WEEKLY COMMENT 17-10-2013
By Barry Edwards
The investment dilemma
The consequences of defaulting on USA government bonds were too much to bear for the politicians and they finally agreed to increase the amount of debt that can be issued by the Treasury. Under the American constitution, Congress has to authorise the amount of debt that can be issued which is done by giving a debt limit that has to be passed in both houses of Congress.
The USA is the only country that has this restriction and that is why we see regular dispute and initial refusal by the opposition to increase the limit without conditions. It has happened many times before and has been as close as this on a few occasions in the past. The justification for this behaviour is that the American constitution intentionally allows Congress to challenge the President on all matters to prevent a concentration of power to a small group of people.
Although the American people are aware of this they do not find the tactics of the opposition sensible or justifiable especially since both houses passed into law the actual reason given for the challenge. What has become known as ‘Obamacare’ is the bone of contention which allows government to subsidise insurance for medical care for many low income earning people. That is why the President refused to negotiate under threat of the condition of delaying the implementation of the programme.
In the UK we do not realise how lucky we are with the National Health Service and do not think that if we are ill we could not get free adequate treatment straight away. In general this is the same throughout Europe although there is some element of insurance in conjunction with free healthcare in some countries.
There are free general hospitals in the USA but they cannot cope with the demand placed upon them and treatment is only provided for serious health problems. The ‘Obamacare’ programme which comes into force next year will allow all Americans to access proper healthcare at a cost they can afford. To Europeans this makes perfect sense but to the conservative leaning voters in America this is socialism creeping in by the back door and they intend to have none of it.
The conservative party, The Republicans, in America believe this is the first step to more European style socialism that the Democrats wish to adopt and they are using all means at their disposal to prevent this happening. This is at the heart of what this wrangling is all about. The Republicans believe this will be the demise of capitalism and should be discouraged at all cost. Unfortunately for them, the people are more of the view adopted by the Democrats and tend to vote accordingly, at least, for the time being.
The concern for the financial community responsible for managing the savings of people is that all this political play affects the belief that American Treasury bonds are the safest investment anyone could hold against all eventualities. The financial crisis queried the safety of European government bonds and fund managers as well as other investors have had to adjust their strategies to allow for the possibility of default on these sacrosanct securities.
The whole structure of the investment world is changing to reduce the reliance on government debt that was the rock of reliability in the past. Interest rates determined the investment decision of fund managers on the amount of this debt they held. Now they have to consider the risk which has changed the nature of the market in government debt in all open economies.
The political tactics that have been employed in the USA and Europe during the recent crisis are having a fundamental effect on investment strategy. Investors have not fully comprehended the effects of this change and only time will tell us the long term consequences and how this will influence the returns on investment. The problem is that the markets in government bonds are very liquid and central banks can intervene to make sure there is not any serious disruption to the movement of prices.
Therefore, the investment strategies of investors looking for other fixed interest securities are limited causing a real dilemma for most fund managers. Low interest rates have made this search difficult enough and the trend to spread investment across the emerging markets has recently been shown to be a risky business.
The alternatives being considered include; infrastructure bonds, large corporate debt and of course the old favourite, property. The first two have small issuance at the moment compared to government bonds and do not have the central banks equalising involvement to prevent rapid price movements. Property investment has been the main cause of most recessions and securitised mortgages are the only alternative at the moment that can satisfy the demand for fixed interest securities.
You get the point, the whole cycle is about to start up again mainly because there is nothing else that can satisfy the demand. The politicians have threatened the safety of government bonds and have been stimulating the mortgage market. One has to think, despite all the talk, we are heading for another real problem sometime in the future. Let’s hope it is a long way off.
That’s all for this week, more comments next week.