by Stephen McPhie, CA
Partner, RSD Solutions Inc.
Forget Greece, Portugal, Ireland and Spain for a moment. Reuters[1] reports that the United Nations warns of a possible collapse of the U.S. dollar. No wonder! And no wonder S&P placed a negative outlook on U.S. government debt! Such public utterances were inconceivable in the very recent past, which indicates just how fast things seem to have got out of hand. The U.S. has hit its $14.3 trillion federal debt ceiling (close to 100% of GDP and close to post second world war levels) and there is now a game of political chicken going on. Some accounting contortions are allowing ongoing funding of expenditures but this can only be very temporary.
The level of spending cuts being mentioned falls far short of dealing with the deficit, let alone the gargantuan mountain of debt. Meaningful tax increases don’t seem to be on the table. Add to this debt at State and municipal level, the demographic time bomb of pension and health care liabilities, etc., and we have the script for a disaster movie. With debt at existing levels, even tiny increases in interest rates will lead to huge increases in interest expense. Currently, U.S debt yields are slightly above those of Germany. However, the more scare stories there are, the more this gap is likely to rise. Canada fell into this trap in the early 1990’s when it found out just how insidious compound interest is – spending cuts were more than offset by year over year increases in interest spending. And the latter cannot be cut. The more it rises, the more spending elsewhere must be cut and the fewer options are available.
Unfortunately, due to the staggering size of the problem, it has the potential to affect almost everyone on the planet but most of us can only look on with astonishment. We don’t have a say in any of this. Foreign currency exchange rates and interest rates have the potential to be very volatile for some time to come.
There is not a lot that we as individuals or companies can do but there are some things. Companies should urgently re-evaluate their foreign currency exposures, even if they have done so recently, and revisit governance and risk management strategies for hedging and mitigating such exposures. They should also examine current and future interest rate / capital structures. It is imperative to have strong handle on these risk exposures and perform extreme scenario analysis.
