Free Markets, Free People

The most important issue in the country today (Updated)

Monty Pelerin, writing in The American Thinker, is thinking about the unthinkable. What would happen if the US held a bond auction..and no one bought any bonds? Even worse, what would happen if we were to default on the $16 trillion in bonds already outstanding?

What occasions this thinking is something he read in Bob Woodward’s new book on the Obama administration, a portion of which is excerpted in the Washington Post. This excerpt discusses last year’s debt ceiling crisis. In it Treasury Secretary Timothy Geithner tries to explain how bad it would be if credit markets stopped buying Treasuries.

But, here’s the thing:

Credit markets have (or nearly have) stopped US government debt financing. That’s why we have the Federal Reserve, the counterfeiter of last resort. If government can raise the debt limit, then it would be legal for the Treasury to issue new debt. The Treasury’s sibling, the Fed, would buy it by printing new money. That would allow the government to pay its bills for a while longer…

No one will buy US Treasuries other than the Federal Reserve. Raising the debt limit only puts the government more hopelessly in debt, ensuring that Treasuries will be even more difficult to sell. Without intending it, Geithner admits that Bernanke will be printing money until the electricity is shut off or until hyperinflation shuts everything economic down. In either case, we reach his "indelible, incurable" situation which will "last for generations."

BASE_Max_630_378Take a look at the monetary base of the United States, which I would describe simply as all the money of all types floating around in the economy. You know why that number has jumped massively since 2009? Because the Fed has been the major buyer of US treasuries, and it buys them by simply printing new money.

Now, the US Dollar is the world’s reserve currency. What that means is that it is expected to be strong, stable, and plentiful enough—though not too plentiful—to be used as the primary backup currency for the entire world’s global trade.

But, since 2009, we have essentially financed our massive debt, which is now at 104% of GDP by having the Fed print the money to buy the Treasury’s bonds. The chart you see here is the result of two separate rounds of Quantitative Easing of that sort, and the Fed is now considering QEIII.

Now, Greece, the sick man of Europe’s financial system, has a debt to GDP ratio of 128%. At the current rate of spending, we could reach that within a decade. But we won’t, of course, because at some point between 104% and 128% of GDP, we will have so much debt that the US will be the world’s financial sick man. At some point credit markets will simply not bid on US Treasuries, because the specter of inflation or default will loom so large that only the Fed would be stupid enough to show up at a bond auction.

When that happens, current foreign holder of US treasuries will face intense pressure to divest themselves of them.  Prices will collapse, and interest rates will skyrocket.  If the Fed steps in to buy those treasuries to support the price—which they almost certainly will, because politicians will demand it—we will then be clearly seen as fully monetizing the debt.

At that point, foreign holders of US dollars will demand that some other currency or asset be used as a reserve, at which point foreign holders of dollars will scramble to repatriate those dollars as quickly as they can.

The dollar will then become worthless in foreign trade, and we will face massive hyperinflation in the US.

On our current spending path, with our current level of debt, this is inevitable, and we have no idea when it will happen. We are literally a single bond auction away from a complete and utter collapse of the US financial and monetary system. We just don’t know when, exactly, that bond auction will be. It might be this week. It might be five years from now.

But, I repeat, at this point, barring a massive change to our fiscal and monetary policy, it is inevitable. There is no way credit markets will continue to buy US Bonds as our debt to GDP ratio climbs towards that of Greece. When that happens, we will either monetize that debt or default on it. Either way, the result will be years, if not decades, of American poverty.

And once that process starts, there will be no way to stop it.  We can’t come back a week later and say, "hey, we fixed it!" Once it starts…we’re done.

After WWII, the US debt to GDP ratio was 124%. At the end of WWII, we slashed government spending by 50%, and eliminated the most onerous and confiscatory wartime taxes, and, though marginal rates were still high, offered a myriad of exemptions that essentially ensured that no one paid the marginal rates. We also scrapped the entire wartime system of industrial production regulation and eliminated rationing. And, of course, we had the only fully industrialized economy left in the world, as everyone else’s had been bombed, if not back into the Stone Age, at least into the Age of Reason, and we became the world’s chief industrial power, exporter, and global business leader.

To do something similar today, we’d have to completely eliminate the entirety of the Federal government, with the exception of the Departments of State, Defense, Justice, Interior, and Treasury, and cut Social Security, Medicaid and Medicare spending by at least 50%.

That’s not going to happen. I believe the current Republican plan to attack the debt and balance the budget won’t even eliminate the budget deficit until sometime around 2040.

Ha ha ha ha ha ha ha ha ha ha ha ha ha ha ha ha ha ha ha!b That’s rich. Like we have 30 years available to fix this. It is to laugh.

Update: And, this morning, right on time, I see that House Speaker John Boehner says he’s "not confident" that Congress and the administration can reach a debt deal. In which case, Moody’s has already warned that they will downgrade the US credit rating by another step. Meanwhile, the rumor is that the Fed is now preparing for another $840 billion in quantitative easing.

That bond auction just keeps getting closer.

Dale Franks
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24 Responses to The most important issue in the country today (Updated)

  • There has been lots of talk over at about the Federal Reserve using “straw buyers” to make purchases in the Treasury T-bill auctions, then after 24 to 48 hours, turning around and selling those T-bills to the Federal Reserve, who stashes them somewhere in the basement of the Fed (next to the Ark of the Covenant probably). 
    If this is true (and I have no reason not to believe it), then we are already in the middle of a huge devaluing of the dollar, that has virtually gone unreported outside the pits of the financial markets.

  • Well isn’t that lovely…

    8:30am, and I already want to drink. Nicely done, Dale.

  • Moodys warns:
    * Budget negotiations likely to determine AAA rating and outlook
    * If budget talks do not produce downward trend in debt-to-GDP ratio, rating likely to be lowered to AA1
    * Assumes “relatively orderly” process for increasing debt limit

  • The best way I’ve heard the US Bond situation described is, “The best horse in the glue factory.”  The US has serious debt problems but other countries have it worse.  Look at Japan going on their second lost decade.  Look at the debt problems in Europe.  They’re worse off than we are but it appears we’re heading rapidly down the same road.  Others are simply closer to fiscal cliff than we are.

    • It doesn’t matter if other countries have it worse. Other countries don’t have the world’s reserve currency.

      That may have kept the dam from breaking so far, but once the dam breaks, gold’ll be the reserve, and the dollar will be scrap paper.

      • I agree that the world reserve status is saving our butts.  Should Europe go over the cliff first, and it looks like they’re about to, then that will also give the US a reprieve.  BUT ONLY A REPRIEVE.  The problem will still persist and the US will take its turn at the fiscal cliff.  Just slightly postponed due to weaker horses in the glue factory.  The only escape from the glue factory for our horse is to get the fiscal situation under control.  That is not likely to happen.
        Instead, it is likely to get worse.  Here is the next crisis in the making.

        Starting next year, new rules designed to prevent another meltdown will force traders to post U.S. Treasury bonds or other top-rated holdings to guarantee more of their bets. The change takes effect as the $10.8 trillion market for Treasuries is already stretched thin by banks rebuilding balance sheets and investors seeking safety, leaving fewer bonds available to backstop the $648 trillion derivatives market.

        It creates a demand for US Treasuries to hide risk.  Of course, a 1% move is $6 trillion and there is ‘only’ $16 trillion in US debt.  A mere 3% loss and you’re considering the possibility of the entire US debt in treasuries being shipped off as collateral.  I sure hope it gets shipped off to someone who likes us because this is a crap sandwich looking for a diner.

        • Let me be clear that I understand that the entire $16 trillion in US debt is not going to be collateralized.  Still, even if portions of it are this is just a bad idea.  It is even more of bad idea if, as the update suggests, there won’t be a budget deal and the US debt gets downgraded again.

  • I have no doubt all of this is true. Therefore, how does one protect themselves and their savings for the impending devaluation?

    • I’m inclined to think there is no sure course.

      Guns, ammo, gold, skills that include fighting and survival and how to fix and repair things, living in a good location, and above all being damn lucky.

    • I’m asking myself this same question.  I am currently in the process of getting very liquid – selling my house, everything.  Once I have all those US dollars, where could I stash it and not have it devalue?  Gold seems like the safe bet but where do you get and store gold in such large quantity?  I don’t want to become a “Doomsday Prepper” but where else is there to turn?

      • Well, I’m just guessing here, but I’m not sure selling everything is the right path. Sell your house? Well, that depends upon location.

        Gold? I think having some is in order. A lot–not so sure.

      • Well, I’m not so sure converting everything to cash is the right idea, if you expect cash to become worthless. A house is an asset. So is a car. Cash isn’t if it becomes useless for anything but kindling.

        • It’s not that I expect cash to become worthless, I expect US dollars to devalue – perhaps significantly.  While I am selling my house, I am going to purchase other living arrangements so I will retain some physical assets, just a lot smaller/cheaper/efficient.  That will leave me with a considerable amount of cash laying around that I gotta do something with that would protect it from devaluation (as much as such a thing would be possible).
          Certainly some gold, that’s a good hedge.  Are there other currencies that would be relatively safe?

  • The problem, as I see it, is that the American people still want their government spending. Outside of the tea party there is little support for cutting government. And even the tea party had plenty who were trying to protect medicare, i.e., spending as we know it.

    Democrats are unhinged from reality. Independents are tuned out. And at best only about 50% of Republicans fully get it.

    If Romney/Ryan produce a plan to get us on track timely, they would have no chance to win.

  • So the Fed is pushing all this cash into the financial system essentially supporting the huge deficits our government is running.

    Yet we’re told that when the economy starts to pickup again, the Fed will pull this cash back out of circulation, thereby preventing inflation.

    Now, how EXACTLY is this supposed to happen? Are tax surpluses going to be used to buy back those Treasury bonds from the Fed, which is then going to destroy that money?  Anyone think that will REALLY happen?  If so, how long will the government have to run surpluses to correct the money supply?

    I have yet to hear any answers to these questions.

    • The Fed could raise interest rates but with the government running trillion dollar deficits there will be enormous pressure for the Fed not to do that.  There is one theory that the zero interest rate policy (ZIRP) is here to stay.  Well, at least till the currency collapses under unsustainable debt.

      • When the Fed raises general interest rates, the market price of their Treasury bonds will drop, making a hole in their balance sheet.  That’s another motivation on an institutional, internal basis to keep interest rates low.

        That doesn’t answer the question of squeezing money out of circulation.  I guess they could increase bank reserve requirements, reducing money in the private sector and making it harder for private businesses to get loans and capital.  That’s a long-term downside to our current policy.

        Romney is going to have his hands full when he takes over.

  • What? I thought that the most important issue in this country was taxpayer-paid contraception! Wow where have I been all this time?

    • It is, it is, do not be distracted by these Republicans, these aren’t the problems you were looking for.
      You are worried about women’s reproductive rights, the Republicans want to control their wombs….repeat 100 times.

      • Might want to stock up on condoms. Someone has to keep the Sandra Fluke’s of the world supplied after the collapse.

  • I personally believe that the biggest issues still are campaign finance reform
    and the selling out of our government officials to corporations and special
    interest groups. Therefore those who are raising the most money are the ones we
    should not be voting for, they are selling their souls for something and you can
    bet it’s not for the benefit of the common man