Your Sovereign Debt Crisis Survival Guide

Published in Investing on 31 May 2011

The global economy is far from healthy, so should you prepare for the worst?

The financial crisis is entering a new, dangerous phase. But while it is risky to try to predict what will happen next, this does not mean that you cannot take steps to protect your portfolio, or even to enhance it, during the turmoil ahead.

The snowball effect

Let us take a step back and consider how the crisis has unfolded so far. 

It started during the summer of 2007 when some investment funds that owned subprime securities collapsed. From there, the crisis moved on to banks, including Northern Rock (September 2007), Bear Stearns (March 2008) and Lehman Brothers (September 2008). 

After the banks came countries: Iceland (October 2008), Greece (May 2010), Ireland (November 2010) and then Portugal (April 2011). 

Although the underlying causes were different, the fundamental problem was essentially the same in every case: these funds, banks and countries were simply insolvent.

Lessons so far

We cannot predict the future, but two conclusions emerge from the story so far: 

  • the entities collapsing under the weight of their own debt are getting larger, from funds, to banks (of increasing size) and then to countries (again of increasing size); and 

  • there is no evidence that any government or institution is on top of this crisis, or able to stop it. We do not know whether this pattern will continue, but we have to assume that it might.

It's not just the peripherals

If Greece defaults on its debt, as is now widely expected, a similar move may follow in Ireland or Portugal, two countries which also face decades of painful, grinding austerity if they are to repay their national debts the hard way. 

Rising yields on Spanish and Italian debt suggest that concerns about repayment are spreading further afield. But Spain and Italy are not the end. 

The national debts (including off-balance-sheet liabilities like unfunded pension and healthcare promises) of both the US and the UK are also far higher than the 90% of GDP threshold at which national debt is considered to become dangerously unsustainable.

Strategies for survival

Here are five suggestions for surviving the next phase of the financial crisis.

1. Diversify

Dollars may go up tomorrow, or maybe equities, or gold, or commercial property, or farmland. The markets are still driven by fear, and will continue to gyrate wildly depending on which asset class is perceived to be the safest at any particular moment. 

Maximum diversification should help avoid a wipeout when the next panic sets in.

2. Seek liquidity

Many recent crises, like the Irish and Portuguese bail-outs, were flagged some weeks ahead. Future crises may also be preceded by a period of increasingly loud warning signals. 

If your assets are liquid then at least you have a shot at moving them out of harm's way before the hammer falls. 

If not, for instance if your assets are tied up in land where transaction times are measured in months rather than minutes, you will be much more vulnerable.

3. Avoid assets tied to countries at greatest risk of default

Historically, defaults by countries have been followed by collapsing property prices, recession and currency devaluation. Each of these will hit foreign investors particularly hard. 

As foreign investors cannot vote, expect the same to happen in the future as well.

4. Think the unthinkable

The crisis has already reached a stage unthinkable even a year ago; why should it stop now? 

The US may default, if only for a few days; Spain may require bailing out; Greece or even Germany may leave the Euro; or something else of equal magnitude might happen instead. The only thing we can be certain will not happen is the Rapture.

5. Be prepared for another credit freeze

If a Western country defaults, expect a temporary panic and possible freeze on future lending as markets and governments rush to assess where the losses will finally fall.


Lastly, watch out for inflation. Countries which issue debt in their own currency, like the US and the UK, are less likely to default openly on their debts as they can simply print the money required to pay them off. However, they may not be too concerned if higher than average inflation eats into their debt for a while. 

Inflation is generally much more acceptable politically than other forms of default, but it is default all the same

Am I being too gloomy, or perhaps even too optimistic? Let me know in the comment box below... 

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The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

malcolmtbm 31 May 2011 , 5:49am

in reference to your "Rapture" you didnt!!!

diddyda 31 May 2011 , 8:27am

Too optimistic I am afraid. No-one seems to have the political clout to take the axe to the unbelievable waste that exists in all areas of government. This coalition is a million times better that the last shower, but the so called cuts are only cuts to the increases in expenditure. The amount of borrowing is still going up. Madness.

We are even borrowing money to give to others in debt (probably less debt than ourselves). When will governments wake up to the fact that they don't have any money. It is our money they bribe us with and then continue waste on bailouts, grand gestures and self-indulgence.

Yesterday (Mon 30th May) was tax liberation day. For the average person in the UK we have been working to pay our taxes up to this point. Today is the first day this year we get to keep any money for ourselves.

CunningCliff 31 May 2011 , 2:50pm

Pain deferred is very different from pain endured.

Likewise, you can't solve a solvency crisis with liquidity measures.

We are in 'the eye of the hurricane' and serious consequences still lie ahead!

Cliff "Doom and Gloom" D'Arcy ;0)

CunningCliff 31 May 2011 , 2:52pm

Also, for some countries, notably Spain, Greece, Russia and others, defaulting on their debts is the norm and not the exception!



tru2me 31 May 2011 , 2:53pm

Th global playing field for national debt has never been level.

Printing money as has happened in the largest single old economies of the US, UK & Japan is in effect moving the goal posts.

The US is starting another new way of doing the same thing.

Raising their debt ceiling. Or raising the level of their own sovereign debt to abate international financial penalties.
Whatever they might be?

The greenback being the global benchmark currency used to value most commodities.
Even gold a hedge against currency is valued in dollars.
Puts the $ in what seems like unapproachable territory for Standard & Poor to dare to re-rate, though they recently hinted.

Who actually is in bed with the dollar?
Guess we all are.

curedum 31 May 2011 , 6:10pm

The crisis you can see coming is seldom as calamitous as one which strikes without warning. For example, the Lehman Brothers collapse was particularly damaging because the markets had assumed that the US government would rescue it.

Anyone care to give an ideal asset allocation to best survive the present uncertainties?

F958B 31 May 2011 , 9:48pm


I would guess that the closest thing to an ideal asset allocation might be similar to the "Permanent Portfolio", which has an equal split across asset classes (cash/bonds, gold, equities).

Perhaps something like the following is worth considering:
Gold: 20%
Fixed-rate bonds: 20%
Index-linked bonds: 20%
UK equities: 20%
Overseas equities: 20%

Like the equities; the bonds could be spread across more than one government/currency (e.g. a mix of UK Gilts, German Bunds and US Treasuries).

It pretty much has all options covered, without being overly exposed to any one government or any one asset class.


My own portfolio's allocation is roughly 25-30% precious metals and 70-75% "low-Beta, non-cyclical" equities with a broad spread of currencies contributing to their revenues.
I have only a few percent cash (but lots of final dividends due very soon which will push cash balance up to 5-10%). I hold no bonds and no property (other than main residence).

My reasoning is that if we see a serious currency crisis/default, cash and bonds will be severely hit, while the precious metals will soar; 25-30% of my portfolio would probably double within a matter of months and offset a severe decline elsewhere in my portfolio.
On the other hand, if we endure a long, slow, disinflationary slump (without any defaults, as per Japan), the relatively stable revenues and good dividend yields of non-cyclicals should hold up much better than most. I'd fancy Tesco or Imperial Tobacco to manage to continue paying a good dividend, even in mildly deflationary times (we won't have severe prolonged deflation; governments will see to that).

Regardless of whether we see inflation, deflation or disinflation, the low rates available on cash or bonds seem inadequate to compensate if we see a default/devaluation/inflation. Rates have basically priced-in disinflation or mild deflation. Ultra-low bond rates have left no room for inflation in the medium term.
Even inflation-linked debt won't offer protection from a government that choses to default.

DouglasMansion 01 Jun 2011 , 9:12pm

I believe we face another crisis of the banks - of solvency, and then of liquidity.
I read today that a high proportion of "new" mortgages are just renegotiation of old as interest-only, a forbearance by the bank. But the banks have bad debt provisions of less than 1% of the mortages outstanding, comparing poorly with the American provisions of more than 5%.
When interest rates rise to a realistic level, as they must surely do, many borrowers will default. The banks will suffer another balance-sheet crisis, and the value of property will plummet due to so many repossetions on the market as forced sales.
I don't know what to do to ward off this. Emigrate, before it happens.

DouglasMansion 01 Jun 2011 , 10:18pm

Correction! If you read today's Telegraph, front page:

UK banks have bad debt provisions of £1.2billion for mortgage debts totalling £1.3trillion. That is 0.13%.

US banks have bad debt provisions of 9% for their mortgages.

Our banks are mad, learned nothing.

RobinnBanks 02 Jun 2011 , 8:11pm

Also in the Telegraph:
there were few buyers of gilts recently - except the banks, who bought billions of pounds-worth with the taxpayers' cash they were given to bail them out!
Just using what was left after paying their bonuses from our cash!

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