The Credit Crunch Won’t Go Away Soon

01/23/2012 6:30 am EST

Focus: MARKETS

David Wyss

Adjunct Professor, Brown University

Right now, US bond markets are safe because it’s the default option, and that has kept US credit safe, but that could unravel if we don’t eventually take strong economic steps, says David Wyss.

We hear a lot about the deficit every night in the news, but why is it important to investors that they follow this news topic? Our guest today is Dr. David Wyss, and he’s here to talk about that. So Dr. Wyss, talk about why investors really should be concerned with the deficit.

The issue is really a long-run issue. In the short run, the deficit doesn’t seem to be causing much problems for the US because interest rates are extremely low. You’re not seeing any sign of tension in the market.

But as debt keeps building up, in the long run, you got to pay it back. And eventually you’re probably going to have to pay interest on it or a rational interest rate…and right now, the deficit level is not too bad relative to GDP; about 70% of GDP, but we’re borrowing 10% a year.

Look at what happened to Greece. Now their deficit is about double ours, relative to GDP, but we sure don’t want to go there.

At what point will it have some dramatic effect on the stock market itself, where we’re actually seeing companies having a difficult time?

Obviously, that is not going to happen until the economy gets closer to normal. At this point, the fact that the government is absorbing too much of the capital doesn’t matter because nobody else wants the capital right now.

But in the long run, when companies get back to investing, when consumers and home buyers get back to borrowing, that cash is not going to be available for them. That’s when you’re going to see the squeeze on the overall economy.

Do you see a time when interest rates will begin to rise and countries who are borrowing our dollars are going to be forcing us to pay a higher interest rate to do that?

Well, they’re already sort of pushing in that direction, but they have nowhere else to go, because where do you send your money? You don’t send it to the United States…do you really want to put it into the Eurozone and risk getting paid back in drachma ten years from now? Japan’s obviously got its own problems, plus interest rates that are even lower than the US interest rates.

So the problem is, the US bond market, the US dollar may be a sick horse, but it’s still the healthiest horse in the glue factory.

What do you see, from the opinion of folks that say we can’t dig ourselves out…that even higher taxes and cutting spending is just not going to work? There’s just no way to get out from underneath this.

Well, that’s silly. Of course you can. You just have to be rational in cutting spending and raising taxes.

I don’t think you can do it just by cutting spending, unless you’re willing to make draconian cuts in Medicare and Social Security, but you can have higher taxes. We have some of the lowest effective tax rates on the planet, and that probably will have to change.

All right. And then finally, how do you see an investor profiting from this? Is there a way to make money because the United States has such high debt levels?

Well, in the long run, probably not, but in the short run, obviously there are things that can be played.

I think to me, a high debt level relative to other countries is going to be bad for the dollar, which suggests that the best play for investors may be moving their money somewhere else and taking advantage of that decline in the dollar when it happens.

All right. Could we do something as simple as maybe a reverse dollar ETF or shorting an ETF?

Well, the problem with doing the ETFs is they tend to be short-term oriented, and they’re often tied up in the futures market. I think in this case, you’re actually better off buying a diversified market basket of shares, of the countries that don’t have debt problems, which right now largely means Asian countries.

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