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Old 12-24-2010, 04:20 PM
Location: The North
5,570 posts, read 9,839,448 times
Reputation: 4900


It's getting a little tiring to read all the doomsday theories about hyperinflation and debt disasters posted by people who aren't thinking clearly. Why not look at things as they would play out in the real world.

First off, China, Japan, Korea and others are not going to stop buying US treasuries. They have pursued this strategy for a long time now, they depend on the US market for survival so doing anything to cause a panic in treasuries and a sharp drop in the value of the dollar would not be in their own interests.

Lets assume for some completely unlikely reason they all did stop buying. Rates would start heading up in funding auctions, which are essentially held to pay off expiring maturities and to fund deficits. At some point the Treasury would have to draw a line in the sand, at least internally. If the rate was significantly above the rate of growth including inflation, then it would prompt some serious discussion about sustainability. As long as it stays "sustainable", then the government would feel comfortable inflating the debt away somewhat through money printing. They would not though go full out to hyperinflation because there are other better options.

The option no one wants to talk about is outright default. Simply tell those with maturing issues sorry, we can't pay you. This would be a disaster. However outright defaults are extremely rare, basically only with companies with no money and no reason to stay in business. For all other cases there is the negotiated default, tell the maturing and existing bondholders here is what we are willing to pay, and here is how we are going to pay it. Bondholders may not like the deal offered, but frankly they would have no choice in this scenario. Every large foreign bondholder is overseeing a domestic economy. The whiff of a default will hit financial markets hard to begin with, but it would take some of the sting away before the default ever came. Not accepting the deal though would cause a full-fledged worldwide panic. So many assumptions in every part of the world have baked in a US treasury rate of return, the so-called "risk free rate". If the default deal is not agreed upon, this sends assumptions into chaos. No foreign treasury could even fathom accepting this and the obliteration to their economy, so whatever the US says it will offer will be accepted with very modest negotiating finding the final terms.

The net result? An orderly default followed by other orderly defaults in other countries. Interest will still be paid, principal will still be promised for repayment. Other crises could arise later, but there is no disorderly panic, no overheating of printing presses and no complete collapse of world economies.

Greece will likely do something like this in the not too distant future and the only real losses will be on paper. Bondholders will do the math for present value on their Greek debt holdings and have to adjust the numbers and recognize a current loss as a result. Money which was supposed to earn effectively say 15% over 12 years will earn 10% over 20 years or whatever the case may be.

These risks are priced into the market in advance and if anyone thought the US would have to do a negotiated default, we'd see the market price pricing it in. Since the market has been very stable and orderly, with yields still near historic lows, its safe to assume this is not an exercise coming anytime in the near future.
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Old 12-24-2010, 04:25 PM
Location: Great State of Texas
86,068 posts, read 76,531,290 times
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That's why the Fed is monetizing the debt. They ARE buying the Treasuries to keep the rates low.
The Fed surpassed China earlier this week and is now the largest holder of US debt.

While China might still be a buyer, they announced they will be helping the Euro nations with their debt which means less money to buy our debt.

We won't default. Just look a the Euro countries. No default there..major austerity measures.
Ireland just used their country's pension money to bail out their main bank.

I think we'll see drastic service cuts, possibly public pension cuts and there will have to be tax increases before we see a default. We're not going to get off the debt hook so easy.
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Old 12-25-2010, 02:12 AM
Location: Ohio
22,798 posts, read 15,897,054 times
Reputation: 19268
Originally Posted by Willy702 View Post
Bondholders may not like the deal offered, but frankly they would have no choice in this scenario.
That isn't quite true. They could always seize US assets, like aircraft, ships, commercial goods etc.

A US Boeing 757 lands and it is seized and auctioned off. A UPS or Fedex plane lands and its contents and the aircraft are seized and auctioned off.

I guess you could start drafting, but seeing how 1 in 4 volunteers to the US military are rejected for health reasons, I don't think that would go over very well.
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Old 12-29-2010, 12:29 AM
Location: The North
5,570 posts, read 9,839,448 times
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US government owns very little property overseas. Tough to seize business assets, but I suppose in some third-world countries you could. Most of what could be seized is US military equipment, good luck getting access from a court to it.
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Old 12-29-2010, 09:49 AM
Location: Sinking in the Great Salt Lake
13,145 posts, read 20,329,234 times
Reputation: 14041
Default Let's rationally look at how a debt crisis would play out

Well, the currency would crash, riots, starvation, violence and general pandamonium would ensue, the military would be deployed all over the country, lots of people would die and freedom would be a fond memory for a while...

...but eventually things would calm down. Old debts would be wiped out, a new currency would be introduced, the economy would be rebuilt and life would go on. It would be an event for the history books on par with the civil war, but it would not be the end of the world. People in general don't like chaos, and chaos would not last long. I would bet the USA would surive more or less intact otherwise.
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