Sunil Shah

U.S. Debt Default, Dollar Collapse Altogether Likely

On 5 Feb, Mr Richmond wrote:

Here's something to make you even more humble: you obviously have no idea how the bond market works or what QE means. When the Fed buys Treasuries it does so specifically to cause long rates to fall, and prices to rise, by increasing demand for them. It does this by printing money and using it to buy Treasuries. And while 2008 may have been the first year when this was done in such a scale, it will not be the last; the US federal budget deficit is projected to be $1.3 Trillion in fiscal '09, and that doesn't include any 'stimulus' bill, so tack on another $800 Billion. Over $2Trillion will need to be borrowed by the US alone; China just went into deficit, BOJ just announced it is going to start buying securities, and with oil at $40 the ME doesn't have much surplus to 'invest'; practically all nations now need to borrow for deficit spending. There just isn't enough money to go around. So where will all this new 'capital' come from?

My Response:

A little less rich air and more humility would serve you well. You make a cardinal error of confusing Govt budget deficits with Current Account deficits. China is still generating a huge CA surplus, as are Japan and indeed the Middle East (where the marginal cost of producing oil is about $15), and whether it appeals to your sensitivities or not, these surpluses are being recycled back into $ assets.

Whether it is direct buying by Govts or the private sector or sovereign wealth funds, they are buying $ assets, including US Treasuries. This symbiotic relationship has prevailed and grown over the last few years and there is still no practical alternative. So next time you visit any emerging country, ask them what their preferred asset as a store of value might be, and ask them where they would like to store their current account surpluses. I suggest you do it soon, before markets oblige you to drop the prefix "Rich" from your poor name.

As an aside, have you considered the velocity of money along with the quantity. You do know they both drive inflation, and relative currency strength should reflect the combination. The paralysis of credit markets has caused a (yet) unquantifiable drop in US money velocity and it will be a while before they thaw. So even if there has been an exponential increase in US money supply, currency markets are telling you overall quantitative money is not an issue with the $.

Your humble poor teacher

U.S. Debt Default, Dollar Collapse Altogether Likely

A humble observation that refutes your admittedly plausible conclusion: In 2008, the year par excellance of quantitative easing, when Federal Reserve Bank Credit exploded from $1Tr to $2.2 Tr (ie issued more liabilities in one year than the cumulative total since time immemorial), why did the US 10 yr Treasury yield actually decline? (4% to 2.4%)

Surely if this monetary explosion presages a default, bond investors would demand a higher premium to hold this 'risk-free' asset. Dollar doomsters have predicted 10 of the last dollar crashes in the last decade; alas there has been one minor correction.

In my humble opinion, the problem is: what is there to crash against. Gold? Too tiny to replace the greenback as the global store of value. Real estate or hard assets? Rather yours than mine. The Euro? Sure if we can find any constancy between increasingly divergent EU states, some on the verge of default themselves.

Tis a skewed world indeed, where apparently obvious conclusions merit much closer scrutiny.