Looking More Likely By the Day

One of the critical planks of a nation built on borrowed money is confidence. Up until recently, that hasn't been an issue. Faith in America's future has remained steadfast. Now, though, people are starting to doubt the wisdom, capabilities and ethos of those in charge. They are increasingly nervous about reactive and open-ended moves to fix the system that aren't working. They wonder if things have moved past the point the point of no return. Some are even asking the question, as the Economist.com's Free Exchange blog does, "Could America Default?" 

Ben Bernanke said [yesterday] that the TARP plan, and any subsequent debt-financed bail-outs, pose no credit risk to America. That is probably true, but it’s a rather remarkable statement.

We have arrived at our current situation due in part to the insatiable demand for American debt. During the savings glut that characterised much of the past decade governments and individuals desired American assets because they viewed them as relatively risk-free. That enabled the government to run up enormous debts, while facing low real rates (especially on longer-dated securities), and made credit a little too easy.

Now America is counting on its assets' risk-free status to persist. It plans, in fact, to help save the global economy by incurring still more debt. The risk-free perception means that America can borrow whatever it needs for a low cost, and can do so without threatening its risk-free status. This isn't typically how credit-worthiness works.

The prospect of an American default seems incomprehensible no matter how much debt the government issues. But is it really? Suppose a major creditor nation posed a security risk and threatened to dump all its American debt on the market. In that case default could happen despite American solvency. That situation is improbable, but feasible. After all, many politically inconvenient creditor nations hold substantial American debt. And stranger things have happened.

And there must exist some level of debt that the market views as unsustainable. Yesterday I mentioned Willem Buiter, who believes that Britain reduced its credit rating as a result of its bank bail-out. America has avoided this problem thanks to the dollar's role as a global reserve currency. But does issuing so much debt ultimately undermine that role?

An extraordinary amount of wealth has been created, all over the world, during the last twenty years. This was largely possible because of the belief that there exist certain assets that pose little risk, and a currency that will always be in demand. The dollar continues to be the world's reserve currency, albeit with some new competition from the euro. Demand for Treasuries remains strong. That suggests the world wants to maintain its faith in American stability, though to be fair, potential competitors look, if anything, worse at this point. What would it take to change this global view of America?

So, come on all you regular visitors to Financial Armageddon: What do you think?

Comments

[roger]

I truely believe this crisis is much much more than a credit crisis,
its a major world realignment with very severe consequences for the
US & the UK (http://www.leap2020.eu/GEAB-N-29-is-available!-Phase-IV-of-the-Global-Systemic-crisis-Breakdown-of-the-Global-Monetary-System-by-summer-2009_a2435.html) For most people its incomprehensible but turn the clock
back to the Industrial revolution this is where it all started

[Tord Steiro]

I think the US moving towards reduced creditworthiness. There are several reasons for that:

One is the mismanagement of the Bush administration. Mounting debt, soaring future expenses and costly, pointless, wars around the planet has all taken their toll on the creditworthiness of Uncle Sam. Further, the US's share of the global economy is falling, hence the economic power backing up the dollar relative to other currencies is falling, and this makes the Dollar less suited as a reserve currency. The dependence on oil should also be noted. With a coming peak oil (although not yet), the US economy appears more vulnerable than many other economies. Unilateralism in foreign affairs also drag down the dollar usefulness. A country featuring the worlds largest army, running solo around the world, is not exactly giving confidence to creditors that they will get their money back. At last I will say that the printing of dollars is harmful too. As the money markets de-freeze, the massively expanded moneybase should spur inflation, reducing the dollars value.

So why do the world still use dollars? Well, what is the alternative? We don't have one. Not the Euro, too many ocuntries, too little discipline, and too small an economy. Gold? Perhaps, but how? A new gold standard may be technically possible, but probably not politically available.

When the Pound Sterling started its decline in the beginning of the 20th century, the did not have a good replacement either - except gold. It took many years of turbulence until Bretton Woods was finally implemented in 1944, and the Dollar took over that role. I hope the "Armageddon" will be strictly financial this time...

[MichaelN]

What do I think? I'll start with humor and write that this is WHY I come to your forum - to learn what YOU think.

But, seriously, on almost a daily basis I pinch myself and say "this can't be happening."

I then take that statement and go back 3,6,9,12 months ago and wonder "did anyone even remotely contemplate what is going on?"

Answer: Yes - and due to reading a reference, I think, from Barron's magazine last Spring, I obtained Financial Armageddon and read that, yes, someone did warn of almost just this.

But of course I discounted much after the first 100 pages of "FA" - this was simply too unbelievably fantastic to take seriously: economic collapse, deflation, inflation, societal stresses (an understatement) and more???

C'mon, I'm 48 years old and have an MBA, am a history and sociology nut - there is NO way that this can occur. None.

Today? I've essentially been out of the market since May of 2007. Why? I'm a mortgage broker (ONLY AAA credit borrowers!) and saw that the world of leverage and perfection required by the financial "super-genuises" could not continue - it was a house of cards. I also remembered "the mess" of LTCM and when everyone runs toward the exit because someone yells "fire," well, it ain't pretty.

But, still, I didn't expect ANYTHING like this!!!

And, for me, here's the scary part: I don't see an "end game." All I am seeing is the almost daily explosions of bad news - and NOT trivial "bad news," either.

Of course MY friends didn't listen to me or my reasons when I bailed last year. They knew, yada, yada, that "investments in stocks always outperform the alternatives!" Remember that the first 20% decline (the historical "bear market" definition) took a while to occur (do I remember right?) - why would anyone think that this was anything more than a normal correction in a bull market?

Want another reason to worry? Above I wrote that I'm a mortgage broker for solely AAA credit borrowers. Want to know a sad fact? The overwhelming number of people that I did loans for, with almost universal six-digit family incomes, have NO SAVINGS. Sure, they had equity in their homes and 401K's, but they otherwise lived pretty much paycheck-to-paycheck. A lot of my refinance loans were to pay off credit card and auto loans.

What do you think happens to people like this (AAA credit!!!) when one of them loses their jobs? NOW you know why so many people are so scared: they ARE worried about their jobs and no have no or little household equity, their 401K's have been devastated and, yep, nothing in savings. Is it any surprise that consumer spending is declining?

I'm a suburban husband/father and have two teenage children. I don't own much gold (can I eat it? No.), no cabin in the woods or farm nearby. I don't know what is next and I can't even guess. I simply hope for the best, but prepare for the worst. What choice do I have?

Lastly, for all of those readers who are generally in good condition - some who might even be gloating a bit right now because of their "preparation" - people are really hurting today and some will be people that you care about. Think of two more things: the depression-era pictures of lines of men dressed in suits waiting for either food or applying for a job. Secondly, don't forget this timeless phrase, "there but for the grace of God go I."

We're all in this together.

[Inferno]

Points all well taken. It seems to me currencies always have been (well, since they went fiat anyway) and remain even today relative instruments. Recent extreme volatility in the crosses signals, just as with any other market that suddenly goes volatile, likely strong moves in some direction.
So, which direction(s)do the crosses go?
In my view the long-awaited outright competitive devaluation hasn't even begun yet. When the very real economic stresses start being felt by the public in the US, Europe, etc politicians will likely have at it. This isn't a new story but the same one the gold bugs have been loudly predicting for years - they were spectacularly early and are probably still early. For now, deflation is some word and Bernanke is actually still sterilizing for the most part. We'll get there though, there doesn't seem to be any other path.

[Tom]

I agree the situation is disastrous but I do not think the USA will default. The simple reason is that we issue debt in our own currency, and we can always print money. Of course, this would lead to a currency annihilation, but the Federal government can always make the payments. Thus, I continue to own Treasuries. The countries that defaulted in the past issued enormous amounts of debt in foreign currencies. Now if we start issuing debt in Euros or Yen, then we could easily default. In terms of the length of the depression, this crash could last awhile for a simple reason. At the start of 2008, I have read that our total American debt of all kinds (government, business, individual, mortgage, investment, etc). was $50 trillion, 3.5X our GDP of $14 trillion. Historically, the average level is 1.5X GDP, which in today's economy works out to $21 trillion. Thus, just to get back to the average means our debt has to fall by half. This is impossible without either lots of bankruptcies, in which debt gets converted into the ownership of the underlying asset, or lots of years to work it down through cash flows.

[Cornholio]

I fully expect over the next 1-2 years that the US will default even if it is due to monetization. If one looks at the bond market blow up in the early thirties, Roosevelt's confiscation of gold which ended the stock market slide by effectively devaluing the dollar by 41%. Like they say history doesn't always repeat but sometimes it rhymes. Perhaps by 2016 we will enter another WW and China will emerge as the new empire if they can limit the fighting away from their shores.

[Lee]

My sense is that things will (more) rapidly unwind when foreign entities (who have historically purchased our debt) increase their stake in gold and silver instead. The Fed will eventually be forced to reverse course and raise interest rates to make Treasuries much more attractive.

The result will be inflation, then hyperinflation then a devastating depression. The current strategy of printing and pumping trillions of dollars into the economy to "rescue" everyone and everything may buy time, but will result in the death of the dollar and our empire. My two cents, humbly submitted.

[Adam]

I don't see how we don't default eventually, whether it's 10 years from now or 50 years, we will default.

# According to the Government Accountability Office, if spending on government retirement programs remains on its current course and revenues grow at their historical averages, interest on the debt could skyrocket from its current 9 percent to almost 30 percent of the budget by 2040.
# Fed Chairman Ben Bernake has stated that the time to solve this problem was "ten years ago." Meanwhile, Congressional Quarterly reports that a delay of even 10 years in solving this will double the required pain to solve it.

From http://www.TruthIn2008.org

[G. Kaiser]

I have my whole life had a fear of debt. Suppose I "inherited" it from my parents. I sold my shares in May last year, and it has for me been almost visible, that things were coming to an end. The excesses of pay, the fancy new houses and cars I knew cost more than people earn in several years. It just didn't make sense.
The greed and entitlement we have witnessed has been shameful, and unworthy, and ultimately it has made me, and many others, undoubtedly, questioning things for years; and yet things seemed to carry on fine for a while. But the doubt has been planted, and it has only grown with time. The Americans have been handling this in weird ways, and they have not repented. Hank Paulson is in charge and is himself personally so involved in the culture of greed that he can never be relied upon. The bankers have been exposed for what they are, and people generally have been cheated, doubted and treated like criminals by banks and yet, the criminals were the banksters. And they are almost all still there!.
Default by these nice people? Hope not; but I don't trust them as far as I can throw them, in the meanwhile I have switched 25% into gold, and I am now growing my own vegetables (if nothing else, it is at least not treated with chemicals), got a generator, installing solar heating, batoning down the hatchets.

'

[redbeard]

Didn't read the other comments. I feel it would be good for the America and the world, long-term, if America were to default on it's debt.
The way I see it, if nobody will lend us money, this would hopefully teach us to live within budget at a government and personal level. Personal responsibility would make a comeback, as well as a disgust toward debt. We would eventually rebuild an economy based on actual capital, versus debt. We are not capitalist, we debtitalist, if I may say so.
The world would also get to learn that there are no golden geese, and that they have to rely on themselves and diversify their export economies to something other than a single, gluttoneous country. That they hope will always be there for them.
Of course, history will repeat itself in 4 generations or so, so it doesn't really matter anyway, does it?
Never bet on humanity learning from it's past mistakes.

[Independent Accountant]

The US will continue its preferred method of slow-motion default, i.e., inflation. I expect a decade of 10-15% inflation with spikes up to 25-30%. Got gold? Get more. Got bonds. Shame on you.

[jim]

Gas prices have been cut in half in 3 months and there are still people forecasting inflation. Amazing.

[Don]

It will take a series of natural disasters. It was no accident that immediately following hurricane Ike; we saw the credit crisis come to a head.

Very few people realize what is actually happening. However, here is a link that will unveil part of the picture. What you will see are very accurate cryptic clues to a coming collapse, directly tied to forces that are beyond the control of the powers currently at the helm of this ship. http://www.marsroverblog.com/discuss-70739-discovery-flies-on-eve-of-atlantic-hurricane-season-arthur-forms.html

The ship has already wrecked, and is being battered by waves on the beach. Sackcloth and ashes are recommended, because the coming Depression will be greater than any seen in history. This entire economy is unraveling, exactly as predicted.

[Tjemme]

"What would it take to change this global view of America?" Foreigners already feel cheated. They were led to believe that they could finance part of US excessive borrowing through AAA-rated paper. Then, there was the sub-prime canary in the mine. After a little while, it turned out that the problem was bigger. How good is AAA-rated paper based on US mortgages? The US Government may be the last to fall, but this is a domino game, where credibility is eroded at the weakest link, and the pressure on the top is getting higher.

[yoyomo]

On the topic of default related fears:

http://atimes.com/atimes/Japan/JK19Dh01.html

Japan Economists Call For 'Obama Bonds'

I agree with Karl Denninger's analysis that once the economy crossed the first threshold of $1 of debt adding less than $1 of GDP it was on an unsustainable (but reversible) path to insolvency. Once it crosses the second threshold where interest must be paid out of new borrowing then insolvency is unavoidable.

[Fred, RTP, NC]

Savings Glut? You need to be more specific. It was Asian trade surpluses recycled into USD to keep the USD artifically strong and competing currencies weak so that their export dumping and wholesale equity purchases of US business going.

The last thing it was, was a US citizen savings glut.

People that talk against a gold standard dont understand history. We are simply repeating what has historically happen when corrupt democracies rule.

[Vaughn]

This isn't tough. There's no point waxing philosophical.

The problem is too much spending fueled by too much borrowing.
The solution of the braintrust is to spend and borrow more.

You cannot possibly fix the problem at hand with the solution they are pursuing. The solution is to let the economy contract to a level from which it can grow again. It is going to contract anyway. The machinations of the braintrust doom us to a long, drawn out disaster. . Every day that passes makes default a much more likely scenario.

[Black Star Ranch]

I personally don't think our nation's leaders can make the changes required to rein in federal spending. The "system" alive and well in Washington DC is infected with the worst kind of virus imaginable; vice, sloth, greed, & avarice abounds. We are being led by a group of money hungry jackals. There is no changing it. The lobbyists dole out the corporatists money and the politicians accept it without guilt. I imagine we have a couple years left at best before our excessive spending and foreign debt bankrupts us.

[farang]

Yes to MichaelN, we are all in this together, the entire world.

But that said, many of us, starting in 2001 when the obscene tax cuts for the ultra-wealthy were implemented and the interest rates cut 8 times, knew the time was coming that the US dollar would become the new Weimar currency. What incentive to we have to save, when we earn no interest for doing so? And yes, today again Bernanke the Fool is talking about LOWERING the rate again...soon will the banksters CHARGE us for "the privilege" of parking our cash in their banks???? I am SO grateful. He should be grateful is neck isn't already stretched, him and his criminal companion Paulson.

When Sir Greenspan the Obscure stated, in 2002, that we would simply "monetize the debt", those paying attention knew the Ponzi scheme was living on borrowed time.

Basically, I see no way out: How will America sustain it's "consumer to the world" status? We don't manufacture enough to export to even come close to a semblence of EARNING our wealth, we just shuffle paper around in hopes of "get rich quick" schemes and bubbles.

Because of our relative isolation during WWII, due to the technology available at that time (but no longer, I warn ya!) we ended up unscathed domestically, while our competitors lay in ruins, dependent upon our "goodwill" to rebuild them. We had no competition, anywhere. Hence, the "golden years" many of us baby boomers recall fondly. It was a brief, unrepeatable condition, my friends, never to return. Ever.

That was 63 long years ago, and that advantage a distant, fond memory that our current crop of corporate funded politicians (spelt: fascists, or better said "corporatists") STILL embrace. Not fascists? When was the last time you had D.C. loaned YOU $700 BILLION with NO accountability, no oversight??? It's called Fascism, embrace it, or fight it NOW, YOUR CHOICE.

Yes, I did see this coming, as long ago as 2002, and started to hoard my cash, buy used equipment and vehicles to operate my businesses (paid cash) do my own cooking (instead of sitting at a local eatery, blowing $40 for lunch, and sucking down $7.00 beers and $10 appetizers with fellow small businessmen after work, while charging it on a credit card), or $100 dinners at some steak house, refused offers from banks to loan my small businesses money to fund projects, and just took work I could fund myself.

I positioned myself to sell my assets 9high) in late 2006, when I simply could not fathom how real estate could soar much higher, while wages remained stagnant, and US government borrowing soared to unsustainable levels.

While I could see the DOD spending becoming more concentrated on large corporations that could BRIBE the procuring officers, or hire them after they would steer business to them (Ask Veco, ask Ted Stevens). You think that was an isolated case? WTF up. It's how it is done, people.

I simply could not understand how THAT model worked. And it doesn't.

I warned my workers to save, save and save some more, because I had lived through a previous military build up (where would our economy be today, if the government wasn't printing obscene amounts to deficit spend on unnecessary military occupations, equipment and materials?) My business was primarily US military projects, and I could see this coming, again, like in the late 80's. Prepared for the slowdown before it occurred.

So, in 2003, I purchased condos for relative peanuts in Thailand. Cash. Less than most in US were spending to remodel their kitchens before doubling the asking price.

Nice places, in lovely location full of friendly people, well built with top notch materials, for literally pennies compared to US real estate. I can eat fresh, prepared food at outdoor markets three times a day for less than $5.00. When I shop for food to prepare at home, the grocery bill is @$50 for a weeks food.

My "common area fees" are $400/yr, my utilities $40/month (and set to fall if energy prices continue to tumble.) I rent one of my units out for more than my monthly expenses.

Like a favorite aunt that lived through the depression, I squeeze a penny until it screams. I see the Asian cultures that also do so, and learned from them. I suggest America does so too.

Frankly, the attitude of Americans abroad is appalling: like we are ENTITLED, and the rest of the world are dummies for not speaking our language, not bowing and scraping when we pass by. We are loud, we are rude, and pride comes before the fall. (Hubris R Us)

I do not wish hard times on my country, and I have two sons in their 20's I worry about very much, their future, their well-being.

But you know what? We live in a country with an illusion-creating media, with liars, con men and thieves in positions of authority, and all most of my fellow citizens want to worry about is whether gays marry, or Britney Spears is sleeping with someone new. They WANT us stupid, therefore pliable. WAKE UP AMERICA.

We have dumbed-down so much, I don't even like carrying on a conversation with half my own fellow Americans, I find them so ignorant. Appalling so.

There is no escape from debt, except bankruptcy or starting another WWIII.

I fear American masses are so foolish, they will BELIEVE the msm meme that Iran, or Russia, or China is "our mortal enemy", and follow some cretins in office into starting another world wide conflict. Of course, those paying attention KNEW Saddam had started accepting Euros for his oil in late 2002, he immediately became our "mortal enemy, a danger to us." And now who is doing the same? Iran.

Get the picture? We WILL CRUSH YOU if you do not want MORE of our "red hot off the presses fiat" dollars. Is THAT making you proud, America???

Isn't THAT what is truly behind that nonsense you see leaking out now by politicians through their corporate owned msm co-conspirators about Iran? About Russia? China???

If you think that Asians and Europeans aren't whopping mad at the US Wall Street banksters using THEIR co-conspirators like Moody's to con them and rip them off, you aren't paying attention to foreign media sources. I do, I read them daily.

I assure you, they are working hard, OVERTIME, to discover a way to dump their dollar reserves in a way they don't tumble in value WHILE searching for a new currency to replace the increasingly undesired US dollar.

Will we declare war on the whole world to sustain "Reserve Currency" status? Isn't that a SACRED position, to be CHERISHED and PROTECTED with MORAL and ETHICAL VALUES, not to PRINT IT RECKLESSLY LIKE GREENSPAN AND BERNANKE (BUSH and CHENEY)??????

Like an addict, or an alcoholic, we will have to HIT BOTTOM, learn HUMILITY, before the long hard haul back up.

You'll see. Toyota, Nissan, Mercedes are having to rent ACRES and ACRES of space at Long Beach port to store all the vehicles they are shipping to our shores, because DEALERS are REFUSING to take on new stock. NO BUYERS. Our only growth export industry, sending our paper refuse, (I'm so proud to be an American in the "Richest nation on Earth, ain't you??), our plastic refuse, to China to use to package the products they MANUFACTURE back to us (while loaning us the money to make the purchases of their products, a twilight zone situation if there ever was one), has fallen off the cliff, and the refuse exporter at Long beach has run out of room to store the SHIT. "Our Exports."

THAT is reality, America. We literally ship our garbage, whether junk-rated CDO's labeled as gold created on Wall Street, or trash thrown in our refuse containers, to the world, and EXPECT that to continue unabated. Lordy.

That, is reality. There is NO 'easy way out", learn to EARN your money again.

Believe it.

[Obamageddon]

I'm of the disposition that this is not just a U.S. problem, but a global problem to which no one is immune. The U.S. is the central focus because our currency is the accepted standard, and we are the premier consumers of the majority of the world's exports. The U.S. is the consumptive paradigm....a paradigm that has imperiled us to a certain fate. This shock we are experiencing right now is just the beginning of many shocks, many of which will be much more horrendous than this one. This shock will be rather benign in comparison. That being said, I think The Plutocracy knows this at the deepest levels and they have contingency plans. We live in a world of dwindling resources. The consumption of the past cannot, and will not continue unabated into the future. This is the humble beginnings of a long, arduous shake-out and adjustment. There will be much suffering and gnashing of teeth, and, unfortunately, we will be relegated to opining about decisons being made in which we have had no input.

[Martin]

I don't think the US will default. They will nuke the world first.

[thinker]

Creditworthiness? not a problem in the US... Creditworthiness is the ability to pay obligations. We are not on a gold standard. We have a fiat currency. If we wanted, we could pay off a billion times our current "debt." Most do not understand modern money. This is really easy stuff. Please understand that the political and economic implications of deficits/surpluses are a different game. This is simply a discussion of creditworthiness.

[mountainaires]

Riddle me this: If it were so easy to "just print money" to pay our debts, then why did Paulson threaten congress that we'd end up with an economic crisis 'worse than the great depression' that could result in 'martial law' if they didn't vote for the "bailout?"

Will the US default? I don't know. But we're currently breaking numerous records as we hurtle downward toward wherever we're headed:

http://www.ritholtz.com/blog/2008/11/record-breaking-data/

[Joe M.]

The USD as world reserve currency is almost over. Perhaps only a few months. Whan this happens we get hyper-inflation AND yes we will default on the debt, before the end of 2009.

[dearieme]

America has defaulted before.
http://faculty.chicagogsb.edu/randall.kroszner/research/repudiation4.pdf