Is the U.S. Solvent?

Includes: SPY, UUP
by: Nicholas Jones

Doom and Gloom, Get it Straight!

There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place. -Telegraph 1/6/09

That quote comes courtesy of Professor Willem Buiter of the London School of Economics. As you know, little comes from the world of academic economics that I agree with. We have an exception here although Professor Buiter and I disagree on how we'll get there.

The "dollar demise" story is one that has been beaten to death up until now. It's been covered, denounced, called un-American, and with the recent dollar strength, it's been all but dismissed. The problem with all the coverage is that the overwhelming majority of analysts, just like Professor Buiter, have the means wrong. They don't understand how this process will shake out.

The fundamentals of the dollar's weakness are apparent and discussed everyday. The problem is that they're discussed in some other context. Let's start by taking an issue I've covered extensively in prior issues of B&B.

Balancing the Budget Deficit

If you are a reader of mine, and/or can figure logic beyond a 5th grade level, the bearish fundamentals surrounding the treasury market are blatant. Let's take a look at this -- keeping the dollar in mind.

Our budget deficit, like Clifford the dog, is big and red. We are already looking at a $1.2 trillion budget deficit, and that doesn't include Obama our savior's stimulus package that will probably increase our deficit by another 2/3. I promise you it won't stop there. Our new left of left fiscal policies are set to only loosen further as this fiscal irresponsibility grows in mass.

As our nation's liabilities grow, it becomes ever more constraining and difficult to make payments. Look at it this way. If you were racking up the credit card debt, it is more expensive in the long run to make the minimum payment, than it is to simply pay off the debt. That is what we're currently experiencing.

One way to ease the burden of our massive debt is to decrease its real value. In other words, regulators can inflate the money supply. In theory, the Federal Reserve could inflate the value of our deficit to zero if they wanted. It obviously worked well for the likes of Zimbabwe and Weimar Germany.

Contrary to the past several months, inflation hasn't been the notable "flation" discussed. Obviously it's the deflation that regulators have been worried about, or at least want you to worry about. Just as inflation reduces the value of our nation's debt, deflation does the exact opposite.

This is one of the main reasons deflation will not be tolerated. The end game here would simply be default on an unpayable deficit. Then there's the other scenario: reflation.

With deflation scaring the pants off our nation's leaders, regulators are doing everything in their power to combat it.

Inflation Avalanche

In prior issues of B&B, we looked at the alarming numbers regarding the recent monetary inflation. Let's revisit some of those statistics.

The Federal Reserve has already lent over $2 trillion through its different lending facilities. The recipients of this money have not been released. Bloomberg has recently filed a suit under the U.S. Freedom of Information Act to find out who this money was going to. The Fed has denied access to the information. This does not pertain to the topic of inflation, but is another example of outright criminal behavior undertaken by the authorities.

Anyway, from the middle of September to the beginning of November, the Fed has increased facilities lending by $1.23 trillion marking an increase of some just 12 weeks!

After Lehman Brothers went bankrupt, regulators entered panic mode. For those who don't know, when regulators panic, they hop in their expensive Mercedes, or Lincoln, or whatever fancy car they drive, and head straight to the printing presses. They flip the switch from "Jesus was printing a lot of money" to "Holy Hell warp speed," and that's exactly what they did.

By the end of October, year over year money supply growth was 38%. For those of you who don't know, when everything is shaken out, money supply growth exactly equals price inflation. The last time the money supply was growing at something remotely close to the 38% figure was in 1939 when money supply growth was 28%.

Little did we know that we were just getting started. Once the first week of Dec. rolled around the Federal Reserve really kicked it into gear. In Dec. 2007, the monetary base was $836 billion. In Dec. 2008, the monetary base is $1,479 billion. That's a growth of 76% year over year.

There's an interesting little twist here. Leading up to the Lehman Brothers collapse, the Federal Reserve held the monetary base relatively steady. This means that the majority of the staggering 76% money supply growth has taken place in the last three months. That's an annual rate of approximately 300%.

(Some figures and statistics provided by William Engdahl)

If that isn't enough, I guess pictures speak louder than words.


So here's the deal. The U.S. is growing both its budget deficit and money supply on exponential levels. Once all of this money starts to show up in the prices of goods -- look out. When inflation takes grip it is going to move fast.

The problem is that this massive growth in the monetary base will make it more difficult and more expensive to finance our nation's debt at a time when we need more financing than ever.

When we begin to struggle financing our debt, the next step is to monetize. This step is one that the Fed and Treasury have already embarked on. Monetizing the debt is simply when the Treasury write the notes and the Federal Reserve prints the money to buy them. Obviously, pending the size of the unfinanced debts, this is very destructive on the domestic currency.

Here's the deal. The U.S. needs to finance a lot of debt. Their monetary looseness is beginning to limit their ability to do so. This will only worsen significantly. The more debt we can't pawn off to foreigners, the more we must monetize. When we monetize, we finance our debt at a great cost to our currency. This will only make it more difficult to sell debt, therefore we will monetize. It's starting to snowball now. It's very simple. The longer the treasury market bubble goes, the more immediate destruction is done to the U.S. dollar.

There is only one end game here. Analysts love to discuss whether or not the financial system or Detroit is solvent. Let me tell you, we got bigger problems. The next big question will be: is the U.S. solvent?

Disclosure: No positions.