Second in a series on currency and monetary default by Benjamin Cox
The flaw with U.S. debt is that you are really just buying a sovereign currency with a yield. There is no intent to ever repay the debt -- at best, there may be an intent to roll it.
The assumption is that the U.S. economy will grow quicker than the interest payments on the debt and the government will outgrow its obligations. That assumption, in the medium and long term, will be tested by an aging American population, the growth of government services, and a serious shift of increased entitlement obligations to American citizens without an expectation to pay more taxes.
At some point, I hope everyone can agree that the U.S. will not be able to support its obligations as currently structured. It will have to curtail benefits, increase taxes, or some combination of both. However, as U.S. elections come fast and furious, no one is really going to want to do either, and this will lead to a real default without a fiscal default.
If the U.S. faces default, they will just print currency to pay it off. The assumption of the gold crowd is that if it defaults, the U.S. will face a gradual default with years of hyperinflation, but the more I think about it, the more I think the U.S. will face a flash default.
In this “flash default” scenario, the buck will be passed until someone says the emperor has no clothes, and when that happens, the external access to debt will be shut down forcing decisions to be made. I think this default will not be a gradual progress, but will probably come from a "theoretical" Goldman Sachs report, or something like it, that details how the U.S. is going to have to default on their debt, which will cause panic and lead to a serious event.
At this point, the U.S. government can print two things:
- Debt (they pay for this)
- Cash (they pay nothing for this)
When times have been tough, the Fed has funded the government; they have "printed" cash to buy debt from the Treasury department. This will be the method used when default comes. The Fed will buy back the revolting debtholders and trade interest-bearing debt for cash.
This process has already started (around 2008). At this point, between the Social Security “trust fund” and the Fed, the U.S. government is the largest holder of U.S. debt. They have already bought $2.4 billion of Treasuries, and another ~$1.7 trillion of mortgages with the Fed alone. The “trust fund” has another $2.7 billion of government paper.
So, when no one else would lend to the U.S., the U.S. lent to itself, and proved that it had no problem buying debt and issuing currency to do it. The question is the scale.
When the tipping point comes, there will be a choice: stick their heads in the collective sand and face a 3-4 year period of crazy inflation and unrest, or do an overnight printing. Once they get to the tipping point, I hope they are rational and just do the overnight deed vs a thousand small events.
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