September 7, 2012: The National Debt and Treasury Safety

The political season is heating up. Rhetoric of US insolvency is a political football leveraged by both parties to push their respective agendas. Some of the politicians might actually believe it, but I suspect some of the smarter ones understand that the whole idea of a currency issuer running out of its own money is ridiculous. Regardless, it is of no political advantage to communicate the intricacies of our fiat monetary system and the institutional arrangements that drive our money creation process. However, if you are trying to make money by managing a diversified investment portfolio, understanding reality is paramount.

Fifty percent of the Permanent Portfolio is comprised of Treasury obligations. Some investors are concerned about the possibility of a US default. They look at the fiscal deficit, debt to GDP ratios, and scratch their heads as they watch Treasury yields plummet. Misinformed pundits label the Treasury market a bubble and wash their hands of their terrible previous predictions. How in the world can yields plummet when our nation's finances appear so bleak?

To truly understand why Treasury bonds are risk free in nominal terms, I highly recommend Cullen Roche's paper which can be found here. I thought about doing my own write up, but Mr. Roche is the main person that taught me the framework and his paper is brilliant and very easy to understand if you are patient. It is the macro economic equivalent of taking the red pill and it might require some serious rewiring of your brain, but it is worth it.

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