U.S. Debt Default, Dollar Collapse Altogether Likely

The prospect of the United States defaulting on its debt is not just likely. It's inevitable, and imminent.

The regulatory black holes into which sanity and reason disappear on a daily basis are soon to collapse under the mass of their sheer size. The circle jerk going on among G7 governments has to end – the steady advance of gold, even in the face of a managed price, exposes the real value of the U.S. dollar, as opposed to its apparent value expressed in the dollar index.

Is 2009 the year that the United States formally defaults? And with that, will the dollar collapse be rolled back ten for one or more?

There are a lot of reasons to support that theory. To Wall Street economists, such an event is heresy and therefore unthinkable. Yet Wall Street is the very La-la-land that bred the idea of a perpetually indebted nation in the first place.

Number one among the indicators favoring this scenario is what is happening in the U.S. Treasuries auction market.

Last Thursday, an $30 billion auction in five-year notes failed to stir the interest of traditional primary dealers. The auction itself was saved by an anonymous “indirect” bid.

Buyers are discouraged by the prospect of what is expected to amount to $2 trillion total issuance for the full year of 2009. The further out the maturities on notes, the more bearish the sentiment towards them. The only way to entice buyers is through the increase in yields.

But with yields at 1.82 per cent, five-year notes were met with a demand for 1.98 times the amount offered - the lowest bid-to-cover ratio since September. A sell-off in treasuries began in earnest upon the conclusion of that auction.

The U.S. Federal Reserve suggested last week that it was going to step up its treasury-buying activity, and the mainstream media interprets this as a form of market support. What it actually is evidence of growing anxiety and desperation on the part of the Fed as the realization dawns that demand for treasuries is progressively evaporating.

The increased demand for gold as an investment witnessed throughout the last two weeks that has pushed gold to a 4 month high is further evidence that investors across the board are gravitating more towards gold and away from U.S. debt.

So what is the catalyzing event that will precipitate outright capitulation?

I think the spin-controlled version of events will make the collapse of the derivatives market the red herring that facilitates the aw-shucks-we-have-no-choice shoe-gazing moment possible, and that’s exactly the parachute the government needs to retain a veneer of credibility - at least in its own delusional mirror.

The announcement that the CFTC was about to become the target of a regulatory overhaul supports this theory. Consistent with his unfortunate proclivity to hiring foxes to guard chickens, Barack Obama’s choice for CFTC commissioner Gary Gensler was the undersecretary of the U.S. Treasury when the Commodity Futures Modernization Act of 2000 was passed, and is one of its architects. This was the piece of legislation that was put forth to appease the opposition to “dark market” trading in certain OTC derivatives first noisily derided by CFTC commissioner Brooksley Born in 1998.

Ignoring Born’s admonishments with this act, it exempted credit default swaps (CDO’s) from regulation, resulting in the somewhere between 58 and 300 trillion dollars in value presently under threat if the positions were to be unwound. Because of their unregulated status, counterparties in the largest transactions can simply “roll forward” contracts, instead of the losing party in the transaction covering their loss with a transfer of money. It is this massive “nominal” value that could be the Achilles heel of what’s left of the U.S. banking system, and by extension, the U.S. dollar.

I don’t arrive at this conclusion because I like making catastrophic outlandish predictions. Its merely the result of following certain logical paths to their most likely outcome based on what has happened in the past.

In discussions on this topic with editors of top tier financial publications, such speculation is dismissed out of hand, and the argument to refute the likelihood of such outcomes is never brought forward.

Gold exchange traded funds (ETFs) are now the largest holders of physical gold, and as a proxy for investors who don’t want to be encumbered with taking delivery of the physical, provide a simple way to participate in the gold market.

United States citizens should bear in mind, however, that should the banking system be brought down completely by the collapse of the futures market, proxies for gold such as ETF’s and bullion funds could theoretically be targeted by a government desperate for possession of value. The risk from security in holding physical bullion is matched by the risk of confiscation by government in these volatile times. Don’t forget, the government confiscated and outlawed private ownership of gold in 1933 in support of an ill-conceived gold standard, which to some extent, was that era’s spin to halt the flight of gold (and real value) from U.S. soil.

Don’t think for a minute such drastic events are outside the realm of possibility. If somebody had told you in 1998 that a bunch of angry crazy pseudo-Muslims were going to fly jetliners into the World Trade Center, what would you have said?

Comments

[yellowhoard]

Interesting. Did the government nationalize any mines in the 30's? How did Newmont and other mines sell at market prices? Or did they?

2009 Feb 03 05:58 AM

[Roger Knights]

"Necessity knows no law." So They might do it.

2009 Feb 03 06:22 AM

[Ian R. Campbell]

Whenever I read the headline of a book or article forecasting an extreme event I typically pass it by. However, in this case the article is short and I read it. Aside from the fact that Mr. West does not discuss possible consequences of the extreme event he suggests possible - perhaps including the pawing of the ground and snorting by at least one of the four horses of the Apocalypse as foreign holders of U.S. treasury bills take a serious bath - Mr. West has caused me to focus even harder than I have been on my own investment mix. I am grateful to him for that.

2009 Feb 03 07:29 AM

[SW Richmond]

Without taking sides on the issue of the possibility of default, I'd like to add this recommendation for this article: the caterwauling from the deflationists and radical dollar bugs centers on the impossibility of US default and the US dollar's "King of the Fiat Sewer" status. Completely ignored, and never discussed, are the very real, sizable and measurable impacts of reduced tax revenues caused by the "recession" and the prospects for actually repaying US debt absent inflation.

There are no such prospects. US debt continued to rise in "good" times, but now, somehow, facing an epic economic slowdown, the US will be able to radically INCREASE borrowing and in this manner grow our way out of debt. In my opinion, taking and supporting such a position requires either an IQ of 70 or a suspension of disbelief. It does not matter if the US Dollar is the best of the turds in the sewer. If there are no prospects for debt repayment, the dollar is toast, and the Treasury market along with it.

I can never imagine making a timing call, and this article alludes to the reason: this government is liable to do anything, absolutely anything, to hold onto the reins of power. It has already demonstrated clearly its willingness to pick winners and losers and steal from taxpayers to enrich its partisans. In such an environment, anything is possible and nothing should surprise.

Just my opinion / not investment advice.

2009 Feb 03 07:53 AM

[MichaelJ007]

Although I certainly agree with the possibility of some degree of a US default, if I took Seeking Alpha's articles to heart i'd be sitting on top of a chest full of bullion with my shotgun waiting to "time" the burst of the dollar bubble. The value of a fiat currency is based solely on belief. Given the level of which the world's financial system believes in and depends on the dollar and the amount of tools and resources the US and other Govs have at their disposal to manipulate currencies and economies I don't see the world abandoning their belief in the greenback in the near term. That is, not without a suitable replacement and a central issuing/governing authority for us to allocate our pent up belief.

2009 Feb 03 08:42 AM

[Cesato]

As unlikely as it may sound, this article make sense, if there is not a sharp turn in America's way of doing business, a drastic change in citizen's financial behavior, and a socialist like (still within the democratic spirit) scheme of regulation then there will be no way back to sanity. Whoever addresses the amazing growth of the economy (out of proportion) in the last decade forgets that it was made out of a bubble with a non-existing equity in citizen's hands, an unprecendent Government spending with borrowed money plus lack of oversight on the greedy, yet rich, Wall Street gurus. I'm not versed in financial stuff but all I've seen so far is people talking about losing money what was never there in the first place (i.e. home equity) feeling sad because they lost material things like car, boats, planes etc that they could have never afforded, if there wasn't for the imaginary wealth that allowed access to easy money and worse that that investing in overvalued companies (read DJIA) because a clown said on TV that DJIA at 14.000 was a good buy. I did not lose money in this hecatombe I just felt emotional for the millions of Americans that are going to suffer without having been active players in this joke and it's not only Americans, the whole world feels the pain that Wall Street inflicted on them. Sorry about this long comment, going back to the Article, the author did a good job, don't bet on the dollar anymore and I'm talking about dollar reversing its strength as soon as Feb 5 2009, as far a treasuries the big sell of is coming, that is a matter of time, as it was the sell-off in the Stock Market, it took a year to get awful and only the ones who took the lead selling at the first sign of market illness (August 2007) were not harmed.

2009 Feb 03 09:52 AM

[cyclingscholar]

With the financial markets desperate for gov't bonds, the US gov't wouldn't have to default..it could 'merely' ROLL over the debt as it comes due, to 100 year treasury bonds. Given the increase lifespan humans will have as medical breakthroughs proceed apace, this would make alot of sense. Raise the retirement/social security eligibility age in stages up to 70, 75, 80, as is appropriate; and most of the government's unfunded liabilities would disappear.

cyclingscholar

2009 Feb 03 09:55 AM

[MMuoio]

We do have a really stupid government but this outcome is truly an extreme view. The idiots on Wall St. need to be replaced with some new ones----also---the goverment can cancel CDOs and Swaps any time it chooses-----the liability/asset structure can be wiped away with the stroke of a pen if DC chooses to. The average guy could give a shit!

2009 Feb 03 10:09 AM

[raytayzmd]

..."The prospect of the United States defaulting on its debt is not just likely. It's inevitable, and imminent."...well, is that any less true for any other large government?...and if they default, will THEIR currencies collapse?...well, gee, if everybodies' currencies collapse at the same time then maybe they'll all just end up equal and it won't matter anymore...but no doubt the gold bugs would then start caterwauling about exploding dollar appreciation causing economic armageddon.

2009 Feb 03 10:11 AM

[David Roskoph]

This storm has already passed and the dollar has necessarily survived. When the world was reassembled in Bretton Woods (1944) the dollar was linked to gold, now it will replace gold. American capitalism has won the world and contracts or not, America will not fall as its leader. The consequences of our failure would cast the world backward 20 years. The world IS supporting the US dollar even though we solemly swear our presses will run round the clock; it's the value of the franchise. Gold is supported by a public frightened into thinking this will result in a complete meltdown (again). Markets are ever-more a fleecing ground, just like the good old pre SEC days. My guess is central banks are selling as gold is moving away from being a monetary instrument.

ps. Nice methapors

2009 Feb 03 10:20 AM

[Mark Anthony]

Hi James:

Remember me? You brought my attention to CSI.to even though I did not buy. But have you given some thoughts to precious metal palladium? You must read this:

stockology.blogspot.co...

Are you still sticking to your call on CSI.to?

2009 Feb 03 10:24 AM

[kelm]

The fundamental trends I believe point to a failing bond market and an attendant loss of faith in the dollar. I have been laying out these arguments for some time for my readers. All of this could lead to the default scenario mentioned above. The difficulty has always been - "who's currency becomes the new reserve of choice?" We cannot consider a dollar collapse and US debt default and assume that all other currencies remain fiat currencies. Imagine what would happen if another nation, say China, converted to a gold standard as the US dollar begins to slide. I am not saying that will happen rather that some unimagined event could occur that changes the dynamic radically.

Mr. West's points on gold and asset seizures are bang on as well. If you are playing in the gold market with a view to preserving your wealth you better have criteria in-place on when you convert from paper to something physical and how you ensure that physical thing isn't a confiscation target. Physical gold held in a vault in the US is problematic. Some outfits are offering off-shore purchase and storage in a transparent way. I don't have a good strategy for this yet.

I would like to see crisping-up of what "imminent" means. This year, next year,...?

2009 Feb 03 10:31 AM

[auto44]

cycling scholar, How many people are really capable of being productive at those ages? Expecting them to have an important positive inpact on our economy, and I am one of the retired myself and can feel the difference in my physical and mental capacities, is I believe not a pratical solutition.

2009 Feb 03 10:59 AM

[Conan the Barbarian]

Kelm: that sums it up.

Imminent keeps cropping up every month. Ever since Oil broke above $40, an Imminent collapse was in the wings.

Imminent=eventually. IMO

2009 Feb 03 11:03 AM

[auto44]

David Roskoph, I don't think the storm has passed, and yes gold is driven higher by public fear, what other emotion would make sense in the current enviironment of mistrust that now exist?

2009 Feb 03 11:06 AM

[Cesato]

Under the actual market conditions, inminence means getting out before (before enough) the big ones do as it happened with the DOW. When things got awful last year, the big ones were already preparing themselves since October 2007.
Fear beats greed in the current environment. I don't bet on a USD total collapse as the financial meldowm became a global issue but moving investments away from USD towards Gold, for example, does not mean the world abandoned the USD, it means USD at 1.50 and that is fine, oil price will rise atracting speculative investment, talks of defaltion will then fade overshadowed by rising prices, oil producers will get more money and reinvest in the USA as a result, and confidence will prudently but steadily get back to investors, consumers and therefore the industry, we will be 10 years back in history but still alive to write a new chapter about the history-making USA as long as we don't forget the lesson (always happens). The time frame may easily be 2 years. I do bet though in a EUR/USD at 1.50 and Gold at USD 1200 by mid May 2009 and it does not mean the USA has been abandoned by the world. That's what I think commentators mean.

2009 Feb 03 11:08 AM

[User 349901]

This is a great article and people need to wake up to the fact that the Federal Reserve and the US Treasury are debasing our dollar at the most alarming rate in history. Can anyone provide a real answer regarding how we can avoid hyper-inflation at some point in the near future?

Thanks,

2009 Feb 03 11:50 AM

[Jake Berzon]

I think most of us here are worried about these same things. I would like to hear from anyone who has already found a tangible way to capitalize on these trends, or at least preserve the purchasing power of capital, without using some offshore (or onshore) scammers.

2009 Feb 03 12:06 PM

[twitee]

It is all part of the plans of the great minds in the US to dominate the world. Who said the devaluation of the US currency is bad for future of the USA.

Slow down of countires growing in the double digits-Accomplished
Bring Russia back to earth and Terrorist oil profits to zilch-Accomplished
Send the entire US bad loans to around the world-Accomplished
Lower the US dept by cushing the dollar-to be done
Reflation to increase home prices by factor of 3.-to be done
Control over the Gold supplies to redominate the world-to be done
Rich home owners to with over 70 percent equity to start refinincing-to be done......

2009 Feb 03 12:27 PM

[twitee]

BUY GOLD

2009 Feb 03 12:43 PM