What Will be the Warning Signs that Countries Will Begin to Call in U.S. Debt?

BY Paul Solman  September 7, 2010 at 6:14 PM EDT

Question: What will be the warning signs that countries will begin to call in the U.S. debt? What should investors do to prepare for this eventually? Thank you.

Paul Solman: David Stockman says the first warning sign will be if the Bush tax cuts are revived, instead of being allowed to expire. He says it will mean that Americans are simply not serious about paying for our excesses. It won’t necessarily be countries calling in the U.S. debt, however; the so-called “bond vigilantes” who invest in sovereign debt would presumably begin to unload first. (For a classic example, look up how investor George Soros made a billion dollars betting against the British pound in the 1990s.)

“And I’m a libertarian who believes half of what government does is useless,” he adds.

What should investors DO? As I’ve written so often before, me, I invest mainly in U.S. Treasury Inflation-Protected Securities. But as I’ve also explained here more than once, they’re no guarantee. On top of which, TIPS are denominated in dollars. That means if the dollar free falls, as Stockman expects, it’ll be a lot more expensive to buy things from abroad. Things like oil.

So maybe an investor should be diversified across currencies too. My wife and I do that as well to a modest degree: maybe a quarter of our savings are foreign-currency denominated. When I ran into American economist David Hale recently and asked him the same question you’re asking me, he said 80 percent of his investments are abroad — in individual stocks.

“But then, I’m a speculator,” he said.