EUR, one of
these days I'm going to ask why) movement for about 3 weeks now. The
Eur/USD was at about 1.208. Today it is at about 1.218. I don't know if
this is considered a big move or not.
>So this is the question - if I think the dollar will continue to drop,
>and inflation will spike up, wouldn't I be best off in foreign
>currency? That way I could always trade, say, Euros for dollars, to
>hedge inflation, right?
Inflation is controlled in the US better then any where in the world. On
the flip side of that, Japan out of all the economic super powers, is the
least effective at controlling inflation.
Also buying a EUR/USD contract isn't a hedge in the classic definition. A
hedge is when you purchase an investment product and then buy a similar
asset to offset any loses in the first class. The classic example is
buying ABC stock and then buying ABC put options. The ABC put options gives
you the right to sell ABC stock in the case of a downward movement. So you
don't go broke if ABC tanks. In buying a EUR/USD contract, you are making
a play and not protecting another investment. I'm not sure buying EUR/USD
contracts will even be effective against inflation anyway.
The first thing is to understand what your objectives are. If you are in
government bonds because you need the money when you retire in 5 years. I
see no reason to sell them even in the face of rising inflation. But if
your goal is to make short term money you want to dump all government
bonds. Take a good look at your commercial paper. If you need bonds you
should look into inflation protected bonds. But I read there was a run up
on that so you might not even get the best price on that.
Perhaps the most important point is this. If you are running a macro hedge
fund - you will be extremely conscious of inflation and currency flows. If
you are running a long-short hedge-fund you will be aware of inflation. If
you are running a mutual fund you will know what the inflation rate and
perhaps make a very general strategic decision on how much of the portfolio
should be case. But if you are a retail investor, I'm not sure worrying
how inflation will impact your retirement account will be worth the
time. Your financial advisor should have out pacing inflation as one of
the top priorities and put you in a diversified asset classes to withstand
inflation spikes. If you live in the US, and from your email I gather you
do, be mindful but don't worry too much. Save and try be fiscally
responsible. If you don't take the most optimal strategy but do all the
basics - like having a savings account and maxing out your 401k and not
eating out all the time and not buying a new car every 3 years - it's not
going to cost you a large sum of money. Is it really worth eking out an
extra $10k in your lifetime by micro-managing your personal savings? If it
is going to make a difference, then you should see a professional and not
being taking advice from a stranger on the CF-community list =)
If you are still worried, then my general advise is to sell of some of the
excess bond holding and move that money into equities. I think the
standard breakdown is like 20% bonds and 60% equity and the 20% in other
investments like real-estate. I'm not sure on this so don't take my word
for it. Since we are moving from one extreme to another, maybe you want to
hold a little less bonds and more equity until things move back to the
middle. Shrug. I'm not a tax guy and I'm not a financial advisor. But I
did stay at a Holiday Inn Express last night. Just kidding.
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