Two disturbing reports came out of Washington last week.  Both are linked to Donald Trump’s attempt to recast his failure in handling the coronavirus threat as being the result of a sinister plot by China to hurt the US.  I’m not sure that saying you’ve been tricked by China into ignoring world health officials is any better than just having ignored them, but…  Trump is, in his usual 1984 style, spewing disinformation and silencing civil servants who want to tell the truth.

As a human being, the key issue is the many thousands of Americans who have died because of his negligence.  From a near-term stock market point of view, though, what’s more important is the cover-up, being expressed in Trump’s desire to “punish” China for COVID-19.

Two actions are apparently being discussed by the White House.  Both are bad.  The second would be devastatingly so.  They are:

–placing new tariffs on goods imported from China, the main effect of which will be to negate some of the stimulus from Washington and slow economic growth

–defaulting on the national debt–specifically, ceasing either to pay interest on Treasury bonds held by China and/or to refusing to repay principal when Chinese bonds come due.

There has been no reaction so far in the Treasury bond market to leaks from the White House about the (to me) chilling prospect of possible default.  I presume this is because the market thinks no sane person would do something so financially damaging to the US …especially when the country needs to issue tons of new debt to finance the huge deficits the Trump administration is creating.  This, despite the fact that Trump did appear to favor a default strategy, as one he employed in his business dealings (btw, a reason no banks would lend him money), in statements he made during the 2016 election campaign.  

The most obvious consequence of default would be that borrowing costs would go up for the US. The dollar would probably decline. Default would also remove Treasuries from some (most?) clients’ list of permissible investments, putting more upward pressure on rates and downward pressure on the currency.  In theory, foreigners would be quicker to abandon the sovereign debt of a defaulting country than locals.  I’m not sure that would be true in this case.  In 1989, for example, a time of budget and trade deficits and an ineffective administration, domestic bond managers were the first to balk at buying Treasuries.

my bottom line:  It seems to me the trial balloons about default being floated by the White House are enough to have shifted the stock market away from the nascent “cyclical recovery” theme back to “flight capital.”

I’m reluctant to raise a large cash balance (hold in what currency?–probably not US$), which would be the right thing to do if I thought there were any chance Trump could carry out default plans.  But I can do some indirect things now. Dollar-denominated variable rate debt (i.e., bank debt instead of bonds) and business models where costs are in foreign currency and revenues in dollars would be toxic in a dollar default, so I’ll get rid of any I have.  I’ve been trimming tech positions recently and buying domestic recovery names.  I’ll stop that for now.  I should also have a list of what I would sell were Trump’s default idea to start to move forward.