Is the US Treasury Near Default?

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So here’s the Plain English version of what’s going on, as I understand it.

What You Should Already Know

Everybody knows that the US Government is running a HUGE deficit — like $1.8 trillion so far this year — way more than the average human can fathom. I think it’s also safe to assume that everybody understands that this money is borrowed from other governments, like China, Japan, Brazil, the UK, etc.

So, obviously, the US government has to pay interest on this money that it borrows. It makes these payments by borrowing more money, which results in more interest payments for which even more money must be borrowed, and so on. The cycle continues as the debt increases exponentially.

What You May Already Know

This works fine as long as other countries continue to have an appetite for US debt. However, if they were to decide not to continue buying more and more US debt, the US Treasury would not longer to be able to afford to service its debt and would have to default. Total chaos would ensue, like you can’t imagine. Many banks would be rendered insolvent overnight, mutual funds and ETF’s would be wiped out, corporate and individual savings would be depleted, tons of governments — both foreign and domestic — would instantly go bankrupt, and the $100 trillion T-Bond futures market would be crushed.

But, that will never happen, because this is America, and the rest of the world will always want more and more and more of our debt, no matter how much we create. It’s a risk-free investment, after all!

What Just Happened

So, long story short, it turns out that last week the Treasury started having trouble unloading some of that freshly-created debt. Actually, they couldn’t sell about half of it. But not to worry — Bernanke’s crew quietly stepped in, printed $14 billion out of thin air, and used it to buy up all those bonds nobody else wanted.

That’s an easy quick fix, because most people probably won’t even learn about what happened, but it should send off alarm bells for anyone who has any interaction with the US economy.

See… if nobody wants to buy the US treasury’s debt, they basically have two options: They can default on the debt, which I described above, OR, since the government can print its own money, they can print money like crazy to continue financing their madness.

The latter is what seems to be going on right now. The problem with this is that as they create more new money, the existing money — the cash that’s in your wallet and bank accounts — loses value. Since your money is less valuable, it takes more of it to buy the same stuff. In other words, prices go up. Economists call this “price inflation” for obvious reasons.

All modern governments do this to some degree. This is why prices gradually go up over time. It’s basically a hidden tax.

However, the more the US government inflates the money supply to finance their deficit spending, the faster the US Dollar will lose its value. If this continues, the US economy could enter into a state of hyperinflation, and virtually all of the value of the USD could be wiped out.

This is nothing unprecedented. The US did it back in the 1860′s, Germany did it in the 1920′s, China did it in the 1940′s, Israel did it in the 80′s, and Zimbabwe is doing it today. These are just a few of many, many examples.

I guess the biggest difference is that everyone in the US seems to think it can’t happen here, but apparently it’s starting to slowly unfold.

3 comments to “Is the US Treasury Near Default?”

  1. Comment by mike:

    Chris

    That foreign investors don’t find US instruments attractive is evident from the fact that the Treasury is about to issue inflation-indexed bonds. We are not only in deep debt, we are–as you say–about to make it grow exponentially greater because inflation is sure to follow the policies of this Administration.

    It might be worthwhile for you to elaborate upon the consequesnces of default as it would affect different groups. Your article is oriented more towards the investor class and how a default would affect the value of financial assets.

    Given that a large percentage of the American public is dependent on government transfer payments in one form or another, from Social Security to Medicare, the inability of government to meet these obligations through foreign borrowing could end in cessation of these programs. Given that somewhere near 40% of the public are dependent upon these transfer payments for most or all of their income, outright cessation of the programs would lead to a precipitous decline in purchasing power and an outright deflationary depression.

    The alternative, printing money, leading to hyperinflation, would allow continuance of the programs only by payment in inflated dollars, meaning that the “real” value of the benefits will decline. Of course, this negatively affects purchasing power, leading to an inflationary depression (think Weimar Republic).

    It is regrettable that opinion leaders on both sides of the aisle are silent on the consequences of governemnt policies.

  2. Comment by mike:

    Chris

    That foreign investors don’t find US instruments attractive is evident from the fact that the Treasury is about to issue inflation-indexed bonds. We are not only in deep debt, we are–as you say–about to make it grow exponentially greater because inflation is sure to follow the policies of this Administration.

    It might be worthwhile for you to elaborate upon the consequesnces of default as it would affect different groups. Your article is oriented more towards the investor class and how a default would affect the value of financial assets.

    Given that a large percentage of the American public is dependent on government transfer payments in one form or another, from Social Security to Medicare, the inability of government to meet these obligations through foreign borrowing could end in cessation of these programs. Given that somewhere near 40% of the public are dependent upon these transfer payments for most or all of their income, outright cessation of the programs would lead to a precipitous decline in purchasing power and an outright deflationary depression.

    The alternative, printing money, leading to hyperinflation, would allow continuance of the programs only by payment in inflated dollars, meaning that the “real” value of the benefits will decline. Of course, this negatively affects purchasing power, leading to an inflationary depression (think Weimar Republic).

    It is regrettable that opinion leaders on both sides of the aisle are silent on the consequences of governemnt policies.

  3. Comment by Dave Meekhof:

    Isn’t it true that all fiat currencies (which the dollar became in 1972) throughout history have yielded to the demise of hyper-inflation? I think for the dollar, it started back in the seventies. But through economic manipulation, the lid has been kept on. When it finally blows, it will happen rapidly. Rapidly, as in a matter of a few days or less.

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