10 November 2012
Do you believe that America is borrowing huge sums of money from China? Would it surprise you to learn that America is not?
Back in January 2011, I explained what was happening then. And this is what is happening now:
Worldwide, sovereign debt is being serially repudiated. Private institutional buyers are being told they are going to get a "haircut." Portugal, Ireland, Italy, Greece, and Spain (the "PIIGS") are in process of defaulting. The Chinese government recently suggested it will bail out Spain (as part of its move to diversify from the U.S. Dollar), appearing to make China the funder of this century's Marshall Plan.
Meanwhile, to ward off deflation, the dollar is being intentionally devalued because it is the only thing the Fed has left to do, the last arrow in its quiver. And the Federal Reserve, which actively promoted the multiple asset bubbles of the last 20 years, will be unable to manage the inflation genie it is un-bottling.
There are two ways to default on a loan. One is to not pay it back, as millions of former homeowners are discovering. The other is to devalue the currency you pay it back with, and this is what America is doing. So China, one-time buyer of American dollars, will get a "haircut," too.
In reply, China is unloading dollars as fast as their economy will allow, but it won’t be fast enough. China struggles today with both inflation (at an unofficial rate of eight percent) and their own asset bubble in an all-cash real estate market. With uncertainty on the rise, China's ruling class is hedging its dollar exposure by snapping up commodities at a dizzying rate, and conducting some international trade in non-dollar currencies. The Chinese Yuan has become fashionable lately for world-trade because, as with any monetary system, its legitimacy is based on the issuer's sustained and perceived future productivity. Unsurprisingly, China's expected productivity is about to rival America's.
With the Yuan ascendant, the world is voting that Chinese long-term problems are less ominous than America's have recently become. The United States is ceding the dollar's default status as the international reserve currency and there is little in the short run that America can do about it. This is a grave threat to American prospects and worldwide financial surety.
The significance of the United States Dollar as global reserve currency is not generally appreciated by most Americans, perhaps because only other countries see the impact first-hand. If Germany, for instance, wants to buy oil it must first buy dollars because oil is a dollar-denominated commodity -- ie, it is only traded in dollars. Or rather, it was: Russia, itself a major oil producer, recently announced trades that will be transacted in non-dollar currencies, particularly the Yuan.
Until now, if America really needed to buy any major commodity -- including crude oil, gold, wheat, cattle, orange juice, coffee, sugar, etc., all priced and traded only in U.S. Dollars -- the Federal Reserve could always just print more money. True, printing money inflates commodity prices worldwide until they reach parity with the newly-devalued dollar -- but America would still be able to purchase them. In the future, if America must first buy the Yuan at whatever price the Chinese say and then buy commodities in a fractured currency market, significant control over purchasing power and domestic economic stability is lost.
So what is happening today is that China is not buying our debt, but simply rolling it over. And each time they do so, they incrementally reduce the amount of American debt they hold.
Then who's buying America's debt? You are. Or rather, our children. The Federal Reserve is printing money and giving it to banks who, in turn, lend it to the Treasury Department at 3 1/2%. Keep that interest rate in mind.
Had any trouble getting a loan lately? This is why. Banks have absolutely no interest, if you'll pardon the pun, in taking a risk on you when they can instead enjoy a sure-fire return of 3 1/2% by lending essentially free money directly to the United States government.
A "liquidity trap" has been repeatedly blamed for America's economic decline. This is absurd. To understand what a liquidity trap is, imagine trying to push a piece of string with your finger. It simply doesn't work. In theory, the Federal Reserve is attempting to push a line of money into our economy so that each of us will borrow, invest and spend. But what is happening instead is that the leviathan federal government is competing with us for this cash.
Banks, not unreasonably, have decided that they would rather lend to the United States government, backed by its full faith and credit (you, the taxpayer), rather than take a flyer on your business, car or home.
So when you hear people decrying the abuse of power by banks, there is some merit to it. But if you had to choose, personally, between a no-risk loan to the United States government and lending money to some individual -- possibly secured by real estate of questionable continuing value -- what would you do?
Banks, run by men, governed by boards, and responsible to investors, make the same choice. There is no liquidity trap. There is only a ravenous federal government vacuuming up all available credit that could otherwise go to you.
The net result of all this is that the federal government buys
70% 90% of its own debt. The right hand is printing money, and the left hand is borrowing it back -- at 3 1/2%. Finance hipsters call this "monetizing the debt."
You call it inflation.
We have all experienced inflation on non-durable goods such as food and gasoline. But these are relatively inconsequential compared to what is coming. Inflation will not get a toe-hold until credit creation gets ahead of credit destruction (deflation). Once it does, watch out. Hyper-inflation is not a gradual phenomenon, it is sudden. Although unlikely -- America is not some third-world dictatorship -- avoiding it presumes that the Federal Reserve has absolute control over global money supply and will act in perfect concert with rapidly-changing scenarios. There's a lot of uncertainty, there.
In the meantime, this entire issue will be disguised by the "fiscal cliff" and "sequestration" and other sideshows fretting about pennies when we owe trillions. But ignoring inflationary outcomes to the global debt crisis does not mean that this serious, existential threat to America does not exist. It does. And you must be prepared
In order for banking systems to survive inflation, interest rates must rise to their historical averages -- or higher. A 30-year mortgage at 4% is worth less than nothing when it is paid back during years of inflation that exceed 5% or more. (N.B.: If you are prepaying your mortgage, I'd stop that right now.) Banks will absolutely charge higher interest rates to the public in the coming years to make up for that loss. They will have to.
But all that is on your measly $200,000 mortgage, or $20,000 car loan. The United States of America, conversely, has upwards of $17 trillion in debt today
, and it is growing rapidly. Large banks are leveraged against $10's of TRILLIONS in debt backstopped by sovereign bonds (this is why tiny, little Greece's unacknowledged default is so significant). Rising interest rates will utterly consume the GDP of America. Completely.
The banks will be cursed and probably nationalized. By that point, we will have embraced very high inflation, and flirting with hyper-inflation. By that point, the government will have destroyed irretrievably our financial system, and the world's. By that point, the U.S. Dollar might become "junk money
." By that point, each of us might be on our own as systems we rely on for our safety and security stop working altogether.
This harrowing scenario is not decades away, it is virtually upon us. The laws of economics are unforgiving. By mid-decade, we shall see extraordinary times that are difficult to imagine today. You might believe that wise men setting American policy would never do this. Don't kid yourself.
It is coming, and in just a few short years. It is why I founded GuardAmerican.
I love my country. My belief, my desire, is to preserve America's Civil Society in the midst of a cascading, global financial failure that will touch each of us in profoundly disruptive ways. It will not be easy.
As I have been reminded by a good friend time and again, no one ever promised that we would not have to fight for our freedom.