Default Our Way Out of the Mess?
Some commentors have referenced a guy named Karl Denninger who thinks he has a solution for the present credit mess. At the website http://market-ticker.org/authors/2-Karl-Denninger, he says we should simply deflate housing values and have everybody with an underwater mortgage default and walk away. At the same time, those with unsecured debts that cannot repay them in the short term should declare bankruptcy. Furthermore, all the Federal Reserve and U.S. Treasury bailout and financial rescue programs should be rolled back and eliminated. Although this might have some very painful economic consequences, Mr. Denninger believes it will preserve the borrowing capacity of the U.S. Treasury, which is key to maintaining American economic might. He views the choice as pretty simple: either we let the private sector default on all debts it cannot repay or the government will eventually be dragged down and defult on all the debts it cannot repay.
While his solution is intriguing, Mr. Denninger ignores the fact that the U.S. government is the largest debtor of them all even without the bailout packages. What is the point of having the private sector default on most of its debts when the total debt of the U.S. is $60 trillion including unfunded liabilities? With a U.S. GDP of $14 trillion, the U.S. government debt is more than four times the total economic output of the nation! At an overall savings rate of 10% (including personal savings rate, corporate retained profits and government budget surpluses), it would take 40 years to fully fund the U.S. debt assuming all private savings are taxed 100%, we ignore interest payments, and there is zero new debt in the private sector. In other words, even if the U.S. government allowed a deflationary collapse of private sector debt until it effectively reached zero, and then somehow managed to maintain GDP at current levels while generating a 10% budget surplus, it would still never be able to pay off its debts in dollars at their present value. And that means its own creditworthiness will evaporate.
Indeed, my back-of-the-napkin estimate is that U.S. government debt will have to be deflated by a factor of 8-12 times over the next few years and decades in order to retain any semblance of creditworthiness. Conversely, the government debt will have to remain static in nominal terms (that means no more deficit spending) while the supply of dollars is inflated by a factor of 8-12. Either method would make debt repayment at least plausible but not necessarily probable. In particular, deflating the government debt would put tremendous pressure on the tax base and would create massive new deficits and/or a complete destruction of the U.S. as an economic, political and military power on the world stage.
The fact is that we are way beyond the point for a constructive plan or structural solution to deal with the debt problems. Perhaps 15 or 20 years ago the plan proposed by Mr. Denninger would have had a chance to succeed. At this point, however, the only option is to either (1) systematically wipe out all debts and start over, or (2) hyperinflate the money supply to the point where debt service becomes manageable in both the public and private sectors. It’s understandable that nobody wants to face this reality. Both choices are ugly.
This type of denial is similar to what I imagine is a common experience of people trapped in a burning high-rise building. Until the very last second before becoming engulfed in flames, there is always some small hope that a rescue will succeed. But once the flames are close enough, jumping out of a window becomes a preferred alternative. There is at least some exhilaration in the free fall that precedes the inevitable splat on the sidewalk below. In most cases, death comes quickly and is relatively painless. On the other hand, being burned alive is recognized universally as one of the most painful, if not the most painful, ways to perish.
Thus we should not expect that the irreversible decision to hyperinflate will come at any moment before it is absolutely necessary. There is always some hope up to the last second, no matter how remote or misplaced, that a rescue will succeed. Yet as the flames of deflation engulf the financial system and all hope fades, there will undoubtedly be that last attempt to seize destiny as the global monetary regime jumps out the nearest window.
As I mentioned a couple of days ago, Rick Ackerman has recently wondered out loud how a hyperinflationary tsunami wave would hit the markets today. In If Gold Hits $5K, Would You Sell?, he says the following:
Indeed, the coming economic collapse may not be the slow, black-hole implosion that we have long imagined, but more like a tsunami. As such, it could make the 1920s German hyperinflation, which took nearly two years to play out, seem almost leisurely in comparison. Back then, the financial world wasn?t wired like the ganglions of a central nervous system. It is now, though, and that is why the banking system, along with the global economy, could conceivably short out instantaneously in a shower of sparks.
. . .
So, what of this idea that the financial system could collapse so swiftly that even those who have been preparing for it would not have time to react appropriately? Realize that many stocks have experienced bear markets in mere days, collapsing 50% to 90% before investors knew what hit them. Some of the largest financial institutions in the world have gone belly-up just hours after ?problems? surfaced in the news. Even a whole country, Iceland, has gone from being a picture of financial normalcy to bankruptcy in less than a week. It happened in Argentina as well. Could the dollar collapse with equal swiftness, laying waste to the U.S. economy in a? matter of days? You better believe it could.? After all, the dollar is already fundamentally worthless, backed by nothing more than IOUs that have swelled far beyond our ability to repay them.
You say the dollar has been soaring recently? Well, yes, it has. But that doesn?t mean it is worth anything. In fact, the dollar is valueless, and the $1 bills in your wallet are worth no more intrinscially than the $100 bills. Those who do not understand why this is so or who would argue otherwise are simply ignorant or delusional. As we explained here a couple of weeks ago, the dollar is rallying because it is caught in a short squeeze. Short-term borrowers, unable to keep rolling their loans, have been forced to settle up in cash. This has created a made scramble for cash dollars, as opposed to credit dollars. And although the Fed has attempted to keep the system liquid with unprecedented infusions of new cash, the amounts pale in comparison to a global financial deflation that has already caused tens of trillions of dollars worth of financial and real estate assets to vanish from the economy.
For more than a decade, we have argued here that a ruinous deflation was the only possible outcome when the credit system finally collapsed. Although we still think that?s where we?re headed ultimately, we now see the possibility of a hyperinflationary spike along the way that would wipe out savers but also challenge the assumptions and investment strategies of gold bugs who have been preparing for the worst.? What would you do with your ingots, krugerrands, Maple Leafs and Pandas if the price of an ounce of gold were to soar in mere days into the thousands of dollars?? Would you continue to hold them?? We think this is a very risky strategy, since the world in which you will emerge from your bullion-lined safe haven will be too broke to pay a king?s ransom for a nugget, an ingot or a coin.
I don’t necessarily believe a deflationary wipeout is imminent but I do consider it a possibility that “a hyperinflationary spike” could come along and wipe out fiat savers over the course of a few weeks or perhaps even a weekend. What would you do with your gold if that were to happen? Sell it for dollars? Buy a cave in the remote wilderness and as many guns, ammo, beans and rice as your horse-drawn buggy can carry?
I believe his point is that we don’t really owe the $60T — most of that is “implied” promises like SS and Medicare, which he think ought to be repudiated. If you remove unfunded liabilities, you’re left with something more manageable, like 10-15T or so in USG debt.
A Collapse is a Foregone Conclusion. The only thing left to debate are the details. If gold and silver are insurance of a collapse of the Financial System, then having farm land paid in full out in the country is insurance on the collapse of the Suburban Infrastructure. I have made that transistion a year and a half ago.
There is plenty of speculation about the future turn of events. No one knows for sure, but the fact does remain…..the United States Citizens will be most at risk……for we have the largest Leveraged Energy System in the world. We have designed a system of DAILY LIVING that needs large amounts of ENERGY to function. Without that energy, the system contracts, and implodes. Our Domestic production of Oil is only a 1/3 of this amount.
This Suburban Energy System of ours was built on the same kind of structure as Financial Derivatives….and that is….the system will continue to function as long as energy keeps growing (the same with Derivatives). Once energy contracts, so does the system….but the problem now is not an INCREMENTAL DROP of energy (OIL), but a SIGNIFICANT DROP due to a collapsing US FINANCIAL MARKET and the US DOLLAR.
As Jim Willie states, if our US DOLLAR no longer used as the world currency, the United States will actually have to trade SOMETHING OF VALUE once again for FOREIGN OIL and GOODS. Monopoly money and worthless financial paper will be taken no longer. I don’t believe we can ship STARBUCKS COFFEE for OIL.
Rick Ackerman brings up sobering points about gold and silver….but I believe the REAL SHOCK to AMERICANS in the future will not be the loss of PRESUMED WEALTH….but rather the DESTRUCTION of the SUBURBAN WAY OF LIFE.
Who will have the money to bid gold prices up that high? What is the mechanism to get all this cash into the hands of homeowners? Outlawing foreclosures or restructuring debt does nothing if home prices continue to decline. With unemployment gaining steam, how are wages going to inflate? Congress could give everyone a $20K rebate check today and I think most people would just stash it away. People are broke.
Hi Tom,
In a post a few days ago (Ocean Receding) you spoke about the first effects of monetary inflation hitting within a few weeks. In today’s post you say:
“Thus we should not expect that the irreversible decision to hyperinflate will come at any moment before it is absolutely necessary”
Are you losing conviction that we are going to see the effects of monetary inflation in the near future? I am really conflicted about whether to hold onto my remaining cash and wait for better buying opportunities in the PMs or go all in now. Ultimately I think hyperinflation is the end game, but I’m worried that deleveraging/deflation could go on for a while.
Your thoughts?
Steve,
The American people will indeed not buy gold en masse. They are too broke and, even more important, will believe till the end that the dollar will not fall apart. But there are other people still living in this world. And the gold market is a planetary one. The Asians, Russians, and Arabs will buy gold.
IF Comex goes bust, which it probably will, a new gold exchange will emerge on the other side of the world. Just like the London Gold pool was closed in 1968. A new gold exchange was opened in Zurich.
I think if we have this hyperinflationary spike, I will wait till I can buy some farm land and house for a couple of gold coins. (I follow SRS on farmland) I had a plan to buy some land (with some houses on) in Sweden a year ago but I had to pay with debt. So I didn’t took the debt, but rather chose to save bullion. I would choose a country like Sweden because if we have this economic armageddon we also might have unimaginable war in the world. Then I rather be in a remote forest in Sweden when nuclear strikes might hit suburban Europe or American cities.
In Weimar inflation you could buy a family house for 1 fourth of an ounce!! Maybe it will be some more now, maybe a few ounces. We’ll need to see about that. More & more I am counting on this scenario.
But I will not change all my gold and silver for dollar, euro’s or other fiat paper. I will buy tangible assets with my bullion and I will set the price. I, as a buyer, will set the price. When you have bullion in the hyperinflation, you can set the price, i believe.
So I don’t understand Ackerman’s last phrase. When the world is too broke, it will be too risky to sell all your gold. When the world is broke, I think we will be able to buy A LOT of stuff with our bullion.
JVD,
Good point about Ackerman’s last phrase. There is no reason why people can’t use gold or silver directly as a medium of exchange. That’s how it has worked for most of history.
Sounds to me like its time to learn a productive trade, like brewing beer and reloading shotgun shells to go along with my gardening/canning operation.
All from inside my bullion-lined safe haven, of course.
To answer Rick’s question, I will only sell gold if I need “cash” for other things (like buying all these soon to be cheap houses). I will never completely liquidate at any price.
[In other news, re: previous rant, my silver arrived from Mr. Tulving today, 2 weeks to the day after he had received my payment.
Also, just went to the local dealer, who, other than a 1/10 oz. Maple, a 1 oz. Maple, and a 1 oz. Krugerrand had only a bunch .06 oz Pesos for sale, and a few Silver Eagles. The only reason he had the 1 oz coins at all was that he just bought them this morning. He still has other Krugerrands, but has too much in them to sell now. He has not made an effort to restock, even at these prices, with premiums being what the are.
I've noted lately that there is always someone there selling jewelry to him. Given the decline in price of late, I wonder if all those sell your junk gold commercials are driving business to him?]
‘Until the very last second before becoming engulfed in flames, there is always some small hope that a rescue will succeed. But once the flames are close enough, jumping out of a window becomes a preferred alternative. There is at least some exhilaration in the free fall that precedes the inevitable splat on the sidewalk below.’
this is the single greatest piece of economic commentary i have ever read.
i salute you.
ATTENTION SILVERAX READERS!
JP Morgan Chase chief Dimon sent death threats
The US Postal Inspection Service has offered a $100,000 (?62,000) reward for information after Jamie Dimon, the chief executive of JP Morgan Chase bank, was sent death threats.
By Tom Leonard in New York
Last Updated: 8:27PM BST 23 Oct 2008
Tom:
Did you notice that the Feds monetary base now jumped $309 bn - or 35.4%(!!) - since Sept 10, 2008 ?
http://research.stlouisfed.org/fred2/series/BASE?cid=124
2008-09-10 873.836
2008-09-24 949.879
2008-10-08 1016.742
2008-10-22 1182.508
the question about buying or selling gold if the dollar hyperinflates or deflates is backasswards…..gold is money - irredeemable currency is not….generally speaking one does not buy or sell money….gold does not ever lose its value….only the currencies for which it trades gains or loses value…..however, in the end irredeemable currency is totally valueless….that truth is only now starting to come crashing in on everyone’s head….greenspan came across today like a deer caught in the headlights if not with his antlers caught in a mack truck radiator grill….he was one of history’s all time quacks preceeded only by keynes and friedman….
the only reason to “sell” gold would be to get currency to buy something else of value….otherwise the dollar is dead…..dead……dead…..the witch doctors can talk about a strong dollar but it is only strong in comparison to other irredeemable currencies….in terms of gold or silver - i.e. money - it is worthless.
if the currency retains any value it is only because of the government’s ability to confiscate real wealth…..and if you don’t think that the department of home land security won’t dismantle factories and houses to ship overseas to pay off debts, you are a dillusional fool….
once everyone recognizes that the dollar is worthless, that the federal reserve is BANKRUPT, and that there is no way out of this economic crisis, then a couple of gold pieces will buy some nice farm land.
Serge,
Thank you for the update on the monetary base. Anybody have any thoughts on how long it will take for the fed’s monetary inflation to cause price inflation?
Serge, yes the $300 billion jump in the monetary base in 6 weeks is quite amazing, it is 300% annualized. The St. Louis Fed chart is just crazy, I’m posting it in a few minutes.
Every Thursday lately, I keep expecting the guy who is supposed to post the Fed figures, H3 and H41, on their website to fall down a stairwell that morning, and not be able to do his bureaucratic duty.
http://www.federalreserve.gov/releases/h41/Current/
It is really a continual State of Shock that the overall financial Balance Sheet is in, however it is kludged to look like a different story in the media.
There is no replacing such a loss of huge Capital except by work, production, and saving. In the meantime, debt repudiation becomes an inevitable reality.
And, our colleague “notgreat” above is right: the humongous amounts projected for Medicare ($40 billion?) will never be paid, and Social Security ($11 billion?) only under severe restriction.
The real debt actually already written in existing bonds will be enough to turn the race between Federal interest and declining revenues in a Depression into a foregone conclusion.
Obama will have to choose between funding bond rollovers and letting elderly starve in cold apartments.
The problem with axing Social Security and Medicare is that working people have actually been paying into these systems and the populace will literally go apeshit if these benefits are “repudiated”. Any attempt to do so would face a popular revolt aimed at repudiating government debt held by foreigners and “Wall Street fat cats”. In other words, messing with an entitlement like this could very well backfire and lead to (an expansion of the) socialist new order in the U.S.
We will inflate our way out of this mess. It is rational, it is elegant and no force can stop us. We have 183 F22’s which have no equal that can fly at 81 thousand feet over any location and even announce their presence with impunity. They can fly at supercruise for hours when all other military planes can only fly supersonic for minutes before they fall to the ground. Did I say they are essentially invisable? We spend 500 billion plus each year more than all the worlds militaries combined and the F22 is but one of our assets. Do I say this to inflame? No. It is a statement of fact. Some say the US is weak and unable to deal with new threats. Nonsense. We have more warfighting days of capability than all the world combined times 23. My point is that just as the owner of bullion sets the price and terms so does the largest power. We will not go into a stone age nor a barter society even if the rest of the world does.
Military strength cannot stand on an economic foundation of sand.
But you are right Peter G.
We will inflate trying.
I think it is very important to keep a long term perspective. People in 1930 also thought it was the end, but we are still around in 2008.
Yes, there may be a hyperinflationary spike but gold may settle at a much higher dollar price after that. We even may go back to some sort of a gold standard after “The Spike” where the price of gold is fixed at $1000+. Then you would have plenty of time to swap your gold coins for paper.
I wouldn’t argue with Denninger, he has made almost every call correctly so far in this crisis. He uses modified Elliot Wave and other technical methods, and it seems to work for him.
He doesn’t like precious metals much, preferring to trade equity options for greater profit, and there I have to agree with him. In his daily technical analysis videos, he sometimes outlines possible short term precious metals trades, but only as a trade, not buy’n'hold.
I’d put his record of accurate calls up against anyone. I know most here would rather just dismiss what he says because he is anti-goldbug.
If the government had followed his plan last Summer, we would be already past the bottom and looking forward to the end of the recession. Instead they did the opposite, and we are going to GD2 as a result. Just because it is unpalatable does not mean he is wrong.
I agree with “notgreat” above, you have misread Karl’s plan, he says the “entitlement” spending will have to be scrapped. If you back that out, his plan is indeed workable, or was last year, now may be too late.
Denniger is crying because his paper-debt-trading scheme is falling apart. Never to return. He will abhor the day he did not buy into the PM complex.
Lets see, firearms; check, lots of ammo; check, defendable homesite; check, food for a year; check, exclusive access to potable water; check…..
JoeM - please. LOL. The guy is a multi-millionaire who day trades, and very well. He’s proven he can make money up, down or sideways, and I don’t see any reason why he won’t continue.
He posts all his trades on his Forum, though you have to be a paid subscriber to access it, it’s all there. His profits, and win/loss ratios are very high.
Let’s see you post all your trades, and results.
Easy to trash talk the guy from your fortress of goldbug isolation. I would say only losers have to resort to simple minded insults worth of grade school students.
He also provides a very valuable free Forum for traders, where many, including me, have learned a lot about trading. I don’t agree with all his calls, but I respect the guy for his contribution to the world. He lead a huge campaign to say NO to the bailout, which failed, but at least he, and the people on the his site, can hold their heads up high knowing that at least they tried to do the right thing.
I’d say right there that was far more than most goldbugs ever did for the world, whose only contribution seems to be whining about conspiracies and bemoaning why precious metals aren’t worth the thousands per oz that you all know they should be.
Honestly, I think your comment exemplifies what is wrong with most goldbugs - a complete inability to accept any version of reality that does not agree with your preconceived notions. Sad to see such rigidity of thinking, but its a common problem.
I used to be a goldbug myself, before I grew out of it. Now, I just day-trade, and make money, and I don’t care if the market or economy goes up, down, or sideways, I’ll be making money. If precious metals double or triple, I’ll still be well ahead, and could care less.
I don’t even know why I bother posting here, you people are delusional. If you think holding precious metals will protect you as the whole world economy collapses, all I can say, is good luck with that. More likely the government will just confiscate all your metals, like they did last Depression. Then where will you be??
CM, its good to hear that you are doing well trading during this crazy time. Buy and hold hasn’t been real successful for me recently. I’m always looking for new ideas. I hope you keep posting as alternate opinions/ideas are what make Tom’s site special. The guys here are real good eggs and rarely belittle others opinions without some kind of backup research. All thoughts about how this mess will play out short and long term are welcome in my book.
CM says” If you think holding precious metals will protect you as the whole world economy collapses, all I can say, is good luck with that. More likely the government will just confiscate all your metals, like they did last Depression. Then where will you be??”
That cuts two ways. If your fiat currency becomes worthless, which I believe it inevitably will, then where will you be? If one is skilled at trading, there is no reason to stop. But that doesn’t preclude one from having PM for insurance. Personally, I don’t trade because I don’t have the skill.
I have my burial sites picked out should PM become illegal. Black markets thrive in conditions like that. The Romans tried it once under penalty of death and still couldn’t squelch the Black Market.
CanadaMetal…..trading paper is a good way to make money. I do that as well. I have a good portion in Bullion. I do not label myself as a GOLD or SILVER BUG…..I rather believe in making money….but long term. I just use bullion as this longer term investment vehicle. I believe other people feel the same way….they are not in LOVE with GOLD and SILVER….but rather see it as a LONG TERM INVESTMENT.
I will say this….those who TRADE in and OUT in a SECULAR BULL market never do as well as those WHO BUY and HOLD….BULLION or PRECIOUS METAL STOCKS. Now a fraction might.
You seem to see GOLD and SILVER BUGS angry at your responses….I don’t believe that is true….you are free to STATE your OPNIONS….but angry is not what I see….but rather a HEALTHY PASSIONATE DEBATE.
Lastly…..if you don’t care about GOLD or SILVER BULLION…but you rather make money trading…..you might consider changing your name to:
CanadaPaper….what do you think?
Tom, I like your burning building analogy except for one flaw.
You?ve placed the ?decision? and the ?consequence? upon the same person who is ready to jump to his death. And from that make the conclusion that he will wait to the last minute.
Instead I would say we have one person about to be pushed out to his death by the pyromaniac in a fire suit who started the blaze. This is not as elegant perhaps as your analogy but maybe more accurate. In this case the SOONER the push the better.
We are seeing a similar process that occurred in 1933. First markets crash, the public is moved out of gold (one way or the other), then further wealth confiscation is realized through subsequent currency devaluation/re-pricing of gold.
It is no revelation that the system is set up to strip away as much wealth as possible from as many people as possible.
Arguably, physical bullion has now been consolidated and the ?confiscation? phase is near completed. It is not desired that people protect themselves. We are simply expected to stand and be sheared.
Next, to transfer as much remaining wealth as possible and to inflate away as much debt as possible, the Dollar gold re-pricing that must come next will probably follow the same script. It will happen in such a fashion as to catch most people OFF GUARD. Stand still and be sheared.
The last group to plunder are those survivors holding onto the cash life raft. Why wait to the last minute and allow them time to reposition or even fight back? FDR did not wait very long.
The man is about to be pushed out the window to his death at any time.
I?d like to add.
The hyperinflation process has already begun. I see that as the fire in the building. Current systemic financial breakdowns are akin to fire-related structural damage.
The inflationary fire takes time to do its thing.
In the meantime we have to anticipate defensive actions by our creditors as they anticipate American defensive actions hostile to their interests.
This is why I agree we?ll get a currency devaluation real soon - the man gets pushed out the window sooner rather than later.
As an aside, I find it interesting to note that the dollar will always have value (in the U.S.) as the sole mechanism for payment of taxes. As it loses value, there comes the point where the G will no longer bother to collect it. I look forward to this happy day !
And if the Government decides to levy property, farm, land or other taxes in gold or silver instead? One might have to dig up all those well-hidden PM caches in order to pay up - or lose one’s “survivalist haven” to the selfsame G.
Anyone with land or property is a sitting duck - renew your passport, buy a tent and a backpack, learn Spanish (or Samoan)… or maybe your property isn’t registered??
Look at the behavior of the USSR Government (as funded by Wall Street via Zurich) during the 1929 “Gold Wave”. As Alexander Solzhenitsyn describes it (Gulag Archipelago, Vol. 1. p.52-53 1973):
“Who was arrested in the “gold” wave? All those who, at one time or another over the past 15 years, had had a private business, and had been involved in the retail trade, had earned wages at a craft, and could have, according to the GPU’s deductions, hoarded gold. But it so happened they often had no gold. They had put their money into real estate or securities which had melted away, or had been taken away in the Revolution, and nothing remained. The authorities had high hopes, of course, in arresting dental technicians, jewelers and watch repairmen…. Nothing - neither proletarian origin nor revolutionary services - served as a defense against a gold denunciation. All were arrested, all were crammed into GPU cells in numbers no-one had considered possible up to then - but that was all to the good: they would cough it up sooner or later!… Only one thing was important: Give up your gold, viper! The state needs gold and you don’t!… Feed the prisoners nothing but salty food and give them no water. Whoever coughed up gold got water! One gold piece for a cup of water!… If you in fact had no gold your situation was hopeless… but if you had gold, you could determine the extent of your own torture, the limits of your endurance…. One of the Tatar draymen endured all the tortures: he had no gold! They imprisoned his wife and tortured her, but the Tatar stuck to his story: no gold! Then they arrested his daughter: the Tatar couldn’t take it any more: he coughed up 100,000 rubles. At this point they let his family go but slapped a prison term on him”.
Relic…..might as well SLIT ONES WRIST….why go on living…LOLOL
I’ll give you one very good reason for going on living: TO PERFECT THE ART OF NOOSE-TYING.
Now that the Banking Cartel have stolen everyone’s money, their Government catamites compel us to bail the thieves out with more fiat, essentially presenting them all over again with the money they stole from us in the first place??
That spells R.E.V.O.L.U.T.I.O.N in my book. Otherwise, we’ll end up slaves behind razor wire in some FEMA gulag, working to “pay off” the debts into which we were conned by our jailers. It’s time we stood up for ourselves - and just hiding in the hills isn’t going to cut it…