morph366

The Fed's Bubble Trouble

Your logic is compelling and it is a very scary scenario that you have painted but there may be some consolation for the US government in all of this - based on the notion of "survival of the most indebted".
During this year, which is the 200th anniversary of the birth of Charles Darwin, it is just possible that a modified version of the “survival of the fittest” dynamic could begin to appear in the sale of bonds by different governments across the globe. And the US government is the least likely to default because it has the benefit that everyone else will have to adapt to the more hostile environment for financing deficits in order to protect their vast holdings of the global reserve currency and their existing holdings of US Treasury paper.
By way of illustration, last week there was a noticeable lack of interest in the German Bund auction with the Bundesbank retaining 32% of the issue. The US government was able to sell a huge new issue of three year bonds with a bid to cover ratio of 2.2:1, which admittedly was somewhat weaker than the average bid to cover ratio, but nevertheless it turned out a lot more successfully than the fears that are beginning to surface in the eurozone market. In addition the UK government in coming months will almost certainly face similar difficulties to those seen in Germany last week as it tries to finance its massive deficits and has to rely on international investors' appetite for a currency which is arguably even less robust than the euro.
If things do get as ugly as you are suggesting, <b> Too big to fail </b> will begin to emerge in the way that sovereign debt is valued and allocated in global capital markets.
Of course the ultimate beneficiary in that kind of struggle will be the US Treasury. With foreign governments holding trillions of dollars worth of US government debt - both explicitly underwritten and agency debt that has an implicit guarantee – these governments can be relied upon to show up at US government auctions, even if they do bear a remarkable similarity to a Ponzi scheme.
The big difference to other Ponzi schemes is that the existing clients of the US Treasury market have vital self-preservation interests at stake that will cast aside any nagging doubts about the wisdom of continuing to feed new money to this voracious financial beast.
That’s the good news.
The bad news, as you have rightly suggested, is that the price that will have to be paid in terms of yields offered by the US Treasury will have to go a lot higher. Whether this all leads to a systemic breakdown and hyper-inflationary collapse I shall leave to those with a more apocalyptic imagination.
The one thing I am pretty confident about is that if the dollar collapses along with the Treasury market then there are not going to be too many safe places, where the rule of law is respected, to hide, and not even possession of gold bars is going to provide much of a security blanket

Why Buy T-Bills Now?

You make some very astute observations.
Whichever way one tries to solve the global deflation problem it is going to be very painful, and I think it is dangerous to believe that Keynesian economics can provide the solutions required.

The real problem is that too many households/companies are buried under a pile of debt. Getting people to spend money when they are fearful and are facing a debt hangover is not just a matter of firing up the animal spirits. What needs to happen is that the debt has to be worked off. This can either take a long time (i.e. the lost decade in Japan) or it can happen more quickly if there are some innovative moves towards debt forgiveness.
A mechanism needs to be established that allows mortgage holders and others mired in too much personal debt to consolidate and write down a portion of that debt without having to go through formal bankrupcty. Just like the auto companies people are reluctant to take on the stigma of a Chaper 11.

Banks and other large companies are allowed to re-structure and swap debt for equity why not some similar and simple mechanism that allows individuals and small businesses to do the same? Essentially you could wipe a part of the slate clean and in return grant some kind of future claims against your future return to prosperity.

That way one would mitigate a lot of flak from the prudent folks that have played by the rules since, if they do not seek any forgivenss, they would not have to supply some piece of their future action.

Ultimately we need to re-establish affordability in the housing market where new buyers will be able to afford and qualify new mortgages without having to factor substantial capital gains into their expectations of the cost/returns.