Friday, July 27, 2012

Perhaps the US is exceptional...

This Time is Different made a very solid point. That is, the opposite of the title. As history shows over and over again when it comes to sovereign debt crises and financial crises, no one is different and no one is exceptional. Everyone thinks they are, which leads to irrational exuberance - "the real estate prices always go up" - then a collapse. Banks, the people who are supposed to be the rational ones about it, are just as guilty as everyone else of this line of thinking.

Reinhart and Rogoff have a very convincing thesis. I bought it lock, stock, and barrel. 

There is only one problem... its not true. We are different. The whole global financial system is predicated on US treasury bills and that has some unique and powerful implications. When uncertainty happens (or the US causes it), then the market usually flocks away from the area of uncertainty and to the world's safest investment - US Debt. 

As David Gordon and Sean West point out, "By mid-summer 2011, bond investors reminded everyone that the U.S. is again exceptional. Despite the games the U.S. played with its debt limit, its failure to do anything serious on deficit reduction and the subsequent downgrading of its credit rating… U.S. borrowing costs remain near historic lows."

Recap: US nearly defaults on its debt, so the world flocks to US Debt.

The nominal interest rate of 10 year for US T-bills is below 2 percent. The US long term inflation target is 2 percent. This means that the real interest rate is negative. Translation: People and countries are literally willing to pay the United States Government to keep their money safe for them. Again, this is even after the US threatened to default on the debt. No other country could do this. No other country would have this opportunity.

It would be some serious gross negligence not to take them up on that offer. Invest in something, or anything for that matter, that has a positive return on investment. It's not as if US bridges are collapsing and schools are in disrepair.... oh  wait...

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