How is the rest of the world (ROW) viewing America’s fiscal problems?
Here is Germany’s Der Speigel,
The US has more in common with heavily indebted southern European countries than it might like to admit. And if the country doesn’t reach agreement on deficit reduction measures soon, the similarities could become impossible to ignore. The fiscal cliff looms in the near future, and its not just the US that is under threat.
There’s more,
…Americans are now facing a different, much more real horror scenario: In just a few weeks time, thousands of children could be denied vaccinations, federally funded school programs could screech to a halt, adults may be forced to forego HIV tests and subsidized housing vouchers would dry up. Even the work of air-traffic controllers, the FBI, border officials and the military could be drastically curtailed. That and more is looming just over the horizon according to the White House if the country is allowed to plunge off the “fiscal cliff” at the beginning of next year.
The author is very astute in recognizing that if markets lose confidence, the U.S. is too big to bail,
US politicians, no doubt, would not be fond of hearing their country compared to Greece. After all, the heavily indebted euro-zone country was used during the presidential campaign as a caricature for the horrors of European-style socialism. But their current finances are not dissimilar, with one difference being that the US can’t count on outside help as the Greeks have received.
Modern Monetarists
We hear a lot these days, “no problem, the Fed is there to backstop U.S. sovereign debt. The U.S. has an independent central bank and will just print money to finance the government if it gets in trouble.”
No words can express how much this scares the bejesus out of us.
We’ve been in and worked with many countries where markets have lost confidence in the sovereign’s ability to pay and rollover maturing local currency debt. The central bank then had to make a decision. Should it inflict the pain on the poor and middle class by monetizing maturities causing hyperinflation (Bulgaria 1996/97); or stuff the sovereign creditors by defaulting and restructuring existing debt (Russia 1998)?
David Tepper, the great hedge fund manager, learned an expensive lesson in Russia in late 1990’s, saying it was one of his worst investment decisions,
In 1998, as the Russian government was having troubles with its increasing debt level, he saw an opportunity by reasoning that while Russia might devalue its currency it would not default on its debt. Of course, Russia went on to shock the global markets by defaulting in the same year. This misguided trade cost Appaloosa 30%.
QE Complacency
Quantitative easing has created a dangerous complacency, in our opinion, not to mention a huge bubble with potential disastrous consequences. That is, a belief in the central banks’ ability to solve all that ails an economy, including fiscal imbalances, excess debt, and falling asset prices. The Germans seem to truly grasp and understand this.
Distorted interest rates
But aren’t U.S. Treasury yields signaling little or no credit risk for the U.S. government?
We have a few observations.
First, the Federal Reserve has totally distorted the price signal of interest rates via QE and has become one, if not, the largest buyer of U.S. government bonds. The Fed is a nonmarket buyer and is not motivated by returns and yield.
Second, we sense that many of the marginal market buyers are cowboys and use long dated Treasury securities as a trading vehicle to game duration and economic cycles, front run the Fed, and as a temporary tail risk safe haven. We doubt many, if any, of these buyers plan to stick around to maturity. Thus, trying to discern any clear signals about longer term credit risk or inflation expectations from current rates is futile.
Global economy and markets in a parallel universe
In addition, we believe the yield on longer dated U.S. treasury securities is the most important price in the world, which all other investment yields are priced and benchmarked. If then the global benchmark is distorted, are not all investment returns distorted?
Quantitative easing, in our opinion, has catapulted financial markets and the global economy into a parallel universe. If aggregate demand, for example, is once again driven by asset price inflation as it was in 1990’s stock market bubble and the 2003-07 housing bubble, is there any hope the private sector will meaningfully expand capacity?
Twice burned by bursting bubbles, corporations and small businesses now see through the veil of demand induced by negative real interest rates and asset price inflation. No wonder they’re hoarding cash and not hiring.
Greek 4.84 percent 10-year yields
Third, Greece 10-year government bonds were yielding 4.84 percent in November 2009. All clear ahead, no credit problems, right?
How the market was so wrong. Less than three years later these bonds were effectively in default and restructured into securities with significant haircuts. When it comes to sovereign risk, we heed the words of the great 49er quarterback, Joe Montana, “confidence is a very fragile thing.”
Nobody knows when, what, where and how that tipping point which cause markets to lose confidence in a sovereign borrower is triggered. It may be next week, next decade, or possibly, but not probable, never.
We do know, however, what Hebert Stein stated so eloquently, “if something cannot go on forever, it will stop.”
And, of course, let us not forget the words of the late, great MIT economist, Rudi Dornbush
In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.
Reserve Currency
We concede the argument there is no current alternative to the U.S. dollar as a reserve currency. Dangerous justification for complacency, however, Spiegel writes,
Should politicians not agree to a credible plan for reducing US debt, it could ultimately harm the credibility of the dollar as a reserve currency
Greece is the Word
Finally, Spiegel sums up the perspective of foreign investors,
Greece’s economic problems and the resulting austerity packages it has passed have plunged the country into five straight years of recession. Germany, Europe and the world are hoping that the same fate is not in store for the US.
We could be wrong, but really think we’re right. Get it done, Washington!
Global Macro Monitor 
Der Spiegel says “US can’t count on outside help as the Greeks have received.”
He is wrong, in that the US is a monetarily sovereign nation that has its own currency and so doesn’t need outside help. The Greeks gave up the sovereignty when the adopted the Euro, so now they are at the mercy of ECB to survive.
Talking about Russia’s default, at that time Russian’s had pegged their currency against the US dollar and couldn’t keep up the peg so instead of devaluing they defaulted.
The US dollar is not pegged to any commodity or currency, so the US would not face the same situation you mention. Unless of course if our stupid congress chose to willingly default by not removing the artificial debt ceiling or by agreeing to austerity measures that cuts spending.
For a sovereign nation with its own currency:
Federal Deficits – Net Imports = Net Private Savings
Gross Domestic Product = Federal Spending + Private Investment and Consumption – Net Imports
You are mistaken. The dollar is pegged, to the available goods and services, for which gold is a proxy. Simply put, the price of a loaf of bread will rise to consume the number of dollars available for its purchase. It’s called inflation, which while decreasing the paper debt increases prices for consumers.
No Sir, I am not. We and the rest of the world went off the gold standard on Aug 15 1971. So there is no gold peg on the dollar, proxy or otherwise.
Inflation existed even when we were on the gold standard and that has nothing to do with the US’s ability to pay its debt that is denominated in its own currency. The US doesn’t have to borrow from anyone to create these dollars.
You lend billions of Euros to an insolvent country.Now you are worried they will not be able to service their debt.
As you sow, so shall you reap never sounded truer.Not to mention the incredible misery that has been bestowed on the Greeks.
A key difference is that the US has its own sovereign currency. Greece is check-mated in part because the market cannot devalue its currency specifically.
What a recklessly written article, both the Der Spiegel article and this blog post. Greece is a corrupt country that cannot collect its taxes, cannot produce goods, has no industry except for tourism. Not to mention they do not have their own currency that the market can depreciate. The only way they can regain competency in the market place is through wage deflation which is almost impossible to coordinate.
Contrarily, US has its own currency, and is a global safe haven currency. US has more in common with Japan than Greece.
Thanks for all the comments. It seems some did not read or understand much of what we wrote. We see a huge bubble in U.S. government, which is partly caused by the false assumption the central bank will backstop the US sovereign if it gets in trouble. This is reflected in some of your comments, “the US has its own currency…is a monetarily sovereign nation.” As we said, if, or when, the US moves into funding crisis, demand for the dollar will collapse and the FED will have to make a decision: monetize maturities/ hyperinflation or let the sovereign default. Recall this:
It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. – Ben Bernanke, CNBC July 1, 2005
“or let the sovereign default.” – How and why would the US default? They cannot run out of dollars.
You assumption that government borrows money from others to fund itself is incorrect.
The US government does not have to borrow money, it issues money, it creates it by spending it into existence, often taking a private asset in exchange. The government sells bonds to satisfy the private sector’s desire to hold savings in interest bearing instruments and to support interest rates in the private market. If the bond vigilantes don’t want dollars-based assets, we can stop squandering sovereign money supporting their market and let interest rates fall to nothing. That just lowers the propensity to save and stimulates consumption The government imposes taxes to insure the value of monetary instruments. Government debt is not debt in the conventional sense of the word – it is the governments IOU issued against the aggregate of the government’s UOME; it is the transduction of a one-sided private sector real asset into a two-sided financial asset (debit and credit), remitting the credit back as private sector wealth. That credit and its associated debit are both extinguished when the government receives it in payment against a tax liability. That is a monetary fact.
And what happens when the markets do not what to hold all the “money” the US government is issuing?
I am not sure I understand your question. The US govt only issues money when it wants to buy something or pay someone. The citizens of the US have to use these dollars for transactions within the US borders, so where is the question of them not wanting to hold these dollars.
Theoretically they can’t run out of dollars. If a tipping point is reached where there is a loss of confidence in the purchasing power of the “money,” as you define, how will the government roll over its debt? No theory, practically? Have the Fed repay bond holders in money they don’t want to hold?
You have to look at what’s being promised when someone is willing to purchase the US debt instruments, i.e. treasury bonds. They are promised the same dollars they used to purchase the bonds plus the interest which is also denominated in dollars.
If you can spare about 30 minutes, please watch this talk by economics Prof L. Randall Wray
Thank you for continuing this discussion.
Sorry the link to youtube was a bit incorrect. Here’s the correct link, the other link was for the entire seminar.
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