Recently, a significant development took place as House Republicans engaged in dialogue with President Obama. Although the specifics of their conversation remain unclear, it likely centered around the impending need to raise the debt ceiling.
Wall Street reacted positively to this interaction, with the DOW and S&P 500 both rising by 2.18 percent, while the NASDAQ increased by 2.26 percent. However, the day ended without any agreement in place.
With the October 17 deadline for raising the debt ceiling fast approaching, we are witnessing the final hours before what could be the most significant sovereign debt crisis in history. It has been centuries since a leader fiddled as their empire crumbled—Nero in 64 A.D.—and the current state of affairs feels equally precarious.
Many are hopeful for a last-minute resolution to raise the debt ceiling, particularly those in Wall Street. Yet, as the deadline approaches, we find ourselves anxiously wondering: What if no substantial agreement is reached and Treasury debt payments become overdue?
Would the global financial system seize up? Would debt markets become as frozen as the Alaskan tundra?
More Unpredictable than Lehman
The true consequences of a U.S. default on its debt obligations remain a mystery. However, Mohamed El-Erian, the CEO and money manager at PIMCO, offers valuable insight.
“What terrifies us the most,” stated El-Erian in an interview with Bloomberg, “is the impact on the plumbing of the global financial system. A cascading failure would result in multiple defaults, complicating the exchange of Treasuries used as collateral, leading many to step back. It would resemble the Lehman crisis but be even more unpredictable.”
Recall that when Lehman Brothers collapsed over five years ago, unexpected financial turbulence lashed out, causing unimaginable spread movements daily. The money market shares of the Reserve Primary Fund even lost value, dropping to $0.97 per share.
Imagining the chaos from a U.S. default on its debt is daunting. It could devastate capital markets and strip the dollar of its status as the world’s reserve currency in an instant.
Consequently, the longstanding advantages the U.S. has enjoyed over other nations would evaporate. The Treasury would lose its capacity to finance its debt through Federal Reserve-created money. This would leave federal entitlement programs underfunded, leaving many dependents in dire straits.
Janet Yellen’s Bad Idea
Compounding these issues, recent announcements indicate that Federal Reserve Vice Chairwoman Janet Yellen is likely to succeed Ben Bernanke as the head of the Federal Reserve come January. On Wednesday, President Obama named Yellen as his nominee for this influential position. Having held various roles within the Fed over the past two decades, her experience is significant.
However, her track record is marred by her association with an era of unprecedented Federal Reserve activism. One thing we do know is that she views monetary policy through a moral lens.
Back in 1995, during a Federal Open Market Committee meeting, Yellen argued for allowing inflation to exceed set targets for moral reasons.
“Ms. Yellen emphasized to the committee that ‘the moral’ of the situation is that ‘the Fed should pursue multiple goals,’” reports the Economic Policy Journal. “She advocated that, when goals conflict and tough trade-offs are necessary, a wise and humane approach sometimes requires allowing inflation to increase even beyond targets.”
It’s important to remember that inflation acts as a stealth tax on savers, diminishing the purchasing power of their savings. Ask any retiree relying on a fixed income or diligent individuals saving for retirement. Inflationary policies are neither moral nor industrious; they lean towards deception and theft.
Yet, within the academic circles of monetary policymakers, inflation seems to be held in high regard as the solution to deflation. In a world burdened with immense debt, deflation must be averted by all means. Any hopes for rationality within the Federal Reserve with Bernanke’s departure were dashed by Yellen’s nomination.
“While we’ve made progress, we still have more work to do,” Yellen stated following her nomination. “The Federal Reserve’s mandate is to serve all Americans, and far too many remain unemployed and stressed about meeting their financial obligations. The Federal Reserve can contribute positively, if it fulfills its responsibilities effectively.”
Ultimately, Yellen’s belief that increasing the supply of Federal Reserve notes will lead to more job opportunities is concerning. Unfortunately, this flawed notion is likely to inform her every decision on monetary policy, setting the stage for challenging times ahead.
Conclusion
The current economic landscape is fraught with uncertainty as both the debt ceiling and impending leadership at the Federal Reserve loom large. The decisions made in the coming days may have lasting consequences on the markets and the overall financial stability of the nation. We can only hope for rational solutions amidst the chaos.
Sincerely,
MN Gordon
for Economic Prism
