Why a U.S. Default Could be Great for Sovereign Wealth Funds

america2Before getting pied by critics, let us consider the possible benefits of a technical default by the U.S. Treasury for institutional investors. As the U.S. Congress reaches the 11th hour on a budget deal, and investors sit idly by waiting for a decision, television pundits and economists in the United States are voicing concerns ranging from the fall of the U.S. dollar’s exclusive global reserve currency status to a full out economic Armageddon.

At the publishing of this article, Congress in a last minute effort approved the debt ceiling, but these concerns will certainly be revisited again.

Yes, the default would cause widespread and hitherto unknown financial consequences. However, on a global historical scale, it would not be precedence setting.

The last Occidental country to default on its payments was Germany 80 years ago. On May 16, 1933, Germany one-sidedly stopped payments on long-term borrowings. By rejecting crushing debts and reparations, Adolf Hitler was able to strengthen his political power. The result of which is, tragically, too well known. Though we make absolutely no suggestion that Hitler’s uncompromising politics are the direct result of Germany’s default, it is illustrative.

The truth is, if a technical default were to occur, the United States would be in a better position to handle it compared to Greece or Argentina, countries whose economies and resources are not as large or diverse.

France and the United Kingdom have defaulted in the past as well, experiencing less dire outcomes.

Yet, the world is a lot different than in the 1930s; it is more interconnected, and the speed of money flows and transfers have increased exponentially.

What would happen initially?
Global stocks would tank and interest rates would rise, panicked investors would flee from stocks as happened during the global financial crises. But sovereign wealth funds are long-term investors, and they (should) know that stocks will eventually go up – one only needs to look at the average portfolio of a global sovereign wealth fund to see that patience and resolve eventually paid off in equities. Next, fixed income yields would increase, allowing a flood of money back into fixed income instead of chasing riskier assets.

Many money managers predict that the United States would lose its global currency reserve status. Maybe, but would this really be the direct result of a default were it to occur? Or isn’t it a fact that the U.S. dollar as a reserve currency has been on shaky ground for a while now, and the default is merely the proverbial final straw? If the U.S. dollar were to lose its status, would the euro or renminbi be an appropriate substitute?

The truth is, if a technical default were to occur, the United States would be in a better position to handle it compared to Greece or Argentina, countries whose economies and resources are not as large or diverse.

The United States would still be a country with all of its great assets in natural resources, land, innovative technology sectors and higher education. Financial investments would suffer in the short-to-medium term and confidence would be checked, but investors should know better. After all, look at the last western defaulter, Germany, today.

Lastly, avoiding the default won’t result in the collective sigh from investors that pundits think it will. The health of the U.S. economy isn’t a binary demarcated by default or not default. The unfunded liabilities of the United States sit at more than US$ 90 trillion, which includes Social Security, Medicare and now the Affordable Care Act. No amount of congressional bi-partisanship is going to change that anytime soon. Institutional investors need to see the big picture of musical chairs. Thinking any country is “risk-free” is, in and of itself, a risky assumption to make.

Sovereign Wealth Fund Buying Spree – The Benefits
So, yes, a U.S. default would be bad, but in the now infamous words of then Obama chief of staff Rahm Emanuel, “you never want to let a serious crisis go to waste.” As such, the resulting crisis and drop in the markets would be a great time for institutional investors like sovereign wealth funds and public funds to stock up on U.S. blue chip stocks and assets. Great returns are earned when the markets touch bottoms and equities are undervalued out of panic. The technical default would produce such an event and trigger a buying opportunity for giant pools of capital. Thus, for sovereign funds, the real patience wouldn’t be required for watching bitter partisan politics, but for waiting to realize gains in their discounted equities.

Contact the writer or creator of this article or page.
Questions or comments: support(at)swfinstitute(dot)org
Follow on Twitter at @swfinstitute and @sovereignfunds
Learn, Attend and Network: Institutional Investor Events and Summits
Go Back: HOME: Sovereign Wealth Fund Institute

institutional investor investment mandates