Government Credit Crisis

One of the hottest topics on Wall Street (other than bank bailouts, healthcare reform, and how it looks like we've narrowly avoided the sequel to the Great Depression) has been government debt. It may seem obvious, but the way it works is that governments (e.g. federal governments or municipalities, etc.) issue more debt during recessions. This is generally done to offset the loss of tax revenue due to the slower economy. Furthermore, many economic theories suggest that government spending is a tool that can be used to lessen the severity of recessions. In effect, a government can increase spending to offset the loss of corporate and consumer spending. This is the rational behind the government stimulus package passed earlier this year.

Since this economic downturn has been particularly strong (we avoided the Great Depression Part Deux, but we got pretty darn close), government spending has also increased markedly. This is not only a US phenomenon, but a global one. This debt, known as sovereign debt, has been the source of much concern and controversy. I recently stumbled on a listing of the countries whose sovereign is considered to be the riskiest based on credit rating (countries have a debt rating just like you and I and companies). Check out the slideshow here. Here's the list of the riskiest countries starting by the highest risk.

1. Venezuela - The socialist government set by Hugo Chavez is expensive to manage. Estimates are that the oil rich country needs to have oil prices at at least $100 a barrel to be fiscally sound. Oil's been below $100 for quite a while now, meaning the country's in trouble.
   
2. Ukraine
3. Argentina
4. Pakistan
5. Republic of Latvia
6. Dubai - Many of you may have heard of the recent debt troubles Dubai has been having. Over Thanksgiving weekend, Dubai requested a freeze on all debt payments to its creditors - a rarely performed action. The once booming emirate was recently bailed out (again) by it's Oil rich neighbor, Abu Dhabi. But the conditions are much tighter this time and there's certainly a crisis of confidence that will likely have lasting ramifications.
   
7. Iceland - This island nation was the first poster child for the credit crisis. It defaulted on its debts early after getting caught up in sub-prime investments, and has since been in emergency mode to recover.
8. Lithuania
9. California - Remember when I mentioned earlier that government debt includes municipalities? Here you go. California is the 8th largest economy in the world. When it has issues, ripples ensue.
10. Greece

What's it to you?

So that's all well and good, but you're probably thinking how this applied to investingdecoded readers. You guys are here to learn about investing. Unless you're a government official (and I don't think Tim Geithner reads this blog), you can't really invest off this information, can you? Well, thanks to the world of ETF's, now you can! As I've mentioned in the past, one of the advantages of ETFs is that they give the average investor access to unique investments. The PowerShares Emerging Markets Sovereign Debt ETF (PCY) gives investors access to the government debt of up-and-coming economies. Of course, there's a good amount of risk here because it is focused on emerging markets (i.e. non fully industrialized nations). But a nice 6%+ dividend yield is a good compensation for that.

Bottom line, a lot of countries have been having issues with managing their debt loads. That usually would be an indicator to stay away from Sovereign Debt ETFs. However, being that contrarian investor that I am, I think there's some good value propositions in sovereign debt - big investors are still nervous to get in. This is usually a great entrance opportunity. I think PCY is a great way to play the sovereign debt market while also diversifying away from stocks.


Questions/Comments/Feedback?
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The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.