FX: The "seeds of crisis" have been planted on Wall Street, and the era of "cash is king" is back?

       Wall Street is likely to view 2023 as a pivotal year and see the agency's move as a wake-up call. The Federal Reserve's fight against inflation has magnified the risk of a fiscal crisis created by decades of dysfunction in Washington. Now,The assets most likely to provide shelter from this storm also now happen to be unusually attractive.

Is cash no longer trash?

        Historically, investors have paid a high price for holding super-safe short-term government bonds. For example, $100 invested in three-month treasury securities in 1928 rose to just $2,141 by the end of last year, while $100 invested in mid-grade corporate bonds rose to $46,379 and $100 invested in stocks rose to $624,534, according to Aswath Damodaran, a professor of finance at New York University.Especially in the years following the financial crisis, there was little return on any short-term and safe investment. 

        Ray Dalio, the founder of Bridgewater, the world's largest hedge fund, was not one to invent "cash is junk," but he was probably one of the most popular quotes of his time. Earlier this year, he changed his tune in an interview with CNBC. "Cash used to be trash, but now it's rather attractiveIt's very attractive relative to bonds. It's actually very attractive relative to stocks. "

        Not only do treasury securities now pay higher interest rates than they did before the financial crisis, but they also pay more than long-term bonds. If interest rates continue to rise, the latter will also suffer greater paper losses. And, as Dalio says, frothy stock valuations make bond returns above 5% attractive.

The growing pressure on the federal government's debt

        But there is a more troubling reason for the cash-as-king approach: while long-term government bonds had the nickname "forfeiture vouchers" in the inflationary 1970s,In times of crisis, long-term government bonds have been the asset of choiceThe 10-year Treasury yield is actually the risk-free rate used to evaluate all other securities

        Now, however, government debt has ballooned in the wake of the war on terror, the global financial crisis and the COVID-19 pandemic. Low interest rates and the Fed's bond purchases mask the pressure: interest costs as a share of federal spending are no higher in the near term than they were in the early 1990s. But the Treasury has barely seized the opportunity to lock in the lowest interest rate by issuing more long-term bonds.

        It may be too late now. Long-term budget projections regularly updated by the Congressional Budget Office (CBO) show that,The U.S. debt held by the public will exceed GDP this fiscal year, and debt interest will be equivalent to about three-quarters of discretionary non-defense spendingBy 2031, this number will reach the same scale 

        Medicare, Social Security and, of course, interest are not legally negotiable, and military spending is not really an option. No wonder the federal government is described as "an insurance company with an army."

        And it got even worse.The CBO's projections actually seem overly optimisticIt expects that while short-term bonds currently yield more than 5%, the net interest rate on these bonds will barely exceed 3% in the coming years.

       The ballooning debt means that small changes in assumptions now have major consequences. Given that about three-quarters of the national debt must be rolled over over five years, assume a 1 percentage point increase in the average interest rate in the CBO's projections and leave other numbers unchanged. This would result in a $3.50 trillion increase in federal debt by 2033. At that point, the government alone would have about $2 trillion in annual interest payments. By contrast, personal income taxes would bring in just $2.50 trillion this year.

       Compounding interest can quickly make a bad situation worse, a vicious circle that has already caused investors to flee countries like Argentina and Russia. Having the world's reserve currency and a printing press that allows it to never default has made things much better for the US, but not without consequences. 

Just letting interest rates rise high enough to attract the world's growing savings might work for a while, but that doesn't mean the stock and housing markets won't be crushed. Perhaps the Fed could step in and buy enough bonds to lower interest rates, thereby reigniting inflation and depressing real returns on bonds.

       But a hard-to-quantify complication of future fiscal tightening is that Washington's room for manoeuvre is limited as interest costs become unsettling, limiting its ability to bail out banks, underwrite vaccines, subsidise cutting-edge technology and even fight wars.A fiscal austerity America would be a country with more economic instability, less international prestige, and ultimately less attractive assets.

       It is difficult to predict when the market will have serious concerns about this, and critics of the federal government's budget have raised numerous false alarms over the years.

       However, for now,FXTforeign exchange representationHolding cash is more attractive than ever.