Investors have become increasingly apprehensive about the solvency of the United States and it’s government. There is also progressive concern among investors globally about the stability and long term viability of the American dollar. As the national debt approaches $18 trillion USD (United States Dollar) the nation has now accumulated more indebtedness than the entire economy produces in a given year. When a country owes more than the Gross Domestic Product (GDP) it should be a cause for alarm. If one would include the liabilities of just Social Security and Medicare debt exceeds $100 trillion USD. This does not include other federal commitments to pensions, medical care, veteran benefits, banks (FDIC) insurance, mortgages,and the list goes on and on.
The interest on the debt itself continues to grow ever larger. The United States Treasury has attempted to minimize its interest on the debt burden by borrowing for short periods of time. When the loans come due they are simply “rolled over” with new loans. The extension of these loans has permitted the government of the United States to assume ever greater amounts of debt, at increasingly shorter duration. Thanks to the Federal Reserve Bank of the United States it is at progressively lower rates of interest. Every few days a rollover takes place to a tune of billions of dollars. In a month it is hundreds of billions.
Eventually creditors begin to realize that full repayment of the debt incurred becomes highly unlikely. At this point in order to bring in new money interest rates necessarily must rise. The financing of old and new debt becomes increasingly difficult. The United States would now face rather difficult choices.
Taxes could be increased dramatically. This will prove politically untenable so although taxes will rise, it will be insufficient to meet the ongoing crisis. It is important to note that a major increase in taxes will also have a detrimental effect on business and investment. The resulting slower economic growth will make the debt crisis worse.
Drastic spending cuts are another option. These will also prove politically unpopular. There will be some reductions out of necessity, but again will be insufficient to head off the debt crisis. Politicians will continue to avoid the obvious. Entitlements in their present form are not affordable to the nation at large.
A third option is to inflate the currency. This would pay creditors with money that is worth less and less as time goes on. The problem with this remedy is that in the end you destroy the American dollar and wreck the domestic economy as well. It needs to be understood that inflation is actually a tax on everybody because wages will not keep pace with rapidly increasing prices. It hits the working poor and the middle class the hardest.
The fourth and most likely choice will be default. Although the other three options are liable to result as well to a certain extent. Default means that the government of the United States declares that it is unable to meet it’s financial obligations.
Two economists Alan Greenspan and Pablo Guidotti published a paper in 1999, outlining when a country is near or in danger of default. The thesis is simple. If a nation is unable to pay all foreign debts that are coming due in the next 12 months with hard currency reserves, that nation is a bad credit risk. Speculators will eventually target the country’s bonds, securities and currency. Further refinancing of government debt becomes impossible. A default is then unavoidable.
What are the assets of the United States government? The United States in the Strategic Reserve has 725 million barrels of oil. At today prices that is worth about $76 billion USD. Of course if all this oil was going to be dumped on the market it would make the price of oil plunge dramatically. It would be used more as collateral in any international deal on American debt.
As the world’s largest holder of gold, the United States is theoretically in possession of 8,133.5 metric tons. That is a total of 16,267,000 pounds. At $1,300 USD an ounce it is worth a total of $338 billion USD. That is making the assumption that the United States is actually still in possession of this cache of gold.
Foreign exchange holdings are equal to around $143.5 billion USD as of June 2014.
These three sources together equal $557.5 billion USD. The debt that will be refinanced in the next year is in the trillions of American dollars. If this massive obligation was all owed to American citizens it would be bad enough but his is no longer the case. Nearly half of all American government debt is now owed to foreign creditors.
The government of the United States is also a large property owner in commercial real estate and business. In addition, the government also manages a huge portfolio of real estate that can be used for lumbering, mining, cattle ranching, farming and other purposes. The amount held is 28% of the total land area of the country, which is 2.27 billion acres. Although these holdings would be difficult to liquefy in the short run, they could possibly be used as collateral in a future deal on debt.
Where will all this new liquidity come from? The United States government has reduced annual budget deficits to below $1 trillion USD, but they are still large by historic standards. The deficit has declined from $680 billion USD in 2013 to a projected $492 billion USD for 2014. The four previous years saw annual deficits in excess of $1 trillion USD.
All the domestic savings in the United States only equal $600 billion USD annually.
The purchase of American debt overseas has slowed. Central banks abroad are reluctant to shoulder additional governmental debt, being issued by the government of the United States.
The shortfall is now coming from the printing press. The Federal Reserve System of the United States has monetized over $4 trillion USD of Treasury and mortgage debt. This quadrupling of money held by the central bank was the result of the policy of quantitative easing and continued government profligacy.
The end result of the above policy is to weaken the value of the American dollar and a devaluing of existing US Treasury bonds. Investors in United States government debt will soon have a difficult choice to make. If they continue to hold the American debt bonds, they will watch the value of this investment continue to wither over time. They other choice is to abandon this type of investment and watch the remaining value of the American bonds held plummet. If these creditors switch to gold, silver or other tangible assets en mass, the overall value of the United States dollar would ultimately collapse.
A sovereign debt default of the United States would have major repercussions around the world.
Markets around the world would most likely plunge and global interest rates would most surely rise.
The nations that are the largest holders of United States debt would suffer far more. The largest holders of American debt overseas are Japan with $1.14 trillion USD,and Mainland China at $1.26 trillion USD. They are followed by the Caribbean Island banking centers at $287 billion USD. Next is the oil exporters of the world primarily found in the Persian Gulf at $257 billion USD. Brazil follows with $256 billion USD.
The countries with the largest holdings of American debt would see the value of their entire investment in jeopardy. In the case of Japan for example, an investment equal to 20% of their annual GDP would be at risk.
A devastating worldwide recession would follow as investors and bankers abandon paper assets to more tangible holdings. The price of commodities would soar particularly precious metals like gold, silver, platinum and palladium.
In the United States itself, the sharp economic downturn would find the American government struggling to meet financial obligations. To print more money at this point would result in hyperinflation. Many individuals and companies would find their payments from the government cut or substantially reduced.
Is the above scenario unthinkable? Well, partial defaults have occurred in the United States before. The most recent was in 1979. This incident was claimed to be a clerical error and given the small amount of money involved ($122 million USD), is quite likely legitimate. The end result of the mini default was an annual cost of $6 billion USD, as interest rates rose 0.6% which was attributed to the error.
In 1790 and again in 1933 creditors of American debt were forced to accept less money then they were owed, but it was not a complete default. It was rather a managed one, directed by the United States government.
The pension and retirement systems of the United States are also vulnerable. Many private funds and state sponsored plans are heavily invested in government debt, of some kind. Whether it is US Treasuries or mortgage backed securities these institutions will topple if a default arrives.
Millions of private investors who assumed their investment in government debt was safe, will also be wiped out.
Only the strongest financial companies ( insurance companies for example), will possibly survive the economic and financial chaos that will follow an American government default. As an economic depression sets in, the resulting economic pandemonium in the United States will spread internationally in due order. It will be a rerun of the Great Depression of the 1930’s, but will happen more quickly. A result of greater global interdependence, the swiftness of communication and transportation as well as technology.
Investors at this point would need assets like gold and silver to be able to take advantage of the collapse in the real estate market, both on the individual and commercial level. In this environment investments will be made for pennies on the dollar, if one is making a comparison in value before the crisis.
Eventually, there will be many business opportunities, similar to what occurred during the economic malaise of the 1930’s. As was the case then, those who have the resources and the patience to weather the economic storm, can become fabulously wealthy.