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     May 7, 2009
US debt on default path
By W Joseph Stroupe

Big government rescues on Wall Street and elsewhere, domestic stimulus plans, toxic asset replacement plans, and new government programs to address a wide range of other longstanding problems are causing the United States budget deficit to skyrocket.

More than US$12 trillion has already been committed and/or spent in this crisis, with the current year's budget deficit projected to reach, or exceed, nearly $2 trillion. The US Treasury is flooding the market with new issuance of debt, while the chances appear increasingly slim that the huge and ballooning deficit will be brought under control anytime soon. With all this spending, we're guaranteeing that huge and persistent tax increases will be

 

enacted down the line to pay for it all. That will trounce economic growth and is an enormously ugly prospect.

The US dollar will inevitably bear the full and ferocious brunt of the decidedly hyper-inflationary policies of Washington, notwithstanding the Federal Reserve's empty promises to reverse such policies swiftly to protect the currency when inflation inevitably rears its ugly head again.

All the while, the strongest evidence indicates that when economic recovery finally arrives, it will be feeble at best for years to come. So the financial and economic sectors won't be able to withstand any promised rapid reversal of Washington's hyper-inflationary policies. But nor will the dollar be able to withstand the option of leaving such policies in place. Washington is therefore setting up the most colossal catch-22 imaginable for the dollar and for the US economy. With the Fed then hamstrung by its own shortsighted and reckless policies, we could well see the arrival of hyper-stagflation. The dollar cannot survive such a scenario intact.
Unless you've been hiding out in a cave somewhere, you know that the big financiers of the US Treasury, namely China and its Eastern partners in Asia and the Middle East, have soured on the dollar's future beyond the short to medium term. They've entirely lost faith in the ability of the US to really get its monetary, financial and economic houses in order before the repercussions of shortsighted policy come home to roost with a vengeance. They're preparing new solutions that will take two or three more years to fully enact but which will shove the dollar aside toward the margins of international finance and international monetary policy. The handwriting is therefore on the wall for dollar-denominated financial assets.

This grim assessment for such assets, including even those considered the safest, namely sovereign US debt, is no surprise to the savvy and informed investor. This fact is borne out by taking a look at the skyrocketing costs of insuring US sovereign debt. The market for credit default swaps (CDS), a form of derivative that insures against default, has seen these costs escalate very rapidly as the government pours money into the spending plans mentioned above, buying toxic assets, non-performing assets, troubled assets, and otherwise questionable assets and shares in collapsing "zombie" banks on Wall Street.

In taking on an ever-greater mountain of such assets with extremely problematic creditworthiness and dubious value, sovereign debt is increasingly tainted as well. That is especially so when one also considers the stark facts, noted above, with respect to the virtually impossible position in which Washington is placing itself, the Fed, the Treasury, the economy and the dollar.

The Wall Street Journal examined the issue of skyrocketing costs to insure US government debt, in its April 30 article entitled, "Volatility in the Markets is Down but Not Out". The author makes the insightful observation that fear and volatility have been transferred from the equity markets to sovereign debt via the government purchases of the wide array of dubious assets referred to above.

As a result, we've seen this recent rally on Wall Street, but we've also seen the creditworthiness of US sovereign debt taking a big hit from the perspective of investor psychology and risk assessment. The closely-watched VIX index, the markets' "fear" gauge produced by Credit Derivatives Research, shows the credit default swap premiums index for seven large sovereign borrowers including the US, the UK and Japan, at present stands at 75, compared with the pre-boom level of 3.

Therefore, the markets are increasingly fear-struck over the prospect of holding for too long dollar-denominated financial assets in particular.

When the catch-22 alluded to above soon becomes fully set in place and irreversible, say in the next few months when sufficient new sovereign debt is actually racked up, and then a short distance farther down the road when Washington, the Fed and the Treasury try to withdraw the present hyper-inflationary policies and find themselves fully trapped in that catch-22 bind, with no viable way out - say within the next 12 to 24 months - then Washington may have no choice but to let the Treasury default on some flavors of sovereign debt, while simultaneously inflating away some other flavors.

From an investor standpoint, though, both policies look like a default. Those investors still holding too large a percentage of dollar-denominated financial assets at that time will be hit hard by such developments.

Unless the most rosy and unrealistic scenario comes about wherein vibrant US economic growth returns very soon, unless the government toxic asset and bailout plans become renowned successes, unless securitization gets a new lease on life and America is able to quickly get its house in order in the next three to four years, the dire forecasts here for US sovereign debt defaults and a dollar crisis, with all their colossal implications and repercussions, are unavoidable in the next 24 to 36 months at most. The UK and Japan face a similar outcome.

W Joseph Stroupe is a strategic forecasting expert and editor of Global Events Magazine online at www.globaleventsmagazine.com

(Copyright 2009 Global Events Magazine, All Rights Reserved.)


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