Where to hide from the US and China’s growing debt crisis
By Zain Wilson, Portfolio Manager, Old Mutual Investment Group
The escalating debt in two of the world’s largest economies, China and the US, is pushing investors to seek value in unexpected places.
In addition to the usual safe havens like gold, the Japanese yen and German Bunds are gaining attention as global investors search for yield opportunities that can withstand a potential fiscal debt crisis originating from the US or China.
Alongside gold, the Japanese Yen and German Bunds, are among the intriguing options at present.
Gold, as the traditional safe haven, is negatively correlated with broader financial markets, offering protection during significant equity market downturns, and it serves as a store of value in the event of US dollar depreciation.
Japan is in a very different stage of its inflation and interest rate cycle compared to other developed economies and should outperform in a scenario where US rates are capped in a disinflationary world.
It helps to think of the yen as capital exported to the rest of the world; that money is going to start flowing back as US yields get squeezed.
He adds that German Bunds remain a niche investment, attractive due to Germany’s fiscal prudence dating back to the late 1940s.
Global debt has reached $305 trillion, a staggering $45 trillion increase since before the COVID-19 pandemic, according to the Institute of International Finance.
The US holds the highest national debt globally at $30.1 trillion—more than the combined debt of the next four highest-debt nations: China ($14 trillion), Japan ($10.2 trillion), France ($3.1 trillion), and Italy ($2.9 trillion). Furthermore, as the November 2024 US Presidential Elections loom, there is a risk that US debt will become politicised.
Investors are concerned about debt in both economies, but for different reasons.
The typical levers that the US government has used to manage debt include fixing interest rates to control funding costs, reducing spending, and incrementally raising taxes.
The US is expected to respond by capping bond yields and raising taxes, though the latter option is seen as unpopular by the Republican lobby.
China has accumulated much of its debt through the state banking system; however, the returns on debt-funded investments have been poor.
It is important to note that debt and demographics, both historic drivers of China’s economic growth, are now faltering.
Chinese growth is tied to the property market, and the property market depends on long-term demographic trends – as property development cools due to weaker demographics, the entire engine that China uses to recycle capital will stutter,” Wilson explains.
The high debt levels and resultant government actions to address them will have a global impact.
If China is unable to transition away from its current debt-driven model, the growth it has historically contributed to the commodity market and South Africa will weaken considerably.
South Africa faces an additional challenge in that US interest rates are likely to ‘fix’ at levels higher than previously expected—certainly well above the near-zero rates seen during the last major rate-cutting cycle in the early 2010s.
If we end up with higher average rates than we did between 2010 and 2020, it will become more challenging for South Africa to address its fiscal issues; there are limits to how much SA bond yields can decrease.
Higher-than-expected US rates will also reset the entire global cost of capital.
The debt paradigm has also made yield-seeking investors increasingly wary of US Treasuries.
If you look across the market, you are starting to see investors holding zero or close to zero exposure to US government bonds at an unusual time in the interest rate cycle; where they do have exposure, it tends to be very short dated.
Central banks are also rethinking their reserve exposures, which may explain the growing interest in gold over US Treasuries, as gold is less likely to devalue than the US currency.
Given the complex interplay between slowing global growth, escalating debt levels in the world’s largest economies, and the uncertainty surrounding future fiscal policies, portfolio managers must navigate a challenging environment.
As traditional safe havens like US Treasuries become less attractive due to potential fiscal slippage, alternative assets are increasingly being seen as viable yield producers.
Over the coming year, the critical focus will be on how the US and China manage their debt paths and whether they can introduce meaningful reforms or new revenue streams to mitigate long-term risks.
In this environment, portfolio managers will safeguard the assets they manage by staying nimble, being innovative in where they search for yield, and diversifying across asset classes to withstand potential portfolio shocks.
For more information on Old Mutual Investment Group, click here.
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