Looming Default Reminder of Past Debt Problems

Currency expert Kathy Lien revisits a time in 1979 when the U.S. missed a Treasury bill payment, pointing out that the value of the dollar only dropped 0.6% immediately following the lapse; however, the value plummeted less than one month after the one-time default. Lien notes that it would be a mistake to attribute the drop in value on the actual missed payment, but the real reasons were increased inflation and global concerns over the security of the U.S. dollar. For more on this continue reading the following article from Kathy Lien.

Although the U.S. government has never officially defaulted on its debt, it missed payments on some Treasury Bills in 1979. Then as now, Congress was playing a game of chicken with Republicans and Democrats bumping heads on raising the debt ceiling. The debt limit was a fraction of its current levels and at the time, the dollar only fell briefly. The 0.6 percent drop in the Dollar Index was so small that it was barely left an imprint. However less than a month later, double digit inflation and concerns about the outlook for the U.S. economy along with the security of the U.S. dollar drove the greenback sharply lower. It may be tempting to attribute this decline to the short term default on U.S. debt but the Treasury started making its T-bill payments again after a very short delay.

Here’s a chart of how the dollar behaved when the U.S. government missed its debt payment in 1979:

This blog post was republished with permission from Kathy Lien.

The Growing Inflation Battle

Inflation is growing in many emerging markets, and a battle is brewing between the US and these countries. The US doesn't seem willing to budge on its current economic path, while the emerging markets are reluctant to allow their currencies to appreciate. Economics Professor, Mark Thoma, takes a closer look at this battle in his blog post below.

Tim Duy notes rising concern about inflation from hawkish central bankers in Europe and elsewhere, and the tension that is building "as emerging markets fight the Fed":

Inevitable Inflation Fears, by Tim Duy: The Wall Street Journal is reporting that ECB head Jean-Claude Trichet is turning increasingly hawkish:

Inflation fears—fueled by spiraling food, oil and raw material prices—are mounting around the globe, prompting the head of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the Continent's debt crisis.

In an interview with The Wall Street Journal ahead of this week's annual meeting of the World Economic Forum in Davos, Switzerland, Jean-Claude Trichet warned that inflation pressures in the euro zone must be watched closely, and urged central bankers everywhere to ensure that higher energy and food prices don't gain a foothold in the global economy…

An interesting development in light of the ongoing (or is it never ending?) European Debt Crisis. Rate hikes will just be adding insult to injury for the peripheral nations already struggling with a debt-deflation spiral. The price for being part of the Euro just keeps getting higher.

Inflation fears have yet to grip the Federal Reserve, for good reason. Back to the Wall Street Journal:

While high unemployment and spare capacity are restraining underlying inflation pressures in the U.S. and elsewhere in the developed world, annual inflation in China is almost 5%—and a sizzling 9.8% economic growth rate in the fourth quarter triggered fears of more price pressures ahead. Inflation in Brazil is even higher.

The next inflation crisis is not occurring in the US, as opponents of QE2 thought likely, but in the developing markets instead. To be sure, my sympathy for developing nations wore thin long ago. They will identify the Federal Reserve as the proximate cause of their problems, whereas they have only themselves to blame. Higher inflation abroad was the only outcome if the protocols of Bretton Woods II did not submit to the onslaught of QE2. And the Federal Reserve has very good reason to keep the pedal to the medal. A review of recent inflation behavior:



If inflation abroad is a problem, it is not because the Federal Reserve has set rates too low, but because emerging markets been unwilling to allow their currencies to appreciate sufficiently against the Dollar. See, for example, recent Dollar buying on the part of Brazil. See also Paul Krugman, who illustrates the clear difference in emerging and developed nation industrial production trends. Again, if inflation abroad is a problem, it is one that emerging markets need to tackle themselves.

Expect global tensions to continue building as emerging markets fight the Fed. While the Fed may identify higher commodity prices as a potential concern, policymakers are not likely to reverse course and tighten policy unless higher commodity prices push through to core inflation. Such an outcome appears unlikely given persistently high unemployment. Consider too that the likely outcome of rising commodity prices is to slow US growth, thereby decreasing the odds of pass-through to core.

I have said this before – I do not see how this ends well. Given that the Fed is not likely to back down from this fight, emerging markets need to put the brakes on their internal inflation issues, the sooner the better. Otherwise they will be facing pain of a real inflation crisis, one that requires stepping on the brakes even harder. How this story unfolds this year will determine of the global economy can transition to a sustainable, balanced growth trajectory, or plunges into yet another of the seemingly all-too-frequent crises.

This post was republished with permission from The Economist's View Blog.

Comparing America's Debt To Greece's Debt

Moses Kim from Expected Returns compares the national debt levels in US and Greece to make the case that a US debt default is highly probable. In addition to similarities in deficit to GDP ratio, the US politicians are promising citizens benefits that they won't always be able to provide. See the following post from Expected Returns.

The bemused indifference surrounding a potential U.S. debt crisis is amazing in light of our similarities to Greece. But I shouldn't be surprised since people behave the same way leading up to any major crisis: hubris is followed by denial, which is then followed by all-out panic. We are currently in the "denial" stage. I am not trying to be hyperbolic here, but a debt default in America is a high probability event.

To corroborate my statement, I have plotted key Greek debt ratios from 2009 against projected U.S. debt ratios for 2010. Now concentrate for a second. See any similarities?



We are no different from Greece in making social promises we cannot keep. Social Security and Medicare have to be slashed significantly one way or the other, either by decree or via inflation. The political will to make drastic cuts to these programs just doesn't exist. Inflation is coming since it is the easy way out for politicians. Never-ending monetization will assure this.

Trillion dollar deficits are here to stay since States will need to be bailed out en masse. California recently announced a $19.1 billion dollar budget shortfall and will need federal aid soon. So will Illinois since they are going the "head-in-the-sand" route of simply not paying their bills. Utterly amazing.

I am quite certain the U.S. dollar will eventually come under intense pressure from shorts. We have reached the point of no return and you can thank our politicians for leading us off the cliff. Gold will be the only asset to come out of this coming crisis unscathed. If you think gold is overvalued at these levels, you clearly are underpricing potential risks. I hate to be so dire, but the evidence is starting to mount that this will get pretty nasty. We are simply not seeing the type of leadership we need to prevent this coming debt crisis.

This article has been republished from Moses Kim's blog, Expected Returns.