U.S. Debt Watch: Paths to Repudiation

As readers of my blog and my newsletter are aware, I have laid out the case whereby the United States eventually repudiates its public debt. The means by which this happens is unclear. There are several paths to the same place however, and it’s not necessary to choose only one method of ultimate default. All the usual methods will do, and I am now confident we’ll witness most of them in the next five years.

For example, we now know that an industrial depression will collapse tax revenues to Washington. This is already in the pipeline, as states from California to Kansas cannot even issue their own tax refunds. So the first path to repudiation comes from a collapse of GDP.

We also know that flagrant monetization will not be allowed to go on forever. That too is in the pipeline, as the Fed has expanded outright non-sterilized purchases of financial assets. They have back-stopped trillions in assets already with Treasury lending, but have since moved on to outright purchases. It’s likely that any month now they will start classical monetization of Treasuries. The Fed has told us so. Thus, the second path to repudiation will come via quantitative easing, and inflation.

Now comes the populist response to the financial crisis. This is the third pressure that will come to bear on both tax revenues to Washington, and Washington financial policy. One face of the populist response is Liquidationist. The other face is Keynesian and Interventionist. The Liquidationist movement, to the extent it's successful, will promote default in the private sector. (It will also be associated with Tax Revolts). The Interventionist movement will seek to move default into the public sector. In the end, it doesn’t really matter which pipeline is the conduit for default. And here’s why…

Default in the private sector deepens the crisis, and further reduces tax revenues to Washington. Default and losses in the public sector forces increased monetization and Treasury borrowings. The result is obvious: an ever greater quantity of Treasury securities, backed by ever decreasing cash flow to the government, and topped off by ever increasing monetization of both Treasuries and Agency debt.

Nationalisation of financial entities such as Fannie Mae (FNM), AIG (AIG), or the impending takeover of Citigroup (C) and Bank of America (BAC) are no longer that important. The only dynamic that is altered with nationalisation is how exactly the debt will be mitigated. Again, in the private sector it’s liquidated. But in the public realm it’s mitigated politically. Fannie Mae and Freddie Mac (FRE) are already political vehicles that will be used to mitigate private debt through rescheduling. If Citigroup is taken over, then all commercial loans, credit card loans, and other debt held by Citigroup will be mitigated by Congress.

Let’s be clear: United States house prices, as one example, will now and for years to come be known as “The Prices of the Previous Era.” There will be no restoration of those price highs for a long time. Accordingly, Congress, once it is in control of Citigroup and Bank of America, will do just as they are doing now with Fannie Mae and Freddie Mac – they will reschedule the debt.

The private sector debt in the United States exerts the same power over the banking system as the public debt of the United States exerts over our international creditors. Collectively, the debtors are in control. Not the creditors. This is why the the Creditors, not the Debtors, will be making most of the concessions in the years ahead. Whether the US public debt is inflated away, rescheduled, or repudiated – or some combination of all three–it doesn’t matter much. The process is already underway.

And only an improbably quick return to a very high GDP in the United States could halt the process. We’d need a pace of growth that the United States has not experienced in decades. I don’t see a quick return to high GDP in the US anytime soon, do you?

Comments

[KSengineer:]

In a democracy, "revolt" happens at the polls. The problem isn't with the federal government, it's with the people. We are getting what "we" (collectively, not me or you) asked for. What needs to happen is for the people to wake up to the reality of what's happened to them. Unfortunately, a majority is more interested in American Idol than American government today.


On Feb 25 08:16 AM ecliptix543 wrote:

> I have heard and read more comments recently about a tax revolt.
> What sort of form might this take? In this computerized withholding
> economy, how does one pull that off? I would think en masse refusal
> to pay property taxes would be the most effective in terms of media
> coverage but it would affect primarily local gov't. How does one
> protest the Federal government?

Feb 25 10:33 AM

[Crocodilian:]

Its worth observing that this article has lots of words, lots of opinions, but no numbers. Not a single one. That's a remarkable achievement in an essay about a subject for which lots of numbers are available, and where no meaningful discussion is held without reference to data, ever.

When I read an essay about macroeconomic issues, I expect to find relevant _data_. "House of cards" isn't data. Its an assertion. Might be true, might not be. There's no data to support it, so how would anyone know?

In a basic macroeconomics class, an answer without reference to any facts might, charitably, get you a D.

"Show your work".

Feb 25 10:43 AM

[Consider_this:]

The key element I agree with this article is this:

"The process is already underway."

What makes you think that repudiation, either the process of, or the threat of, either gradual, or sudden, isn't the reason for the crisis we're witnessing? I on the one hand, believe it is one of the key reason for the behavior we see in the market.

Everyone knows repudiation is coming, and is trying to do trades to "escape" it -- whether by shorting, or by buying gold, or by stuffing money in mattress or by NOT LENDING or by not employing, by not spending, etc. These actions exacerbate the situation and is creates a self fulfilling prophecy in some ways.

So the key question is whether repudiation will actually solve the problem, or actually be the straw that breaks the camel back and crashes the system?

How can anyone be so sure that this is the "right" action to do?

I implore everything to think deeply about this. For if this is right, then the correct means to solve the jam is to fight the perception.

Remember, USA was on the brink of collapse in 1930's, and a true leadership call by the President to NOT withdraw money from the bank; and trust the recovery is one of the key actions that helped restore stability. People queued up to deposit money, and it really helped to unjam banks.

Perception is everything in an economy. In some ways, if everyone decides to hoard, no system can survive, not even gold, not even *RICE BASED* economies (Ancient China, trades rice as a currency.). It's a deadly spiral that punishes people who's NOT hoarding, so it seems to justify hoarding, which worsens the situation.

It's akin to society competing with each other to see who can starve the most. If I can starve more than you and you die, I laugh at the ones who died and feel morally justified to do so?!

I have savings, heck I'm one of the biggest savers in everyone I know in my circle, but I also realize this is not a crisis that can be averted by saving or being miser, or being "prudent" or being thrifty. For someone can always out thrift me, outlast me, and if this is the criteria and the trend, even my formidable savings will be exhausted one day.

Despite everything I disagree with Keynesian economics, one thing is true. Price is sticky on the way down (witness houses, salaries, pensions, benefits), which means trusting supply and demand curve to self adjust is a fallacy (you'll have to wait a LONG LONG time for prices to adjust, possibly longer than what you can survive through or what the system can survive through); for it can turn into a self fulfilling prophecy that wrecks the whole system.

Unfortunately, improvement in technology is making this worse: panic happen much faster, and more importantly: Employment and costs can be reduced ad nauseum, esp on the way down in terms of capacity. (Automating everything, don't even need to upgrade systems as output is down. You'll be surprised how little workforce you need to keep things running.) Computers and robots *can* do majority of work, esp if you reduce the need to upgrade and stay ahead.

Recognizing this is half the battle. I'm not trying to preach reckless spending and wild gifting; but we need to recognize the miser craziness going the other way too.

I want everyone to realize that we all play a part in making this WORSE, with every bit of action we do. If you postponed buying something you need and can afford today, it may cascade in a way that you may not be able to afford that thing you need soon.

The key is to draw a line in the sand, and spend anyway -- not recklessly, but also not give in to thinking you can save on a need and get yourself out of the crisis. It makes it worse.

Feb 25 10:50 AM

[Consider_this:]

What I say applies to countries as well:

China should spend more, heck a LOT more, if it has the reserves to do so. Ditto to any country that still have capacity to do so on the balance sheets.

Anyone with excess resource, companies included, should buy and acquire resources, other companies, assets.

Not blindly, but buy if the need is there and the affordability is justified. Trying to time the bottom is NOT the way out of this. The bottom will form when there's enough buyers, not when there's enough waiters.

We need to FORM the bottom, not TIME the bottom.

Feb 25 10:59 AM

[ecliptix543:]

I agree. I also see that this is not so much a democracy in that a democracy would allow for the best candidates to stand forward and be voted upon, not just the moneyed candidates to the exclusion of others that may be able to do a better job. How can one revolt at the polls if there are no viable candidates from which to choose? It's unfortunate and has been a factor in where we are now, in my opinion.


On Feb 25 10:33 AM KSengineer wrote:

> In a democracy, "revolt" happens at the polls. The problem isn't
> with the federal government, it's with the people. We are getting
> what "we" (collectively, not me or you) asked for. What needs to
> happen is for the people to wake up to the reality of what's happened
> to them. Unfortunately, a majority is more interested in American
> Idol than American government today.

Feb 25 11:08 AM

[Lawrence York:]

It is unfortunately the case but we have time. China our largest creditor is trapped--one the one hand they know it and don't like being overconcentrated in US Treasuries nor getting puny interest rates and on the other until their own economic crisis dissapates they can not afford to let their currency appreciate. The US therefore has time but the clock is ticking. First order of business is to stablize the economy and stop the job losses. Second order is to create jobs through small business and circumvent the money center banks by direct lending to small businesses. Thirdly we must build confidence by working together. Hearing the rebuttal of Obama's address and knowing the Republican agenda of keeping dysfunction until the 2010 elections, I think the author is correct but would say the probability is greatest for hyper inflation to pay off our debt in cheap dollars. With this plan the Congress can still bring home the bacon to their constituencies.

Feb 25 11:09 AM

[Mad Hedge F...:]

If you believe that imminent and massive Treasury issuance is going to pop the Treasury bond bubble, and that Obama’s reflationary policies are long term inflationary, you have to be looking at Treasury Inflation Protected Securities. TIPS offer investors a US government guaranteed protection against future price hikes by raising the principal in line with the inflation rate. A 3% coupon TIPS facing a 10% inflation rate automatically boosts the face value of your bond from an issue price of 100 to 110, giving you a total return of 13%. You can buy these directly from the US Treasury, or buy the iShares Lehman TIPS Bond Fund (TIP). The best time to buy flood insurance is at the end of a long drought.

Feb 25 11:40 AM

[sr9web:]

Don't be absurd. Long before USA defaults, whoever is president will declare a national emergency, invoke exectuive various orders and do the following:

1) Declare martial law
2) Fire 50% of all government workers Federal and state (he can do this in a national emegergency)
3) Draft all fit non-working people into a new CCC
4) Use national guard forces to distribute food and essentials.

In fact, firing 50% of all government workers now would solve every budget crisis we face, federal, state and local.

Feb 25 11:53 AM

[raytayzmd:]

...oh, I do indeed believe they could be "serially correlated"...in fact, I'd be willing to bet money that the probability that anybody posting on this website can accurately forecast the future is zero...consequently, Gregor's forecast that $66 was the absolute bottom for oil prices was as reliable then as his rather oddball predictions are now...by the way, WTF does he mean by "monetization of Treasuries"?...using teasury notes for currency?...for that matter, is any of this article intelligible?...Keynes... Interventionist, Liquidationist movements?..."The only dynamic that is altered with nationalisation is how exactly the debt will be mitigated."?????...I mean, I know the guy is Russian but even that's not an excuse for such babble...freshman English dictates you begin your argument with a premise -- e.g. US will repudiate debt...this is then followed by a logical progression of supporting evidence -- usually from lesser importance building to some climactic offering of particularly pertinent data to cinch your point...finally, you close with a brief summary of the point you are aiming to make...this guy is just presenting a disorganized, disjointed collection of practically incoherent speculations only to arrive at an irrelevant conclusion:

"And only an improbably quick return to a very high GDP in the United States could halt the process."

...so what exactly did YOU get out of it?

On Feb 25 09:58 AM klarsolo wrote:

> raytayzmd, unless you have reason to believe that the validity of
> a particular blogger's ideas are serially correlated (and either
> all right or all wrong), I think it is advised to analyse every post
> on a stand-alone basis.

Feb 25 12:09 PM

[Socialism c...:]

reteaparty.com

I'm in!!

Feb 25 12:20 PM

[Socialism c...:]

Long gold, long lead-based products. ;)

On Feb 25 10:26 AM kelm wrote:

> As my readers know this forms the fundamentals of my market positions
> with trades built off of this. Short treasuries, short dollar, long
> precious metals.

Feb 25 12:22 PM

[klarsolo:]

raytayzmd, I just skimmed the post, so I didn't get anything out of it. I just wanted to make a statement to the effect that just because somebody was right a few times in a row doesn't necessarily make him a much better forecaster than somebody who was wrong a few times in a row. But yet, people do that all the time.

Feb 25 12:44 PM

[klarsolo:]

Oops, post got cut short. I meant to say: But yet, people do the mistake all the time that they follow somebody just because his last few forecasts turned out to be correct.

Feb 25 12:45 PM

[Jubilee Year:]

He is correct in his One Big Idea: debt will be repudiated, because the people are getting fed up.

Feb 25 01:16 PM

[shootpar2001:]

First, max out your withholding allowances.
You are allowed to claim up to 12 on your w-4; without your employer saying a word. If your HR person says something; tell them that this is a privacy issue and they have no say in the matter (this is true).
At this point, you are getting as much in each check as possible.
Now form a small company and start reading the tax laws (boring... yes, but worth it). Make as many of your normal activities as possible; a deductable business activity (as long as you are trying to solicit business during the timeframe they are now a business deduction - dollar for dollar). That should get you started.



On Feb 25 08:16 AM ecliptix543 wrote:

> I have heard and read more comments recently about a tax revolt.
> What sort of form might this take? In this computerized withholding
> economy, how does one pull that off? I would think en masse refusal
> to pay property taxes would be the most effective in terms of media
> coverage but it would affect primarily local gov't. How does one
> protest the Federal government?

Feb 25 02:24 PM

[Dave Wrixon:]

Yes, and you don't think China hasn't spotted this? They are getting real nervous, which means printing money is probably the only option Obama has left.

Feb 25 02:42 PM

[ecliptix543:]

Kent State II we may get to see later this year... sometime around July 4th from what I'm reading around the net. And besides, there are just enough crazy nutbags in this country that will shoot back.
shootpar2001 - I've been on a similar plan since 2001.


On Feb 25 02:40 PM monday1929 wrote:

> You can't- they will shoot you down, just like Kent State.

Feb 25 05:57 PM

[c smith:]

tax revolt is happening; small business is being squeezed mercilessly and therefore withholding is as well...Federal Revenues are falling fast. No need for revolt.


On Feb 25 08:16 AM ecliptix543 wrote:

> I have heard and read more comments recently about a tax revolt.
> What sort of form might this take? In this computerized withholding
> economy, how does one pull that off? I would think en masse refusal
> to pay property taxes would be the most effective in terms of media
> coverage but it would affect primarily local gov't. How does one
> protest the Federal government?

Feb 26 08:39 AM

[Bocaboym22:]

Lets spend our way out of spending too much money. We spent too much money in the past ,and our solution is to spend more. That is like obese people eating more. Lets default on our debt, print more money and make our payments worthless. Lets show our true selfish colors. After all, our money is printed in God we Trust, but in our country on credit we ride. The Faith and Credit of the US governent. Voted in by people who are thinking of not making mortgage payments or credit card payment because after 3-5 years they no longer like the terms of their agreement. We deserve this crisis and we deserve the pain. Nothing brings motivation like poverty, at least it motivated my grandparents

Feb 26 04:21 PM

[henarl:]

The first act of declaring a national emergency and imposing martial law will be the confiscation of all civilian firearms to preclude firing back at the National Guard troops as they quell any organized protests, uprisings, or riots. The government would cite "crime control" as an excuse for this action, as they have done in Australia for instance. This would have to be done very quickly before resistance has a chance to organize., The authorities would not hesitate to do this if they believed they were losing control of the population. Let us hope and pray that the situation does not deteriorate to that point as it would mean the end of what's left ot the American experiment with Democracy.

Feb 26 05:42 PM