- Created on Tuesday, 04 December 2012 20:50
- Published on Tuesday, 04 December 2012 20:50
- Written by Bill Bonner, Chairman, Bonner and Partners
- Hits: 1000
Hearts that are broken, love that's untrueThese go with learning the game.
Yesterday, we learned who would win this game: Folks who bet against the feds.
Including the promises made to old people, the U.S. federal government owes $86 trillion -- five times annual output. And debt is increasing 21 times faster than increases in GDP.
No one knows exactly what will happen. But this much is sure: Hearts will be broken. Not everyone will get what has been promised to him. It's not mathematically possible.
A Bailout for Uncle Sam
Who will get stiffed? In a Financial Times piece a few days ago, Robert Jenkins argued that the U.S. may need a bailout from the IMF. Why?
Each percentage point rise in interest rates adds (over time) $160 billon to annual debt financing. Thus a 5% rate rise adds $800 billon to the budget deficit and, given compounding, more than $8 trillion per decade to the national debt.
The second factor is that more than 45% of tradable U.S. debt is held by foreigners. The Japanese are in hock to the Japanese people. The U.S. is in hock to -- among others, the Japanese.
Third: sovereign bonds are no longer presumed to be risk-free. Indeed, there is now general awareness that at some level of financing costs, government debt becomes unsustainable. Five years ago, posing the question: "At what interest rate does Italy or Spain's deficit financing become untenable?" to analysts, economists or journalists would have elicited a shuffling of the feet or a shrug of the shoulders. Ask today and the quick reply will be: "Why 7% of course." We have been educated.
Fourth: globally, there are some $20 trillon of funded pension assets, $60 trillon of professionally run assets under management and $600 trillon of various derivatives. The pricing of the related liabilities, expected returns and valuations is tied directly or indirectly to the yield on U.S. Treasurys -- all on the assumption that U.S. paper represents a risk-free rate of return. Remove that assumption and we are in a financial world without gravity.
[Another] factor concerns the "ugly sister syndrome". Ever wonder why the euro has been so strong against the dollar? That the euro has not tanked may say more about the global search for an alternative to the dollar than it does about confidence in Europe's determination to save the single currency. So it is worth considering the degree to which progress on the euro might trigger a crisis in the greenback. When the spotlight shifts from Europe, where will it light?
And yesterday's Wall Street Journal told us that the "fiscal cliff" hasn't gone away either.
The White House and congressional Republicans remained at loggerheads -- in both public and private -- over how to design a deficit-reduction package, with just a few weeks remaining before the nation hits the fiscal cliff.
Leading figures on both sides doubled down on their positions in interviews that aired Sunday, and they blamed each other for the current standoff, reflecting the talks that House Speaker John Boehner (R., Ohio) told "Fox News Sunday" have gone "nowhere."
Senate Minority Leader Mitch McConnell (R., Ky.) has said a deal could include raising the eligibility age for Medicare above 65, requiring wealthier Americans to contribute more to the cost of their care, and slowing disbursement increases for Social Security benefits.
The smart money is betting that the feds will make a gesture toward reducing deficits... and then spend, spend, spend. The debt will grow, not shrink.
Confused... Frustrated... and Angry
Then they will try to "inflate their way out," raising consumer prices over a period of years rather than defaulting outright, so that most people won't know what hit them. Creditors -- including millions of old people -- will be confused... frustrated... and angry.
They'll be poorer too. But they won't be wiser.
But hold on. Creating consumer price inflation is harder than it looks. Sometimes prices go down faster than they go up -- even when the feds are printing billions of dollars.
And sometimes, prices can shoot up a lot faster than the feds would like. So, just because the feds want moderately higher rates of consumer price inflation doesn't mean they'll get them.
But there's another problem. Federal benefits are indexed for inflation. The feds don't get as much gain as you might think -- at least not from moderately higher rates of inflation. Hyperinflation, on the other hand, pays off quickly. Benefits are adjusted, but not fast enough to protect the old folks.
Bondholders can be ripped off easily too. A few percentage points of increase in the CPI... and trillions of dollars of U.S. financial obligations disappear.
What will happen? Darned if we know. But it is almost sure to be thrilling.
Editor's Note: Will the Stock Market Melt Down on New Year's Eve?
All of the evidence points to an "economic suicide bomb" attack striking the stock market on Dec. 31, 2012.
When this "bomb" hits, it could cause double-digit one-day losses in all of the major stock indexes.
That's only happened three times in history, including the start of the Great Depression.
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