World Starting to Lose Confidence in Our Debt

[FlyingTiger]

Jesus. This is some scary stuff.

Without using too many big words (you're welcome, Mrs. Palin), Credit Default Swaps can show how confident investors are in the future prospects of, well, just about anything. You can even get Credit Default Swaps on the government of the United States, which will pay out if the US defaults on its national debt. There are only two possible outcomes if we ever find ourselves in that scenario - one, the country actually does default on its debt, which will instantly turn us into some sort of mutant hybrid of Iceland, Bratislava, and Marty McFly's hometown in that part of Back to the Future II when everything is run by Biff Tannen. That result is incredibly unlikely because of possibility number two - having run out of all other payment options, we fire up our printing presses to create trillions of new dollars, which we immediately give to China. Either way, the value of the dollar drops off a cliff.

Nobody can be sure about whether or not things will actually get that bad. But remember, it's also important to monitor how many people think things might get that bad, because if they do, they won't consider the dollar to be such a safe haven. And if you look at a part of Credit Default Swaps called basis points, you can figure out just where that thinking is. Again, without using too many big words, the general rule is that when basis points go up, more people believe that default is possible. When basis points go down, less people believe that. Traditionally, the basis points involved in Credit Default Swaps on the federal government have been really, really, really low, because, come on, it would take some pie-in-the-sky perfect storm of a new Great Depression and unheard-of mountains of debt for there to even be a chance of America defaulting, and we all know that'll never happen. Recently, however, there's been a disturbing trend in the market. Here's a graph of the basis point levels of Credit Default Swaps for the United States, Pepsi, and IBM:

http://www.meltingpotproject.com/mpp/jar-of-dirt-economics.html">Link to full article

[begin_within]

1. How will the U.S. ever pay off the national debt?

[truedelphi]

7. We will ahve to forget about paying off ithrough use of any paper currency

if it is true we owe about 550 Trillion dollars to pull the world out of the Global economic collapse that our Credit Default Swaps have incurred, there simply are not enough trees to turn into paper to make up that amount in full.

We could start using currency whose lowest amount is like two million bucks.

[GoesTo11]

8. Don't think it would work that way

The 550 trillion or whatever in credit swaps have winning sides and losing sides (counterparties), it's not just money destroyed. It's as if Brad Pitt got drunk and bet George Clooney $550 Trillion that Arizona would win the Super Bowl, and when they lost, Clooney said Pitt owed him $550 Trillion and Pitt said he needed a $550 Trillion bailout from the government. The difference is Clooney is also saying that the economy will collapse if he doesn't get his $550 Trillion. You know what, it will go on. We may have to keep paying Clooney to make movies, but there is no need to turn all $550 Trillion of play money into real money.

[truedelphi]

19. Except in your example, let's say that the smart money was

Not on Arizona, and that the majority of bets placed were placed against Arizona.

[mike_c]

2. watch it happen....

We live in interesting times.

[ixion]

3. here is the crux:

...the dollar isn't actually backed by anything. Anything at all. Its entire value comes from the perception of how badly somebody else wants the paper in your wallet. Which makes it incredibly similar to... a jar of dirt.

[A HERETIC I AM]

6. After looking at that authors profile....

and reading the article, I get the feeling he is as clued into what actually backs the US dollar as a ....jar of dirt.

Not impressed.

[ixion]

11. whether you are impressed or not...

that's the way a fiat currency works.

[RedEarth]

18. The author's profile doesn't impress you?

....doesn't impress me either.

Bio

Born in the giant cornfield known as "Iowa," Joe walked away from a life of vegetables and bacon for a much different life of late-night coffee and Orange Chicken specials. He has worked for numerous publications and web sites, contributing a healthy dose of sarcasm and obscure movie references to everything from NFL columns to media watchdog reports. His political leanings, once simply defined as "whichever party is screwing up less," could now best be described as a hop, skip, and a jump away from libertarianism. An avid Redskins fan, Joe frequently travels obscene distances to attend games, and often refers to the Washington Nationals as "a potential 162-0 team." He is currently enrolled at Boston College.

http://www.meltingpotproject.com/mpp/joe-tauke.html

[HamdenRice]

12. Nonsense. The dollar is backed by the government's ability to make you work for free for 3 months

This right wing, free market, goldbug, libertarian bullshit meme gets tired, and no matter how many times it's debunked and reality is explained, it never dies. It's like an incurable mental virus. Once it infects someone with stupidity, it stays in their system forever.

The dollar is backed by the fact that the government taxes people and companies. If the overall tax rate is 25%, it means that in effect, people work and produce goods and services for the government for 3 months of the year.

That is what backs the dollar.

Would you rather have it backed by a heavy yellow metal?

For that to happen, the world economy would have to shrink to something like 1/1000th its current size, and we would be farming with mules while the super rich owners of the world's gold lorded over us like a medieval aristocracy.

Is that what you want?

We tried it and it didn't work very well.

[ixion]

13. I want to see real value, not hocus pocus bs

and I never signed any contract saying that I would work for free for the government. That is conscription, and it is no different than the feudal world which you describe.

[HamdenRice]

14. And what has more value? Goods and services or yellow metal?

What has more value? An up to date computer? or a gold coin? The services of a dentist? or a gold coin? A ride on a train? or some gold dust?

And no one conscripted you. You're part of a democracy. We decide together through the democratic process how much of those goods and services will be directed to the common good. For example, if we decide on single payer universal health care, then democratically we will also decide that we will pay the government more.

Oh, I forgot. Free market goldbugs are against universal health care too.

[FlyingTiger]

17. Huh? "Didn't work very well"?

You realize we were on a form of the gold standard from the Revolution until the 70's, right? How exactly did it "not work very well"?

(And as a postscript, I'm not a "gold bug." I don't think it's a very good investment. But to say that it would be impossible to have a modern economy with a currency based on gold or some other precious metal simply isn't true.)

[HamdenRice]

20. Actually you are wrong

although it depends on what you mean by "gold standard." The person I was responding to was questioning what "backs" money. The definition of the gold standard that we were debating is the idea that money should be "backed" by gold -- and that's the free market, conservative, libertarian idea I was responding to. For money to be backed by gold, every person who holds a dollar in circulation must be able to go to the government and demand gold for that dollar.

In that sense, in the US, money ceased being backed by gold -- and went off the "gold standard -- in 1933. The gold standard was a catastrophe that had a lot to do with causing the Great Depression, and every non-retarded western government left the gold standard between 1931 and 1933. You can trace the demise of the gold standard back even further, to the creation of the Federal Reserve Bank in the first decades of the 20th century, which enabled a public banking system to control the money supply regardless of the amount of gold in the vaults.

By referencing the end of the gold standard in 1971, you are referring to the system for pricing various western currencies in relation to each other, which used an arbitrary value of gold to keep the dollar, pound, frank, deutchmark, etc., within a narrow trading range -- the Bretton Woods arrangements. But in reality what "backed" those other currencies wasn't gold; it was the dollar; and what backed the dollar wasn't gold, but was the taxing and purchasing power of the United States. They could have used oil or any other commodity as a reference price, but the real point was the relative value of the currencies, not of the commodity, whether gold, silver, oil or any other commodity.

Up until 1971 central banks continued to theoretically settle their differences in gold (actually they settled in dollars priced against other currencies according to an arbitrary gold based pricing index), but privately held dollars were in no way backed by gold. No private holders of dollars had been able to demand gold for their dollars in decades. Hence, the gold standard did not last until the 1970s.

The gold standard was the source of untold economic misery, and therefore "did not work well," which was why it was gotten rid of during the Great Depression, and -- unfortunately, there's no polite way to say this -- anyone who wants to return to the gold standard is quite simply a blathering idiot. Actually, I take that back. Not a blathering idiot, but an economically heartless, far right wing, lunatic, blathering idiot.

[FlyingTiger]

21. But isn't fiat currency leading to THIS Great Depression?

I mean, it kind of sounds like you're saying, "I don't want to shoot myself in the foot, I want to shoot myself in the OTHER foot."

[HamdenRice]

22. No, it's like saying that because one doctor committed malpractice, let's abandon modern medicine

It is true that the housing bubble that caused the financial panic that is causing this recession was the result of Alan Greenspan's ludicrous monetary policies that were intended to allow the Bush administration to finance their wars.

But with a few exceptions, since the Great Depression, monetary policy has prevented a depression and ameliorated most recessions. Saying that the gold standard would be better because Greenspan fucked up is like saying let's get rid of all modern surgery -- all the lifesaving routine appendectomies and gall bladder operations -- because one doctor committed malpractice.

If we had stayed on the gold standard after 1933 we would have had 70 years of the Great Depression or many, many depressions.

http://econ161.berkeley.edu/Politics/whynotthegoldstandard.html

The gold standard and the Great Depression. The current judgment of economic historians (see, for example, Barry J. Eichengreen, Golden Fetters) is that attachment to the gold standard played a major part in keeping governments from fighting the Great Depression, and was a major factor turning the recession of 1929-1931 into the Great Depression of 1931-1941.

* Countries that were not on the gold standard in 1929--or that quickly abandoned the gold standard--by and large escaped the Great Depression
* Countries that abandoned the gold standard in 1930 and 1931 suffered from the Great Depression, but escaped its worst ravages.
* Countries that held to the gold standard through 1933 (like the United States) or 1936 (like France) suffered the worst from the Great Depression

[GoesTo11]

4. Pretty bad, but not a sign of end times.

If it really is AA, that's very bad symbolically - US Gov't debt has always stood for the risk-free investment. In practical terms, it means higher interest rates and hence higher interest payments. I could see it costing the country another $50B per year or so.

Possible outcomes

- US recovers from downturn, grows its way to have debt - even new debt - be a manageable fraction of GDP.
- US raises taxes a lot, shrinks services and military a lot, still makes payments
- US blows off Social Security and Medicare to make room for payments
- US inflates dollars to make payments with cheaper money
- US defaults and goes bankrupt.

I think the last is pretty unlikely as they would go through the first four options and only go to the last if the others fail. Steps 3 and 4 won't be fun.

[FlyingTiger]

5. It's not so much the rating as it is what the rating MEANS

Look at what's happening to Britain right now. Investors worldwide are officially fleeing the country - actually, there's another post on that site http://www.meltingpotproject.com/mpp/2009/03/ready-for-britain-to-go-bankrupt.html">about how there was a TRILLION-dollar run on their banks last Friday - even though Britain probably could have taxed and inflated its way to full payoffs if everything had just stood pat. It's not about our situation if the world doesn't change anything - it's about our situation if enough of the world starts to doubt us enough to shift to other investments. Kind of like how everyone is trying to sell excess real estate right now, which is pushing prices lower than they would go if everyone still had the same attitude that they did two years ago.

[jakeXT]

9. If people still have faith in CDS, good luck to them

Record highs not a good sign

The rising costs to buy credit protection undermine hopes that credit markets are improving -- a turnaround that could set up the U.S. economy and stock market for revival.
Such costs also reflect an increase in money spent buying the type of complicated derivatives that sent American International Group Inc. (AIG:
a seller of credit-default swaps, to ask for several rounds of bailout money last year -- one of the series of shockwaves that have hit the financial system.

The chance that a seller of CDS won't be able to make good on its commitment to cover an underlying entity's debt default, or what's known as counterparty risk, prompted "Black Swan" author and investor Nassim Taleb to describe CDS purchases as tantamount to buying insurance on the Titanic from someone on the Titanic.

http://www.marketwatch.com/news/story/cost-buy-protection-against-us/story.aspx?guid=%7B8A08067B-E9C2-4B7F-A235-DAEFE3EA08C4%7D&dist=msr_1










The Road to National Insolvency (March 9, 2009)


Insolvency does not just mean liabilities exceed assets--it also refers to being unable to pay the interest and principal on one's debts and cover one's other expenses. The U.S.A. is headed for this insolvency.

How could the U.S. government become insolvent? Easy: when the costs of servicing its rapidly increasing debt rise to the point that it is no longer able to pay its mandatory bills.

The Mainstream business media is offering some faint recognition that borrowing several trillion dollars a year might have some consequences such as higher interest rates and less money available for private-sector-borrowing: Will the Obama Budget Hurt Private Borrowers? The humongous sums the U.S. Treasury must raise in coming years may eventually make credit unduly expensive for businesses.

...
http://www.oftwominds.com/blogmar09/insolvency03-09.html

[quadropusrex]

16. the "of two minds" blog...

I've read articles from the "of two minds" blog before ... gathers lots of figures, throws them together in an article, but doesn't bother to do the math.

In one of his posts he rants on about FHA/VHA loan defaults that amt to $6 billion but fails to recognize that the biggest default risk is from the emptied AAA ARM/refi/HEL tranches of MBS in Citi, Merrill, BOA, etc. Most of the biggest write-offs have already occurred, but the unemployment situation has to be remedied. The "oftwominds" blogger also listed overlapping categories of mortgages that ends up with more than 100% of the actual total value. Very poor analysis, don't put too much stock into casual bloggers.

Obama's doing the right thing by pumping money in from the bottom & middle, pumping money more money in from the top into the "too big to fail" banks right now would just end up with more money trapped inside Citi, etc. while everyone's trying to figure out how to value their assets (hard to do even in good times).

The thing to recognize here is that we are going to down-flate the debt through inflation. We have to.

And American's GDP is $17 billion, our bail-out is actually smaller by proportion than Germany's or England's.

Tough times ahead but no apocalypse.

[notesdev]

10. CDS prices are going up for another reason

Which is that the issuers of these CDS have been getting creamed. The higher prices reflect a cost of business that is closer to reality than the previous prices. Fewer suppliers, more demand, higher risk all around - these are the reasons CDS prices are going up.

[quadropusrex]

15. Reregulate CDS's & let the phony ones expire

It's scary, but the potential outstanding obligations beggar belief ... $70 trillion of notional CDS value on just $5 trillion in bonds. Suffice it to say the price tag on the notional value is astronomical, simply absurd and based on real fraud. Selling a contract with no intention of ever honoring is fraud, and there's a point where no government would intervene to honor fraudulent claims.

$5 trillion is manageable, bad enough, but manageable. The $65 trillion beyond $5 trillion are the *potential* claim totals belonging to the speculative CDS bets placed by speculators who neither issued nor hold the actual bonds, where Companies A & B issued & hold the actual bond, but Companies Y & Z were just playing with funny money using silly hedge tricks.

Worst case: In a severe panic where a large fraction of the total CDS notional values could be claimed only the actual bondholders' claims would be honored, the speculators' CDS claims would either be left to hang out to dry (losing the CDS fee) OR if they're lucky they would be reimbursed for the price of the original CDS contract, losing just a bit of potential profit. The bond market wouldn't melt down and the U.S. dollar would remain intact.

Regardless these CDS's would only be executed in the case of a bond default. In order to prevent a run on the American dollar the U.S. government would do whatever it takes to functionally reinsure the legit CDS obligations by backing the corporate issuers of the originating bonds or the actual bond holders.

Again, the best the CDS speculators could hope for is that any CDS paper unrelated to the actual bond transaction might be reimbursed for the original contract price plus $.05 for the trouble.

It's probably the case that managing the CDS mess in such a manner would not cause a run on the dollar. IOW the danger is probably theoretical & we just need to get manage the hazards.

But expect serious new statutes governing the CDS market.