When Foreign Investors Pull Out of U.S. Bonds…

As everyone is celebrating the market at record highs, another record was just broken and no one appears to be celebrating it.

Of course, I’m talking about the fact that the U.S. government debt total has just exceeded $17.0 trillion.

No one should be really surprised, since we continue running deficits each year. This just means that our government debt will continue to climb, with no end in sight.

Government debt totaling $17.0 trillion is a staggering amount of money. That equates to almost $149,000 per taxpayer. Of course, this doesn’t include unfunded liabilities. When you add in Medicare, Social Security liabilities, and a vast assortment of other levels of government debt, the total is well over $100 trillion.

Again, this may not be much of a surprise to our readers, as most of you are aware of our government debt problem; what may be a surprise to many, however, is the continued global demand for U.S. bonds.

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Because we have been able to sell U.S. bonds for so long to investors around the world, this has enabled us to keep spending and to procrastinate when it comes to getting our house in order.

However, I don’t believe this can go on forever. At some point, foreign investors are going to start getting worried that all those trillions of dollars they pumped into U.S. bonds might be worth a whole lot less in the future.

This political circus that we are witnessing in Washington just barely scratches the surface of how much work really needs to get done to solve our government debt problem.

Because the rest of the world is a mess, foreign investors continue to pile into U.S. bonds while hoping that our politicians can actually fix the problem. If you were a large foreign nation with hundreds of billions of dollars invested in our U.S. bonds, wouldn’t you at some point get nervous that you might not get your money back? I know I would be very nervous, especially at these low yields.

We’ve already seen China begin discussing moving away from the U.S. dollar as a reserve currency, and this would mean they could then begin shifting their investments away from U.S. bonds. Even a small, marginal shift would be massive for U.S. bonds.

What disturbs me is that none of these facts seem to worry politicians. They simply care about the next year or two. But piling on ever-higher levels of government debt just means that we are taking wealth from future generations.

If foreign investors do decide to diversify away from our government debt, selling U.S. bonds would mean higher interest rates. When a bond declines in price, interest rates increase (they move in opposite directions).

One type of investment to hedge and profit from higher interest rates is exchange-traded funds (ETFs) that move inversely with the price of U.S. bonds, which means they follow interest rates.

One such ETF is the ProShares UltraShort 20+ Year Treasury TBT. The chart of this ETF below also has the 30-year U.S. bond interest rate overlaid versus the price of this ETF. As you can see, from the summer of 2012, long-term interest rates moved from a low of approximately 2.46% to a recent high of 3.9%. During that time, this ETF moved from a low of $56.32 to a recent high of $82.80

Chart courtesy of www.StockCharts.com

Just a note: many exchange-traded funds won’t move completely in sync, as there are lags and issues over a long period of time. The general idea is to look for ways to add assets to a portfolio that would actually move up if interest rates also increased.

The current $17.0-trillion government debt is just the tip of the iceberg. With over $100 trillion in unfunded liabilities and no real plan to fix this mess, over the next decade, I believe foreign investors will begin to sell U.S. bonds due to an ever-increasing government debt—meaning higher interest rates to come.

This article When Foreign Investors Pull Out of U.S. Bonds… was originally published at Investment Contrarians