With U.S. Treasury debt at $12.3  trillion, and the annual  deficit running near $1.5 trillion, it is dawning on the world that it is impossible for the U.S. government to bring deficit spending under control, let alone repay the trillions it already owes.  With no solution in sight, investors here and abroad are raising the question of the century: could the U.S. government default on its sovereign debts?

It’s well known that government s are notorious for defaulting on debts.  Since 1900, 26 European and Latin American countries defaulted on sovereign debts a total of 100 times, without counting defaults by Asian and African nations.  Greece could be considered the poster-child of outright sovereign default.  They defaulted on government bonds in 1826, 1843, 1860, and 1893, and again in 1932.  Austria has been an even worse deadbeat, defaulting or rescheduling sovereign debts six times in the 19th century and twice in the 20th.  We’re all old enough to have witnessed more recent defaults by Mexico and Argentina.  To most people, however, default by the U.S., the world’s most powerful nation, seems inconceivable.

To anyone who remembers history, it is far from inconceivable:  the U.S. government has a long history of defaulting on its IOUs.  The U.S. first defaulted after the Revolutionary War on continental dollars, the certificates promising payment in silver to soldiers that served in the war.

In 1933 Congress and Roosevelt defaulted on the gold backing of U.S. gold notes and voiced all gold clauses in contracts.  In January 1934 Congress passed the Gold Reserve Act, outlawed gold ownership for Americans, and changed the price of gold from $20.67 per ounce to $35 per ounce.  This one act defrauded dollar holders of 40% of the value of their savings.  In 1968 President Johnson announced that silver certificates could no longer be redeemed in silver, and removed silver from coinage.  On December 31, 1970, President Richard Nixon abrogated the Bretton Woods agreement, breaking the U.S. promise to foreign central banks that they could redeem dollars in gold.

How Do I Cheat Thee . . .
Let Me Count The Ways

Today, while outright repudiation of U.S. government debt is hypothetically possible, it is no longer necessary.  Today’s T-bonds, and T-bills promise only dollars, and the dollar itself promises nothing – not gold, not silver, not oil – nothing.  The government no longer needs to pay off the debt with real goods; it can simply expunge them through monetary inflation.  That’s what it’s doing, and that’s what it will continue to do.

Fortunately, fiat currency inflation is a devious method of default that a sovereign individual can protect himself from, and even profit.

The obvious defense is to minimize holdings of dollars and any debt payable in dollars.  That includes cash balances, and also CDs, savings accounts, and bonds.  Bonds are particularly dangerous because interest rates will rise abruptly and the market value of bonds will fall.  Long-term bonds are atrociously overvalued, and doomed to fall.

Get rid of cash by converting it into tangibles – useful things from copper and oil to razor blades and soap.  Things with ‘utility’ value are the ultimate safe haven during periods of currency depreciation.

Going beyond simple self defense, sovereign investors are already zeroing in on opportunities to profit.  They are wagering that interest rates must rise by shorting bonds on the futures market.  They are speculating that currencies will fluctuate as world governments battle to keep their exports strong.  Finally, they are betting on natural resources.  The earth is a vast, but still finite, warehouse filled with raw minerals.  Exchanging depreciating dollars and overvalued bonds for ownership in companies that acquire, explore, develop and extract those resources is a rock-solid hedge against the sovereign default of governments.

In our portfolio commentary this month, Investment Director Eric Roseman recaps some of our best recommendations in the commodities complex.  Plus you’ll find a new recommendation in this issue from Ashish Advani for a currency that should rise with the rise in the commodity prices.

John Pugsley founded the Bio-Rational Institute
www.biorationalinstitute.com