I spent the day parsing Kenneth Rapoza’s article at Forbes.com, “What a US Default, Downgrade Might Look Like”. Boy, it is some scary stuff, if you are a weak-kneed congressman from a red state — the kind who has to choose between his instincts and visions of total global meltdown should he push the wrong button. Says Rapoza:
“If the US doesn’t raise the debt ceiling…it will be unable to borrow to meet short term obligations.
Rapoza doesn’t say why this is true, nor does he discuss any other alternatives to borrowing. We are expected to swallow his party line. Couldn’t the US just print the money it needs? Couldn’t it prioritize payments to meet its debt service obligations? Couldn’t it simply defer payments or force its creditors to restructure Federal debt? Rapoza doesn’t explain why the Congress’ failure to raise the debt ceiling has to end in default. Instead, he just jumps to his nightmare scenario:
“A short-term default would be a disaster for the US economy, and ruin its legacy as global safe haven.
Rapoza conjures up the woeful fate of Greece, which now has “the worst credit rating in Europe.” He is suggesting the US will suffer the same fate: we too will have the “worst credit rating in Europe” — only we are not in Europe. Moreover, all other debt is rated against US debt — not just other US entities, but all other debt in the world market. To give one example: the suggestion was made the other day by Sean Egan of Philadelphia-based Egan-Jones Ratings that the Fed will have to backstop Europe
All things being equal, the most likely source of support for the ECB is the U.S. via Ben Bernanke, who during the first signs of the crisis, ginned up more than $580 billion in dollar swaps in 2008 and 2009 with central banks around the world. These lines went out in a size and with a velocity never before seen in the Federal Reserve system, but were repaid. The swap lines have been extended through August 2012. The dollar-liquidity swap lines are with four major central banks—the ECB, The Bank of England, The Swiss National Bank and the Bank of Canada. The lines with the ECB are unlimited. The rationale was that there is no credit risk, because they are short-term, and the ECB was interposing itself between the sick European member banks and the Fed.
This implies, all debt — even pristine German debt — ultimately rests on the full faith and credit of the United States; downgrade US debt, European debt markets implode. If people no longer have faith in US debt, there is no debt to speak of any longer — because Europe cannot backstop its bank deposits. Once a bank run began, there would be no entity capable of “shock and awe” intervention — like TARP — except the Federal Reserve Bank.
So, Mr. Rapoza is, to put it mildly, overstating the rating impact of a US refusal to raise the debt ceiling. The rating agencies will not call BS on the US. It will never happen — even if the US never paid a penny of debt service again for all of eternity. The US debt ceiling vote is a revolver pointed at the heads of the plutocracy, Clint Eastwood style — do they feel lucky?
“Well, do you, punk?”
Anyone who thinks US debt will be downgraded only has to look at the asset ledger of American banks — mark to fantasy accounting. Still, Rapoza plods his way along his already discredited argument — a campfire tale to scare the junior campers Lake Woebeuntous: “My God, the US is in worse shape than Greece — if you add up all its obligations due until the sun blinks out of existence.” He quotes the head pimp at PimpCo, Bill Gross,
“We owe more than Greece…or any other developed country. We’ve got a problem…”
Bill the Pimp adds,
“…and we have to get after it quickly.”
So, you see, there is no time left for debate. The sky is falling. No time to examine the argument or facts of the case. If we don’t fix this, mankind as we know it will be extinct in two weeks. Hand the suckers in Congress a three page draft of a fragment of an idea of a plan to address the crisis, and yell, “Fire.”
I once saw a guy lose $20 to a three card monte gang on a street corner in New York using this very same technique. I am not exaggerating about that — I really saw it. As soon as he lost his money, someone in the back of the crowd yelled, “Police are coming.” The poor mark stared in bewilderment as the gang quickly scooped up the implements and scooted. Shit was funny.
Okay — now we have the bleak prospects of a nation hurtling to its economic and financial doom — let’s offer a glimmer of hope. So, Rapoza writes:
“The US does have a problem, but it has something Greece never had, nor any country in the world… AAA credit status”
Can’t you sheeple get it? The one hope we have of avoiding Armageddon is the very thing the Tea Party is threatening to destroy — our national FICO score! Imagine what it will cost to borrow, if we don’t borrow, to service the obligations what we have already borrowed We can still save the day, but it will be difficult at best:
“The US Treasury Department has a lot it can do…but before it does any of those things, it needs the debt ceiling to be raised”
So we have an impending extinction level event that will blot out the sun forever and render the planet uninhabitable. Timmy Geithner can fix it, but he really needs to borrow your credit card — and soon. Those idiots in the Tea Party, however, are preventing him from getting access to your bank accounts, social security number, and 401K. If they keep up their antics:
“…the government would have to stop, limit, or delay payments on a broad range of legal obligations… including Social Security and Medicare benefits, military salaries, and interest on the national debt… which is paid to big, market maker banks… not to mention the government of China…”
Did, Rapoza forget anyone? Let’s see: he aimed a fear message at seniors, and everyone who has a living grandparent, the sick, military families anyone who has every had money in a bank, or a 401K — and, of course, the Chinese. That may not be everybody, but it sure is a fair slice of the voting public. Oh, I almost forgot:
“Defaulting … including coupon payments to bond holders, would cause severe hardship for the US economy.”
Now, it includes everybody — on the entire planet! Everyone who directly or indirectly has business with anyone in the United States. We’re all going to die! Say your prayers, and grab your ass — this will be worse than Hiroshima.
“Those who survive will envy the dead.” –Our Lady of the Rosary
And, it is all the fault of those creationists in the Tea Party — damned fools think they are going to heaven anyway, so they don’t care. According to Rapoza,
There are two things investors consider when buying government bonds. They are essentially making two bets. One bet is on the government’s ability to pay that debt within the maturity of the bond, so whether it is 10 or 30 years, investors are betting that the government will make good on its promise to service its debt and pay it in full throughout the life of the bond. The second bet is political. Investors are hoping that the government doesn’t suddenly change its political and economic system entirely (emphasis added) and, as a result, opt out on paying bondholders. When it comes to the US, investors know they are investing in a political system that will remain sound.
In plain-speak: investors are betting Washington never stops inflationary economic growth. “Inflationary economic growth” is just a fancy economist term meaning Washington gets you to work longer and harder for less income. It should be clear, that debt creation is not a side-show to this policy: IT IS HOW THE POLICY WORKS. Essentially, it means you end up working more time just to pay off past debts, and less time feeding yourself and your kids. I wish I had one of those “red-pill, blue-pill” Matrix thingies, to get this into the heads of every so-called progressive and Marxist: Every additional dime of debt service means a dime of more work with less income. Rapoza writes,
“When it comes to the US, investors know they are investing in a political system that will remain sound.”
Translation: Americans are idiots and will never catch on to the scam. However, when Congress began publicly talking about the idea of default this was not a good sign. Rapoza writes,
Until Ryan, there has never been talk of any real possibilities of a short-term default. Bond holders at bulge bracket banks said off record that Ryan’s comment was “the dumbest thing they have ever heard.”
(According to Wikipedia, “The term ‘bulge bracket’ frequently refers to the group of investment banks considered to be the largest and most profitable in the world…”)
Now, with the default cat out of the bag, Rapoza ticks off a series of deliberately confusing events that allegedly would ensue following a US default:
One can only imagine what would happen if the US government missed a payment now. In short, it would be much worse. Bond prices would fall [yields would jump] higher. Interest rates on short-term loans would jump like a gazelle. Gold and oil prices would push higher, causing inflation in big emerging markets like China and Brazil, and pressuring gasoline prices in the US.
Why would this happen? Rapoza has no idea; he is just repeating what was told to him, because he is a parrot masquerading as a journalist. So let’s go down this list.
Bond prices would fall? Why would they fall? First, the bond market is a wholly owned subsidiary of the Federal Reserve Bank. Why would bonds prices fall when the Fed can create as much money as it needs to buy up every bond out there? A fall in bond prices would amount to a run on the Federal Reserve Bank, which has unlimited capacity to satisfy demand for bonds. The Fed could backstop itself, and all other banks on the planet at the same time — just as it did during the financial crisis of 2008. As Marshall Auerback and Rob Parenteau put it in a 2010 post, the Fed could slam bond vigilantes faces in the concrete as often as necessary until they get the message:
Then, every time some big swinging dick bond trader tries to push [bond yields] above 3.5% by shorting Treasuries, the Fed slams their face into the concrete by having the open market desk buy the hell out of UST until the 10 year yield is back to 3.5%. Burn Fido enough times, yank his chain enough times, and like the Dog Whisperer, he gets it and stops.
So, bond prices, at least in theory, need not fall. However, the Fed might stand on the sideline to let them fall just to deliver a message to Congress: “Raise the debt ceiling or else!” Which is to say, the Federal Reserve could start dictating terms to Congress.
Since, yields are simply the inverse of prices, without falling prices, you don’t get higher yields. Moreover, as was shown by the financial crisis, instability in the global economy induces investors (speculators) to move into the dollar. Now, why would this be true?
Simple: only the US has unlimited capacity to print currency to satisfy bondholders. No other nation has this capacity. This is why, ultimately, European banks must be backstopped by the Fed. So, the much vaunted bond vigilantes are, in reality, another campfire horror story to scare the junior campers. It is designed to dump so much scary and confusing information into your lap, you will simply lie down and let your rapist have his way. The information is not designed to encourage debate, but to avoid it.
The next scary-horror-thriller-terror-tale is that gold and gasoline prices with skyrocket. So, let me ask you: when is the last time you bought gold? Yesterday? Last week? How much of it did you buy? A couple of pounds of it, or a necklace? So much for gold prices, right?
Gasoline, of course, you probably buy twice a week or more — so this just might be a problem for you. So, let me ask you another question: what happens if Congress doesn’t increase the debt ceiling? The correct answer: The economy slides deeper into depression, as suddenly Federal spending drops just like state and local spending. When the economy contracts, demand for goods falls — gasoline is a good, just like shoes. If the debt ceiling is not raised gas prices will drop because speculators foresee less demand.
In fact, Rapoza, in his desire to make his bankster masters happy, has given in to outright fraudulent arguments. If you have been keeping track, you would have noticed that gasoline prices — and the prices for everything — has risen with increasing US debt. As each iteration of quantitative easing has been announced, commodities of every sort have reached new peaks. Prices have been driven along by the growth of US debt, and Fed quantitative easing — and food riots have broken out everywhere. A contributing factor in Egypt’s revolution were price increases spurred by Fed quantitative easing. Rapoza, however, would have us believe that inflation is caused by NOT CREATING new debt — again, this guy is not to be trusted.
Rapoza doesn’t have an argument with the internal consistency to stand on its own: he is relying entirely on throwing too much allegedly sophisticated information at you. This blizzard of confusing pseudo-factoids is meant to stand in place of an argument. He continues:
A default, let alone a credit downgrade if a default of any length were to happen, would have catastrophic economic consequences, potentially including the loss of millions of American jobs. It could lead to the loss of jobs, primarily, because as the US credit rating goes from AAA to AA — which would be the most likely downgrade — credit default swaps, or insurance on bonds, would increase for corporate bond issuers. That means it would cost companies more money to borrow. Many companies, seeing their bond prices fall, would likely be forced to offer the market higher interest rates to bring them back to the table. Higher borrowing costs is not good for growth. The job market, already hit or miss, would likely be put on pause.
As usual, Rapoza cites no source for his job loss estimate, nor any real hard number of how many millions of jobs would be lost. Is “millions” ten million? Is it twenty million? Fifty million? Two million? The US economy creates a million jobs a week even in a depression. So, are we talking about a loss of week’s worth of jobs or six months’ worth of jobs? Again, this is scary-horror-thriller-terror-talk.
The object, of course, is to avoid questions like: “What can we do to offset or avoid these job losses.” Rapoza is essentially arguing that the US public debt must increase constantly just to stay in the same place on employment. There is, he argues, no choice but to constantly increase US public debt if we are to avoid catastrophic jobs losses. If earlier Rapoza argues investor confidence is tied to job growth, now he argues job growth requires increasing debt to investors. The circle is complete: investors demand inflationary job growth, because inflationary job growth demands we borrow from investors. The flip side of his argument, of course, is that the accumulation of new debt itself is not sustainable over any reasonable period of time. And, the corollary of this latter argument is that job creation is not sustainable over any reasonable period of time.
Notice also how Rapoza argues the job losses would result from increased borrowing cost borne by the “job creators”, i.e., corporations. He proposes a domino effect: The downgrade of US public debt, increases insurance on corporate bonds, increasing corporate borrowing costs. Rapoza could make this argument stick but he would need to prove corporations have created a single net job in the US in the last 30 years. If Rapoza could show us figures proving US corporations created any net new jobs in the US economy in the past 30 years – BINGO! – he wins.
In fact, only a relatively small number of information age start up companies have created net new jobs in the US, and, when taken together, overall job growth is net negative. Essentially Rapoza is making the argument the US should raise its debt ceiling and borrow more to keep interests rates low so corporations can create jobs in — China? Folks, I am not making up Rapoza’s argument. You can follow my chain of reasoning based on his own words. The debt ceiling should be raised so companies can borrow at low interest rates here to export productive capital overseas.
Okay. Let’s go on. Rapoza says:
Many mutual funds and sovereign wealth funds (SWF) would instantly be forced to either change their investing covenants from AAA-only, to allow for the purchase of AA bonds. Many funds are only allowed to invest in AAA debt. If the US got downgraded, says Sara Zervos, who manges $14.03 billion in international bonds at Oppenheimer Funds in New York, every SWF and teacher’s pension fund in the country would be forced to change their rules. “You couldn’t possibly have a mass exodus out of US Treasurys like that, it would be a disaster,” she says. “I can’t image that a technical default would lead to a downgrade because that credit rating is based on the ability to pay,” she says. “Losing our triple A status would be a very big deal.”
There is no question US treasuries are the largest single form of wealth on the planet, so let’s just imagine every holder trying to sell at once. Clearly, a US downgrade, even if some lunatic at a rating agency took himself seriously enough to announce a downgrade on US debt, would be ignored by the markets. If, for no other reason, than the lack of buyers for the treasuries, and the lack of liquidity to facilitate the transaction. Only the Fed could provide such a facility, and it could provide it only in dollars.
So note what Sara Zervos, of Oppenheimer Funds, says:
“You couldn’t possibly have a mass exodus out of US Treasurys like that it would be a disaster…”
Although Ms. Zervos says it would be impossible to exit US bonds, Rapoza positions the quote to make it appear she is predicting an actual disaster. The operative phrase is this:
“You couldn’t possibly have a mass exodus out of US Treasurys…”
It’s like the scene from the Richard Gere movie, An Officer and a Gentleman, where he tearfully admits “I got no where else to go!” Bondholders got nowhere else to go. Global holders of US treasuries are screaming,
“Don’t you do it! Don’t you do…I got nowhere else to go… I got nowhere else…”
And they are saying this to you. The same bastards who took down your job, the value of your home, your retirement, and your children’s future, are now trying to scare you into continuing to play their Ponzi scheme, because they got nowhere else to go.
And be sure to piss on their graves after its all over.