Debt Default

There’s something both amazing and astounding going on.  Last month, Standard & Poor’s lowered its long-term outlook for the federal government’s fiscal health from “stable” to “negative.”  Since then yields on 10-Year Treasury Notes have dropped 18 basis points.

Here at the Economic Prism we may not know exactly how the world works.  But we have ideas on how we think the world’s supposed to work.  One of these ideas being that higher credit risk demands higher compensation.

Obviously, junk bonds are supposed to pay more than investment grade debt.  Who wants less compensation for buying riskier debt?

Hence, when a credit rating agency lowers its long-term outlook on the U.S. government’s fiscal health to negative we expect the 10-Year Treasury to pay more – not less.  If deficit spending isn’t reduced soon, not only will the credit rating outlook be lowered, the actual credit rating will be lowered too.

Surveying the fiscal landscape of the U.S. economy, and the bozos balancing the books, Standard & Poor’s came to a simple conclusion…

“Our negative outlook on our rating on the U.S. sovereign signals that we believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years,” said Standard & Poor’s credit analyst Nikola G. Swann back on April 18.  “The outlook reflects our view of the increased risk that the political negotiations over when and how to address both the medium- and long-term fiscal challenges will persist until at least after national elections in 2012.”

Work More, Get Less

No doubt, the medium- and long-term fiscal challenges that Standard & Poor’s is concerned about will persist.  The debt hole that’s been dug over the last 30 years is far too deep to climb out of anytime soon.  It will take at least a generation or two of diligent servitude to pay off the tab for our spendthrifty forefathers.

Over the long-term the money’s already been spent.  Unborn citizens will have to work more and get less than those who came before them.  Yet before the ascent out of the debt hole can begin the digging must first stop.  In other words, the short-term fiscal challenges facing the U.S. are of great urgency.

According to Treasury Secretary Timothy Geithner, if Congress doesn’t raise the debt limit by May 16, the government will max out its $14.3 trillion dollar credit card.  May 16, if you hadn’t noticed, is Monday…and a Congressional deal’s nowhere close to being reached.

House Speaker John Boehner wants increases to the debt limit to be accompanied by spending cuts larger than the amount of the allowed debt increase.  Democrats, from what we gather, want to reduce the deficit by soaking the rich.  Luckily for Congress, by shuffling some money around, Geithner thinks he can keep the lights on until August 2.  Between now and then there should be quite a show…

“Global economies are intently watching the fight between Republicans and Democrats over the U.S. debt and related demands for spending cuts,” reported Reuters on Tuesday.  “Failure to raise the debt limit could lead to the first-ever default for the United States and higher interest rates that would be harmful to its fragile recovery.”

Debt Default

Prospects for a first ever United States default may seem alarming.  However, the Reuters statement is not entirely true.  In fact, the United States defaulted on its debt nearly 40 years ago.

On August 20, 1971, President Richard M. Nixon closed the gold window.  Seizing the unique and exceptional opportunity he had, Nixon defaulted on the Bretton Woods system, and stiffed the world unconditionally.  Suddenly, foreign governments could no longer redeem their dollar reserves for gold as promised…they were left holding paper.

“The dollar is our currency, but your problem,” remarked Treasury Secretary John Connally to several anxious European Finance Ministers at the time.

Now, once again, through years of fiscal and monetary mischief, the fiddly fellows at the Treasury have painted themselves into a corner.  The only way out is a debt default…which is already happening.

Increasing the debt limit may temporarily avoid a traditional default where the government cannot pay its bills.  But it will further the default that is already underway.

To explain what we mean, we’ll defer to Bill Gross, the world’s largest bond fund manager.  According to Gross the default will not happen “in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies – inflation, currency devaluation and low to negative real interest rates.”

To sum things up another way: Bank of America Certificates of Deposit are currently paying an annual percentage yield of 0.35 percent.

Sincerely,

MN Gordon
for Economic Prism

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