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giovedì 28 aprile 2016

Kolanovic: This can eventually result in the devaluation of all currencies against real assets such as gold, high inflation or even outright defaults


Kolanovich (via JPM, via ZH) - Why Is JPM's "Quant Guru" Suddenly Worried About The "Endgame"

(...) However, fiscal measures also bring an increased level of government debt and increased market and credit risk of owning government bonds. These risks are in addition to current low yields and a less favorable correlation of bonds to risky assets. The unfavorable risk-reward of government bonds near the point of zero yields will likely prevent asset managers from increasing holdings of government bonds. If there are no private buyers, governments can still place their bonds with central banks. This trend is of course already in place – for instance, the Fed’s holdings of US Treasuries increased from ~18% in 2008 to ~34% today.

Increased government spending, financed by central banks could indeed create inflation, but will further elevate the problem of debt viability. If investors lose confidence that the debt can ever be repaid, they will reduce their holdings, increasing the cost to governments or inviting more central bank buying. This can eventually result in the devaluation of all currencies against real assets such as gold, high inflation or even outright defaults (as was the case in Greece). If such a trend develops in one of the large economies, it could have far-reaching consequences. 
Once fiscal measures replace monetary measures, we think investors will increasingly focus on the dynamics of government debt and currency valuations, particularly in Japan and the US. 
How can an investor hedge against the risk of these potential developments? One can reduce allocation to bonds and increase allocation to real assets and equity sectors related to real assets. Investors can also move away from bonds that are not backed by reserve assets such as currency reserves or gold. The ability of a government to pay back debt and at the same time as maintaining the value of the currency should be measured by hard assets for which transfer to bondholders is politically viable. For example, during the Greek crisis, the option of selling islands owned by the government was off limits. On the other hand, governments can easily part with assets with no national or cultural attachments such as FX reserves or gold, as was recently the case with Ukraine and Venezuela. (...) 


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