Category: How to hedge against an increase in the cost of U.S. borrowing? Fear # 1: If the Japanese - who have provided the U.S. with years of cheap financing due to a dismal disinflationary economy, and thus excess Japanese savings over Japanese investment - economy begins to pick up steam, will the combination of increased domestic (Japanese) investment and higher long-term interest rates (which will rise alongside investment, due to long-awaited increases in expected inflation, among other things) cut off the U.S.'s supply of cheap foreign financing? Similarly, once China's middle-class develops, and the country is no longer dependent on its industrial sector, will it begin dumping U.S. treasuries? Fear # 2: If U.S. net foreign debt continues to creep upwards, would foreigners begin to view the U.S. as not being as favorable an investment (on a risk-adjusted basis) as before, thus leading them to put their money elsewhere? Hedges: 1. Japan (EWJ): Japan, at first glance, appears to be a good hedge b/c of the direct affect described above. The fact that Japan has been the largest net capital exporter for past 10+ years further emphasizes this importance. This being said, it is uncertain how the appreciation of the yen that would likely follow such a "stoppage in net capital outflow" would affect the Japanese economy, specifically its export sector. Other possibel flaws to this theory include Japan's large government debt (as a % of GDP), and aging population... If you are worried about these affects, the following "solution" (Pacific Asia) might be more appropriate... Other Possible Funds: DFJ, DNL, DXJ, MJFOX 2. Pacific Asia: This might be where money heads instead of to the U.S. Possible Funds: SASPX, APF 3. India: Yet another place where the money might turn Possible Funds: INP

Category: How to hedge against the "dismal U.S. savings rate"? Note: this applies directly to the "current account deficit" problem as well. Fear # 1: A "negative" savings rate today might correlate directly to lower investment in the future (especially if we receive lower capital flows in the future, which is very likely; also, if lower future capital flows coincide with the basic trend of lower real rates of return earned on US assets, this could prove dangerous). At the very least, it increases our vulnerability to fluctuations in the returns generated by investments currently being made, as well as investments that will be made in the future (thus, the efficiency with which we invest the capital flows we are currently receiving is of utmost importance). Regardless, a reduction in investment would probably reduce the rate of return earned on U.S. assets in the present and the future (compounded reduction in the present + additional problems in the future?), which might trigger all the problems mentioned above and below. If this were to occur, the negative accumulation of net foreign assets (due to "negative savings") would further hinder future income, and thus further slow the U.S. economy, and thus asset returns. However, continued success of the U.S.-turned-global corporation might help offset such an affect, if it were to occur at all. Might I also mention that a housing burst would, in effect, take out the benefits of our current increased investment relative to spending by draining the wealth that has been created. This, too, would likely put American in a tough spot. Fear # 2: see analysis below Hedges: 1.China (ETF: FXI): They are in the opposite situation as U.S. ... they face risks that occur b/c savings are too high. Thus, to hedge too-low U.S. savings, one might as well go with too-high Chinese savings. Other Possible Funds: PGJ, CZH, CYX, DJCH, HXC 2. Japan: Excess savings, as hinted at above Possible Funds: EWJ, DFJ, DNL, DXJ, MJFOX 3. Europe: Aging demographics should lead to excess savings Possible Funds: ADRV, FEZ, EKH, IEV, DEW, DEB False Tell: 1. Russia: although they have realized a federal surplus over the past several years, private savings has actually decreased. Similarly, a fall in the price of oil and/or natural gas would also likely do away with their current CA surplus, reducing its effectiveness as a hedge against the U.S. economy.

Category: How to hedge against the Current Account deficit (continued)? Fear # 1: See analysis above. Fear # 2: As long as the U.S. has a current account deficit, it will need to borrow from foreigners. Although current levels of cheap foreign financing are likely being spurred by the well-known "global savings glut", the unknown future-sustainable-current-account-defecit level will depend on whether U.S. assets will continue to offer attractive risk-adjusted rates of return, among other things. Any decrease in real output, then, would prove disasterous, reducing the real return realized on U.S. assets, while simultaneously leading to an increase in interest rates (due primarily to reduced demand for US assets, which would be a by-product of the lower returns created by a maturing U.S., as well as the savings "deficit"). A combination of increased interest rates and lower real output would likely be accompanied by a higher "natural" rate of unemployment, leaving the debt-laden U.S. economy in a tough spot. Hedge: 1.China: They have a gigantic current account surplus that has reached the point where they're trying to reduce it by increasing domestic demand (which also helps them fight inflationary pressures). They're also one of the few countries with huge current account surpluses that is not tied directly to them exporting oil Possible Funds: PGJ, FXI, CZH, CYX, DJCH, HXC 2.All Asia [ex Australia, Japan] (Fund: PRASX): This is another way to play this, and is more diversified than the just-China option. However, make sure to exclude both Australia and Japan, both of whom also have very large government debts and/or current account deficits (as a % of GDP) Other Possible Funds: MDPCX, SASPX, MPACX False Tells: 1. Canada: Despite exports being greater than imports, a shock to the U.S. economy would likely (greatly) affect Canada's economy as well. A reduction in Canadian exports (which make up about 35% of their GDP) and Canadian GDP would likely follow such an occurence. 2. Mexico: see above...

Category: How to hedge against future healthcare and pension liabilities? Fear # 1: Ties in with all the subjects discussed above. In reality, this is the greatest problem. If there were no future pension and healthcare liabilities, one would not see the current account deficit or the "dismal" savings rate as being as big of a problem. Our ability to grow out of these future healthcare/pension liabilities likely lies with our ability to continue to receive cheap foreign financing - and thus depends on the real return that can be earned on U.S. assets. Also, in regards to the current health care and pension system, the U.S. needs changes to be made. Hedges: 1. India (ETF: IFN): The average age in India in 2020 will be only 29 years. Thus, no pension worries in India. IFN has a good portfolio manager with a long-term track record, and is currently selling at a discount to NAV. Although I believe India to be the best long-term hedge against this, their current economic status (trying to slow growth, fight inflation) is a little troublesome. So is the fact that the country is so reliant on financial inflows into their equity market, rather than on foreign direct investment. Thus, over the short-term, one should think carefully about the possibility of a pullback. Long-term, though, India is a terrific growth story... Other Possible Funds: I also like INP 2. China: They don't even give their people free health care or pension payments. Thus, this isn't even a problem there. That being said, the average age in 2020 will be 37, just like in the U.S. Possible Funds: PGJ, FXI, CZH, CYX, DJCH, HXC

Category: How to hedge against the diversification/depreciation of the dollar? Fear # 1: Diversification of the dollar leads to faster-than-expected depreciation, reducing the returns foreigners earn on U.S.-based assets, and thus leading to further diversification away from the dollar. In addition, the possibility of increasing inflationary pressures due to this dollar depreciation is also worth worrying about. Fear # 2: US dollar depreciation might also lead to fewer foreign inflows, specifically fewer treasury purchases. This would likely lead to higher yields, which would stunt US growth, and leave the US in a precarious position. Hedges: 1. Europe (Fund: VEURX): The reason why the U.S. dollar makes up more than 65% of foreign reserves is because of: a) its safety; and b) the fact that so many people invoice things in USD's (ex: oil). The next safest? The euro. Back in the early 1990's, the euro made up around 35% of foreign reserves. Today, it makes up less than 30% Other Possible Funds: ADRV, FEZ, EKH, EZU, IEU, DEW, DEB

Category: How to hedge against the U.S. failing to de-regulate its financial system? Fear # 1: Failure to do this might trigger many of the problems listed above to occur (reduced ability to receive cheap foreign financing, etc...). Increasing corporate - as well as capital gains and dividend taxes - might also have a similar affect. Hedges: 1. Europe: their less-regulated financial systems are the reason why they're already where the majority of FX trading occurs. Failure to de-regulate the U.S. financial system might just send more business there. However, because I have already used Europe above, I decided to go with a plain-old foreign fund. The reasoning: if we don't de-regulate, then firms will just list in their own equity markets, as has been the trend recently. A foreign fund is an easy way to diversify against all the risks mentioned here.

Category: How to hedge against a future reduction in the risk-adjusted return earned on U.S. assets? Fear # 1: This simply goes along with all the risks discussed above, in that lower returns on US assets might persuade foreign investors to go elsewhere. If this occurs, the U.S. economy would likely be in some trouble... Hedge: - Eastern Europe, Russia (Fund: TREMX): Although one could easily just go with China/Asia, we've already done that above. Thus, another area that is already receiving solid increases in foreign direct investment - and should continue to in the near future - is Eastern Europe/Russia. Indeed, as I have pointed out elsewhere, one positive for the U.S. is an aging Europe. However, if the risk-adjusted return on U.S. assets is suddenly reduced, one might expect future European savings to instead be filtered into Eastern Europe & Russia. Although Communism is sure to mute some of the positive affects of these foreign inflows in Russia, many Eastern European nations are very pro-capitalism. Thus the reason to want exposure to the area... Other Possible Funds: PIEIX, SSEMX Poor Hedge: 1. Mexico: Exports make up almost 40% of their GDP. A fall in U.S. asset prices - and thus (likely) an economic slowdown (crises?) - would negatively affect the Mexican economy, being that America is a primary importer of Mexican goods.Thus, Mexico would be a poor way to hedge this.

Category: How to hedge against rising U.S. inflation? Fear # 1: Although this somewhat goes along with future USD depreciation (which was discussed above), there are some that believe that the best way for the U.S. to fight its future debt problems is to excessively increase U.S. inflation. By doing so, it will - in essence - reduce the amount of foreign net debt outstanding (in other words, it'll reduce the net amound of debt the U.S. will have to pay back). Although I disagree that excessive inflation is the best thing to do (it would seem as if rising inflation will put the return on U.S. assets at risk), it certainly is a future possibility. Although I disagree with the notion of "inflating our way out of debt", I do agree that a disinflationary economy would be disasterous. The Fed knows the repercussions of such an occurance as well. Thus, one should expect the Fed to err on the side of caution, and keep prices moving higher at a steady pace. Thus, one would suppose that inflation will probably be a tad bit higher moving forward than it has been in the recent past, although - as I pointed out above - excessive inflation seems unlikely for various reasons. Regardless, TIPS would be useful to hedge against either the "excessive increase in inflation", or the mere "slight increase in inflation". The fact that a disinflationary economy would be so utterly harmful leads to little severe downside risk in TIPS. Hedge: 1. TIP: Basic TIPS... their value will increase right along with inflation, thus protecting your principle, and earning you a steady real rate of return.