Actionable insights straight to your inbox

Equities logo

4 Rules to Survive the Coming Worldwide Debt Default

There are things many countries can do to put things back on track, but most are not politically possible in this fractured world.

Over the last two months I made the case (summarized here) for a coming worldwide debt default/restructuring/financial engineering. Call it whatever you want but it won’t be good.

While I think we have a few years, I see little chance we can escape some kind of painful reckoning which I believe will culminate toward the middle to the end of 2020s. Unfortunately, the opportunities to change course are behind us now.

Yes, there are things many countries can do to put things back on track, but most are not politically possible in this fractured world. It will require a crisis to muster the political will to fix this.

While we can’t do anything about that—and the people who can do something are choosing not to—we can take steps to protect ourselves and maybe even profit from this “train crash.”

Since I started writing about this, many readers have asked for specific advice. I’m somewhat limited in what I can say, both for legal reasons and because there’s no one-size-fits-all approach.

But I can give you some general ideas and rules to follow.

Rule #1: Get Active

The last decade’s generally rising markets have given rise to passive “buy and hold” investment strategies. Why pay a manager when you can get great results for lower cost—nearly free for some index ETFs?

I’ve never been a buy and hold fan. Nobel laureates who say it’s the only way to succeed in the long run are right about the numbers. But they are wrong about human nature.

Any investment strategy works only as long as you stick with it. And most investors don’t stick with holding their investments. They will panic and sell at exactly the moment a bear market sets in. Every advisor/broker has seen it happen.

Ideally, an advisor should prevent you from making rash decisions. But advisors can only do so much. It’s still your money and they have to pull it out of the market if you say so.

That doesn’t mean advisors are useless—a good one can save your bacon. But it should be someone philosophically aligned with you and in whom you can place enormous trust. They aren’t easy to find.

An active manager worth his or her salt will manage risk as part of the deal, and risk management is exactly what you need as we enter the decade of volatility.

Rule #2: Diversifying Active Managers

No one is perfect and neither are active managers.

That’s not a reason to avoid them. It is a reason to use several of them covering different strategies and asset classes. Assembling the right combination takes some skill, though.

It does you no good to have three managers who make and lose money at the same time. That only creates more paperwork. Your portfolio of active managers, so to speak, has to be uncorrelated.

Multiple managers are the core of my personal strategy. I have money allocated to several different managers who use it to trade ETFs. In other words, they’re actively trading a passive portfolio. I think this is an ideal combination.

I also am a strong believer in data rather than human discretion. Don’t give your money to gun slingers who “have a feel for the market.” They will lose their feel right after you invest your money. Trust me.

Also, look beyond the common long/short equity strategies. There are all sorts of interesting markets available. As I’ve written in the past, the “alpha” in long/short equity has evaporated where passive investors simply buy everything. Even the dogs go up.

It’s very frustrating for a value investor, which I consider myself to be. Our time will come, but for now, let’s do something else.

Rule #3: Sell Liquidity

This one takes a little more explanation.

If we anticipate a global debt default, then it’s obvious we don’t want to be a lender. But in reality, it’s practically impossible not to. Even stashing your money in a bank is technically a loan. Your savings account is a liability on the bank’s balance sheet.

Even if you avoid corporate bonds and buy equities, you still might be an indirect lender in case the company leases equipment or real estate to other parties. Those are a form of debt.

The only way not to lend your assets to someone else is to invest in physical, storable property. Gold is an obvious candidate and I think it’s a good idea to own some, but only some. What else can you do?

The answer is to keep lending, but be smart about it.

Maybe you can’t avoid lending or predict whether a debt jubilee will take away your principal. But you can make sure that you earn yields that compensate you for the risk. And the best way to do that is to sell liquidity.

The nice thing about bank accounts, money market funds, and Treasury bills is you can always trade them for something else, with no notice. That is, they are highly liquid.

But we forget that liquidity isn’t free. Your “price” is a lower yield on those assets.

High liquidity make sense if you really do need that money available instantly, but that’s often not the case. People leave cash in money market funds for months and even years. They earn much less than they could by simply buying a three-month CD and rolling it over. There’s no significant difference in credit or interest rate risk. It is simply a lost opportunity—a gift you hand to other parties.

Obviously, you want some liquidity because things happen, but most investors want too much of it. And it cuts deeply into their returns. With very little extra risk, you can increase your return on cash by 1-2% annually.

You just accept lower liquidity on money you don’t need to keep liquid anyway.

You might do even better. In the private credit world I’ve written about (see The Seven Fat Years of ZIRP), it’s possible to earn 300-600 extra basis points in additional yield. Those opportunities are legally accessible only to high-net-worth investors. But they are worth investigating if you qualify.

Rule # 4: Get Radical on Taxes

Woody Brock, President and Founder of Strategic Economic Decision, predicted that our debt problem will get solved with a wealth tax.

Even if he’s wrong, I think the era of lower tax rates on wealthy people is drawing to a close. We had a good thirty years or so, but this most recent tax cut may have been the peak.

However, higher tax rates don’t necessarily mean you pay higher taxes. We’ll just have to get more creative in the business and lifestyle changes we’re willing to make, within what the law allows.

For instance, there are ways to use life insurance to defer your taxes. And there are very low cost annuities (as in $20 a month) in which you can control the investment and defer your capital gains until you sell. It’s just as liquid as a bank account, but tax-deferred.

If you own a small, privately-held business without many employees, consider setting up your own defined benefit plan. You can control the investments and place a lot more money into the plan than with a traditional IRA or 401(k). I know people with several of these.

Join hundreds of thousands of other readers of Thoughts from the Frontline

Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.

A weekly five-point roundup of critical events in the energy transition and the implications of climate change for business and finance.