A few days ago, despite my conviction that the Treasury market is going to collapse in the near future, I said we may see some retracement in yields -- maybe even a retesting the lows -- for two reasons. First, the Fed may make good on its threat to buy the long end of the yield curve and second, the Japanese might defend the strengthening yen by buying Treasuries.
The economy is in tatters. Corporate earnings are dismal. Consumer confidence is at historic lows. And I believe the worst is yet to come -- massive credit card defaults and unemployment leading the way. The Fed has embarked on a path of quantitative easing, and while that path is typical of a fatuous monopolistic government with absolute power to dictate policy to its minions, I also believe it has no choice but to follow through with the policy -- regardless of the ferocity with which some of us condemn the decisions. No, the Fed has to keep rates low as long as it can, regardless of the consequences. But the consequences will surely come.
Unfortunately, despite my confidence that the Fed will buy Treasuries to keep rates low, there are still so many variables in this equation that I don't feel comfortable trying to time it. What if the Fed starts buying, but at the same time the Chinese suddenly stop buying? Or worse still, what if the Chinese start selling? Who would win that battle? And then there are the short-term psychological implications; with each subsequent media account of either side's actions, investors are likely to overreact accordingly.
Don't get me wrong -- as I've said so many times before, I can't wait to find a point to short Treasuries again. But the timing of this move is everything. With players like the Fed, the Chinese, and the Japanese able to move prices on a whim, I don't want to be caught on the wrong end. Yes, the ultimate direction for Treasuries is down -- along with the dollar. But in the interim the tides are going to be strong and swift, and I do not want to drown before all the fun starts.
With that in mind, I want to deviate from the short-term speculation and address a note I received from a reader:
I can see that at some point no one will buy our debt for zero interest, which will cause interest rates to rise, which will increase our payment burden, which will increase default risk, etc, but I can't visualize how it plays out the rest of the way. That would make a great article!
Let me begin by saying that my whole argument is predicated on several pretty glaring conditions.
1. The U.S. Federal Reserve has printed more money than ever before in history, and plans to print even more. The argument can be made that the actual amount of dollars printed doesn't even begin to approach the losses in all asset-classes over the last two years. Unfortunately, proponents of this argument fail to account for the fact that the dollars being printed will eventually find their way into the economy, triggering the effects of our fractional reserve banking system, exponentially increasing the amount of currency available. These same proponents also fail to give credence to the fact that the effect of these dollars in the system will be rising rates and prices -- partially or completely offsetting any previous losses.
Said another way? Record numbers of dollars will flood the system at the same time asset-prices will be moving toward (or beyond) previous highs. That is a recipe for hyperinflation.
2. The United States has never owed so much money to the rest of the world. We manufacture very little, we borrow heavily, and we consume at rates far greater than any other nation on earth. And yet there exists a preposterous and onerously persistent philosophical bent -- among the financial elite and the average citizen alike -- that the United States will be able to continue to issue debt indefinitely because there will always be lenders. No belief, however, could be more fallacious or dangerous to the future of our economy and our country.
3. The demand for housing will never come back with the same unbridled momentum we saw in the years leading up to the collapse -- nor do we want to see it return to such frothy levels. Indeed, foreclosures will continue and I feel very confident the contagion will bleed into commercial markets in coming months.
4. On a similar note, the default rate on (almost universally unsecured) credit card debt has begun to increase. The American consumer is dead, and if he knows he cannot get loans for the foreseeable future, he is much more likely to consider defaulting on that debt.
The demise of the dollar is imminent, and there aren't a whole lot of different scenarios that could play out. I've established that the amount of currency in the system -- especially once multiplied -- is going to result in rising prices and rates. Likewise, the massive amount of existing and future debt is going to demand higher and higher yields. So which one is going to to lead the downward charge? My guess is the Treasury bubble will continue to unwind and this will damage the dollar's integrity -- after which the imminent rise in prices and rates caused by inflationary printing will only be exacerbated. Of course the dollar could start to weaken in anticipation of these rising prices and rates, pushing Treasuries lower.
In the end, however, does it really matter which happens first? I don't believe the destruction of either the dollar or Treasuries is mutually exclusive -- that is to say, they are inextricably dependent on each other and whatever fate holds for one, so goes the other. In my mind it's far less important to consider how it will happen than it is to think about when it will happen -- and perhaps most importantly, what it will to mean to the average citizen.
What we're talking about here is a massive loss of faith. Since the average person isn't going to understand the concept of using leverage to short the dollar, the only real way to offset the effects of devaluation is to buy real commodities and goods -- in other words, getting rid of cash as quickly as possible. This will work if the pace of the dollar's slide is kept moderate but if the currency goes into free fall and we experience hyperinflation, it is going to be very difficult to mitigate the effects. That's when things can become dicey. The only possible bright spot -- if you can possibly call it that -- is that debtors would see the value of their loans collapsing, relative to the increase in general prices. I don't know about you, but that doesn't give me much solace.
In the 1970s and 1980s, Paul Volcker managed to stop hyperinflation, but he was barely successful. In fact I would say he and his fellow policy makers were downright lucky. Add the fact that the United States then was nowhere near as indebted as it is today -- at the governmental or consumer level -- you begin to understand how dangerous our current situation is. If the dollar begins to lose value at such a clip, I find it difficult to understand how the government will continue to service its debt.
In recent decades the U.S. has paid interest on Treasuries through increased borrowing, and by printing ever more money. But how will that work in an environment in which the currency is deteriorating at such a perilous rate? One could make the argument that inflation is actually helpful to the U.S. debt position; as the dollar becomes less valuable, so too does the debt it represents. But that doesn't eliminate the obligation to service debt, and since the government will almost certainly not be able to borrow its way out of insolvency -- nor to print more money without completely destroying the economy -- I am at a loss to understand how it will solve the problem.
As much as I admire people like Peter Schiff, they do not go far enough in their assaults on the enormous problem we face. When they are asked, on various news and financial networks, what can be done to stem the tide of the coming catastrophe, they cavalierly toss out the the same tired solutions: cut spending, cut taxes, raise interest rates, and back the dollar with gold.
I don't disagree that an immediate and simultaneous implementation of such policies would certainly save our economy. I also happen to believe that an infinite source of easily accessible energy would help a lot. For that matter, so would a loan from God. I guess you should know, at this point, that I'm also battling an irrational belief in Santa Clause and the tooth fairy -- both of whom, by the way, seem to be inflationary, due to the fact that they can apparently manufacture "toys" and "quarters" with reckless abandon.
Look, there is absolutely no way the gargantuan political machine in Washington will ever consider backing the dollar with gold -- much less (God forbid) cutting spending and taxes at the same time. The dollar is doomed.
So what will happen next? I keep coming to only one bleak conclusion: the United States will have to default. And that will be the final call for the dollar. Food shortages, rationing, and martial law could become the status quo.
It will undoubtedly seem farfetched to some of you, but I don't think the United States can survive the failure of its currency -- especially considering that the catastrophe will be the direct result of decades of governmental lies and manipulation. The states sent legislators to Washington who have systematically and purposely destroyed our currency. They manufactured an irresponsible Ponzi scheme that created false prosperity, over and over again. I simply don't think the states in the Union -- many of whom asserted their independence at another point in history -- will sit still for more of the same.
So why not be realistic? Why not consider the true consequences of the $8.5 trillion in stimulus coming down the pike?
According to the Bureau of Economic Analysis (2005), if Texas were an independent nation, its economy would be the 15th largest on earth -- ahead of Australia, Switzerland, Taiwan, Saudi Arabia, and Israel. The state is extremely business friendly; its constitution requires a referendum to implement an income tax -- an initiative which has never come close to becoming reality. Texas has the longest contiguous border with Mexico, along with some very large port cities. Beyond all that, Texas sports three of the ten largest cities in the United States.
If that isn't enough to make you raise your eyebrows, consider this: the economies of New York and California are both larger even than Texas's. Now, remind me again why these economic blocs would want to remain in a bankrupt union whose currency has failed?
I know you're staring at the flag on your wall, tears coming to your eyes. I know you think I'm a traitor and a iconoclast. But before you get too patriotic, remember that I am a classical liberal -- a Jeffersonian to the core. I am a student of the American Revolution, and I am passionately dedicated to the United States Constitution.
We do not live in the United States set forth by our Founding Fathers. The document has been violated, usurped, ignored, and bastardized countless times by U.S. Presidents, the Congress, and the Supreme Court alike. The imminent failure of our currency and our economy will not be a sickness, it will be a cure.
So how do I see it all playing out? I firmly believe that once the dollar dies, people will once again come to recognize the inefficiency and corruption that comes along with the Hamiltonian dream of centralized government. Never again will citizens of any state or country allow their governments to control empty currencies on which we depend for our pursuit of life, liberty, and property.
In the meantime, watch Treasuries, the dollar, and gold. Treasuries have already started to unwind, although the Fed will undoubtedly buy the long end of the curve to try to keep yields in check. Of course, it will have to print yet more money to do so, and that will obviously only exacerbate inflationary pressures. Equity and real estate markets continue to fall, the flight to Treasuries has evaporated, and people are flocking to time-tested stronghold of gold -- up dramatically in recent weeks.
Copyright 2009, Paco Ahlgren. All Rights Reserved.