Monday, November 22, 2010

Austerity, Hyperinflation, Or Default

Jeff Nielson writes that austerity measures and hyperinflation are poor ideas for reducing US debt, and suggests that the US pursue a policy of "benign default" in which bond debt is restructured so only principal is paid back. See the following post from The Street.

It was nearly one year ago when Wall Street began its "attacks" on the debt-markets of European nations, which was dubbed by the U.S. propaganda-machine the "euro debt crisis."While Wall Street piled-into the credit default swap markets, and made enormous bets against the solvency of various Euro economies, the propaganda-machine began nine months of around-the-clock fear mongering-- designed to create the largest crisis-of-confidence possible.

The reason for this is that interest rates rise in tandem with fear, and every percentage-point which interest rates rose made these nations less-solvent and made Wall Street's economic terrorism that much more profitable, via those credit default swaps.

Let's be clear that there is a long-term eurozone debt crisis, as the solvency of many of these nations (notably the "PIIGS") is seriously at issue. However, the short-term "crisis" was entirely made-in-the-USA, with "crises" now being one of the leading U.S. exports.

At the time, I put these matters into perspective by noting that any rational viewing of the fundamentals revealed the U.S. economy was experiencing a far worse debt-crisis than the worst of the uurozone debt-sinners: Greece.

Let me add some new numbers here. Greek interest rates have been pushed up to over 11%. If the same approach drove U.S. interest rates to that height, it would result in an extra $4 trillion per year just in additional interest payments-- on the U.S.'s $60 trillion in total public/private U.S. debt (not counting another $70 trillionor so in federal "unfunded liabilities," which will soon also have to be funded).

If the U.S. were forced to pay out that additional interest (equal to nearly 1/3 of U.S. GDP), on top of the existing interest it pays on its debts, it would be a mere matter of weeks until the U.S. economy collapsed into a Soviet Union-like debt default or degenerated into hyperinflation-- as the only way to prevent default would be to print-up countless trillions (more) in new Bernanke-bills, just to pay interest on its debt.

With the U.S. debt problems being much, much worse than those of Greece, and with the U.S. economy being nearly 100 times as large, for anyone living in the real world, the "debt crisis" currently facing the world is the U.S. In comparison, the debt problems of all other nations comprise nothing but a debt-nuisance.

Be that as it may, with Greek interest rates artificially pushed-up to over 11% by Wall Street, that is clearly enough to make Greece's economy insolvent due to the excessive interest rates. Similarly, it is only the endless "quantitative easing" of the Federal Reserve which keeps U.S. interest rates artificially at 0% (propping-up the U.S. bond-bubble ) - allowing the U.S. government to pretend that the U.S. economy is still solvent.

As I have frequently pointed out in previous commentaries (and the above example), the moment that U.S. interest rates are allowed to rise to their natural level, the U.S. economy is instantly insolvent. This is why the original "quantitative easing" by the Federal Reserve did not end (and could not end). All that has changed recently is that Ben Bernanke is temporarily admitting to all the secret money-printing (i.e. counterfeiting) in which he has been engaging.

Whether "artificial" or not, a crisis has been created in many euro debt markets (and economies). Equally obvious, with interest rates pushed to these punitive levels, "austerity" alone cannot restore solvency to these economies.

With massive, structural unemployment -- which has led to 40 years of steadily falling (real) wages in Western economies-- our incompetent governments, and the ultra-wealthy aristocrats they serve have totally hollowed-out our economies. As massive unemployment and falling wages have impoverished the middle-class, the inherent "theft" built into any/every income taxation system has resulted in $10's of trillions in wealth being transferred into the pockets of the ultra-wealthy.

That massive pool of wealth (the largest in the history of our species) is simply being hoarded by these greedy misers-- doing no one (and no economy) any good, at all. Thus, the only hope for long-term solvency for these hollowed-out economies is to tax-back (over time) the $10's of trillions in "ill-gotten" gains for the ultra-wealthy.

Sadly, there is not even a glimmer of comprehension in any of our governments as to how income taxation has hollowed-out (and destroyed) our economies. This means the transition to a sustainable economic model isn't even being contemplated by any of our governments. In turn, this means some "formula" is needed over the shorter term to survive the current debt-crises-- until the inevitable reform occurs in our taxation systems.

In this respect, back in February I pointed out the need for Western debtor-nations to create a short-term formula for restoring solvency: "benign default." Understand that there are only two "options" currently on the table for dealing with these crises.

There is the approach currently being pursued by the "PIIGS" (Portugal, Ireland, Italy, Greece, Spain): "austerity." And there is the approach of the U.S.: lying about its debts, while engaging in a stealth-default on those debts via hyperinflation. Neither "approach" can succeed in doing anything but destroying all of these economies.

"Austerity" cannot work, for the reason I have already given: you cannot "squeeze blood out of a stone." The Western middle-class is already squeezed-dry. Trying to make euro economies solvent through massive economic "sacrifices" from millions of people who were barely surviving before the crisis started is nothing less than economic suicide, which will end in devastating debt-defaults.

As bad as that scenario is, it's still much better than choosing the "American solution" of hyperinflation. Hyperinflation also inevitably leads to a debt-default scenario. The difference being that taking the currency to zero (first) effectively wipes-out all of the wealth of an economy, while in a straight debt-default there are still large pockets of wealth remaining.

More importantly, both scenarios explicitly guarantee massive losses for bond-holders. This is what makes the greedy demands of bond-holders to be "fully repaid" totally idiotic. By attempting to insist on 100% repayment, all they do is guarantee that they will end up with a tiny fraction of that amount.

Conversely, if bond-holders take a "hit" today, sufficient to restore solvency to these economies, then the orderly repayment of these scaled-down debts can take place -- producing a much, much better long-term result for all parties. I coined the term "benign default" for this process (being the government equivalent of a structured bankruptcy).

The key here is to focus upon the root-cause of insolvency: compounding interest on these massive debts. It is not repaying the "principal" which inevitably bankrupts debtors, but rather the compounded interest on the original debt. Thus, all that is required for benign default to be successful is either for dramatically scaled-back interest payments, or total "forgiveness" of all interest payments.

What this means is that bond-holders lose nothing, in that they get their principal returned to them. Let us also not make the mistake of considering this "charity." The free choice by greedy bond-holders to lend-out these vast sums of money-- without ever considering whether those debts could actually be repaid is both grossly reckless and negligent.

Surrendering only the interest payments they hoped to receive on these ill-advised loans to insolvent governments is clearly no worse a fate than they deserve, given their own irresponsibility. It is also tremendously important to set a virtuous precedent here. Imposing a "haircut" on bond-holders today will be the fastest/easiest way to prevent more irresponsible borrowing/lending in the future.

Bond-holders who understand that they will not be subsidized/bailed-out by impoverished taxpayers will learn to lend-out money competently. What this translates into is realistic interest rates-- as opposed to the fantasy world of "free money" which the banksters foisted upon us, with their reckless money-printing and even more reckless credit-expansion (at near-zero interest rates).

Clearly, some of the eurozone governments are beginning to "see the light" here. Indeed, German Chancellor Merkel and French President Sarkozy recently announced their joint position on this subject: in all future bailouts or debt-restructuring, bond-holders must take a haircut. In the words of Bundesbank chief Axel Weber, "Next time there is a problem, [bond-holders] should be part of the solution, not part of the problem."

Keep in mind that in the private sector, such a basic principle of shared responsibility goes without saying. When a private company is about to "go under," rational debt-holders readily agree to a new schedule of reduced payments and debt-forgiveness. It is only the greedy/reckless lenders to insolvent governments who can't be bothered to engage in "due diligence" in lending-out trillions of dollars-- simply because they arrogantly assume that taxpayers will be forced into involuntary bailouts.

Those days are gone. Even if governments prefer to punish their own citizens for the reckless greed of bond-holders, "the people" are broke. For the bond-holders, it's either accept less, or end up with nothing. This is what makes "benign default" genuinely benign, in that it results in an optimal solution for governments, bond-holders, and the perennially-abused taxpayers of these nations.

It is also an antidote to U.S. economic terrorism. The "games" (i.e. crimes against humanity) that Wall Street is playing in euro debt markets become irrelevant-- once governments and bond-holders settle on a fixed repayment schedule.

Given the choice between "benign default" or total, economic Armageddon in the Western world, there is obviously no "choice" at all. Governments must create a feasible path back to solvency. Bond-holders must learn an important "lesson" about lending money. All other considerations are secondary.

This post by Jeff Nielson has been republished from The Street, a site covering financial news, commentary, analysis, ratings, and business and investment content.
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