Today’s global financial landscape is increasingly disconcerting. Governments across the world are facing significant monetary challenges, and Europe is at the forefront of this crisis. Countries like Greece, Ireland, and Portugal have seen their credit ratings downgraded to junk status, with Italian and Spanish debts likely to follow suit.
A default by even one of these nations could devastate major banks in France and Germany, which are heavily exposed to their debts. Meanwhile, the situation in the U.S. remains precarious, as Congress and the President struggle to cut spending and raise the debt ceiling.
The economy resembles a sinking ship, with the Federal Reserve making frantic attempts to bail it out by increasing the money supply. “We have to keep all options on the table. We don’t know where the economy is going,” Federal Reserve Chairman Ben Bernanke stated to the House Financial Services Committee, shortly before Moody’s Investor Service placed the nation’s credit rating under review for potential downgrade.
There are limits to how many times Bernanke can inflate the money supply before a collapse occurs. What will happen when this financial bubble finally bursts?
To explore these critical questions, we’ve invited retired Finance Professor and author, Michael S. Rozeff, to share his insights.
Enjoy,
MN Gordon
Economic Prism
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A Run on the United States Government
A ‘run’ refers to a mass withdrawal of cash from a borrower. We are currently enduring a continuing global credit crisis, marked by various “runs” that attract differing levels of attention.
These runs are not mere panics or psychological quirks; they represent a rational response from investors who recognize their funds are at risk. They act swiftly to withdraw their assets before they lose them.
The peril arises when an institution stops receiving sufficient cash inflows to meet its obligations. In business, this often occurs due to poor investments, while in government, it results from unproductive spending that fails to generate tax revenue.
In 2008, we witnessed a series of runs on major Wall Street investment banks, money market mutual funds, domestic banks, and even foreign banks. Today, these runs are directed at European governments like Greece and Portugal, where sovereign debts are being heavily sold off as investors convert their bonds into cash.
Three years after the 2008 financial crisis, the Federal Reserve continues to support U.S. banks with extensive credit to prevent bank runs. Periodically, the Fed also extends loans to foreign central banks to maintain stability in their financial systems. However, these measures are temporary fixes and rely heavily on the faith in one currency: the U.S. dollar.
Runs on various institutions typically manifest as a flight to short-term U.S. Treasuries—the dollar—because of the market’s depth. However, as the dollar is also a credit instrument, it is not immune to credit risk. What happens when trust in the dollar collapses? If confidence falters, the numerous financial institutions bolstered by the dollar’s creation could be at risk. This scenario could lead to severe financial system disturbances, prompting governments to freeze bank funds and restrict withdrawals, as witnessed in Argentina. At that juncture, gold’s value may skyrocket against the dollar and all other fiat currencies.
I am discussing a potential run on the United States government, characterized by mass withdrawals of cash financing. This would mark a severe credit crisis, leading to widespread civil unrest and significant political changes. Stock and bond prices would likely plummet, with the S&P 500 possibly losing at least 60% of its value and government bonds yielding at least 10%. While this outcome is foreseeable, it is still preventable, albeit with substantial effort.
Now, more than ever, we are all currency speculators, a role few of us welcome.
The possibility of a run on the U.S. government rests in the hands of its creditors, largely contingent on their faith in the dollar. This trust is influenced by their understanding of America’s political and economic landscape.
Anyone observing the U.S. government’s current actions aimed at maintaining its credit would likely arrive at a negative conclusion. The country’s leadership has been on a downward trajectory for decades. America resembles a once-ripe apple that is now gradually rotting. While some parts remain edible, large portions have deteriorated, and it is time to start anew.
Dagong Global Credit Ratings, an agency with 15 sovereign debt ratings, currently assigns the U.S. a rating of A+. This was downgraded from AA- in November 2010, following the Fed’s announcement of a new quantitative easing program.
In a striking assertion made in mid-June 2011, Dagong’s president stated, “In our opinion, the United States has already been defaulting.” Moreover, Dagong has invested $1 million to enter the U.S. market, yet their request to the SEC has so far been declined.
The ongoing debate over the debt ceiling—like all debates in Washington—sends negative signals about U.S. creditworthiness. President Obama plays a pivotal role, publicly discussing various proposals instead of working quietly with key Congress members. If he were genuinely committed to effective solutions, he would have been proactively addressing the budget long before now, showing leadership in the process. Presenting multi-trillion-dollar proposals and expecting serious debate within a couple of weeks is unrealistic. Obama’s credibility regarding budget control is virtually nonexistent. Both Republicans and even some members of his party have little reason to trust him, given his tendency to manipulate circumstances to further his agenda. Thus, the present debate lacks seriousness.
Did the near-catastrophe of the 2008 credit crisis spur the U.S. government into action? Yes, but that manifested as bailouts, ongoing wars, increasing deficits, and the absorption of Fannie Mae. The U.S. government has had years to implement strategies to rejuvenate the economy, eliminate bad debts within the banking system, and manage the federal budget effectively. Truth be told, it’s been closer to three decades or more since any significant steps have been taken. A brief examination reveals that healthcare and Wall Street reform seem to be the centerpiece—not the solutions the country desperately needs.
The U.S. government lacks credibility when it comes to restoring America’s financial health. It operates on the vestiges of its past reputation, akin to a once-great performer who has lost their touch.
Under these circumstances, trust in the dollar, along with other fiat currencies linked to it, will likely continue to decline. Unless a shift occurs, a run on the United States government seems inevitable, and I see no indication that such a change is forthcoming.
Sincerely,
Michael S. Rozeff
for Economic Prism
[Editors Note: Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. He is the author of the free e-book Essays on American Empire: Liberty vs. Domination and the free e-book The U.S. Constitution and Money: Corruption and Decline.]
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