The Fed Stands Ready
- For Anything?

William (Bill) Buckler
Captain of The Privateer
Jul 26, 2010

Amongst a lot of other interesting information contained in the recently released US Federal Reserve Z.1 “flow of funds” data, this snippet stands out: Over the past two decades, from the end of the 1980s to the end of 2009, the rest of the world’s (ROW) holdings of US Dollar denominated debt paper has grown from $US 1.9 TRILLION to 15.3 TRILLION. That’s an increase of 705 percent. It has also brought ROW holdings of US debt from 60 percent to 108 percent of US GDP.

Don’t forget, government spending at all levels (most of it made possible only through borrowing) is counted as part of any nation’s GDP.

Historically, no nation which owes more to foreigners than its annual economic production has ever repaid that debt. It has either debauched the currency in order to “pay” with money of a vastly reduced purchasing power or, more often, it has simply defaulted on its debt altogether. In reality, the US cannot repay its foreign creditors, let alone its domestic ones. Mr Bernanke knows this, yet what is his considered advice to Congress? “I believe we should maintain our stimulus in the short term.”

Perhaps, given his background and his reputation as a profound scholar of the 1930s depression, Mr Bernanke HAS to believe this. But the rest of the world doesn’t have to believe it, and Mr Bernanke knows it. What he wants the “ROW” to do is to go on acting as if they believe it.

A Foundation Of Financial Quicksand:

The rest of the world has very hard evidence based on fact as to what happens to a nation which gets as deeply into debt as has the US over the past two decades. If markets are allowed even a pale imitation of their normal functioning, interest rates in the nation in question soar and the nation suffers a period of hugely depressed economic activity as it tries to put its fiscal house in order.

If markets are NOT allowed to function, interest rates may not rise or may rise to a much lesser degree than they normally would. If that happens, the currency of the nation in question plummets, putting even greater strains on an attempt to pay the foreign debt owing. The nation goes through the same depressed period but it is made much worse and lasts much longer because the markets are hamstrung.

That is what happens to any “normal” nation. The two decades since the end of the 1980s have seen every major nation on earth (with one exception) go through a more or less extended financial crisis at some point. Currencies have soared and plunged right along with interest rates as international financial agencies such as the IMF impose “austerity” measures which in many cases made the current ones being suffered by Greece and its fellow “Club Med” nations pale into insignificance by comparison. All over the world, investment markets have suffered accordingly. It is only since the start of the GFC three years ago that this phenomenon became worldwide.

A “normal” nation is a nation which does not provide the world with its reserve currency and which is not therefore capable of borrowing internationally in terms of its own currency. To take just one example, Hungary has recently come back into the sights of the US ratings agencies. Hungary’s main problem is the size of its foreign debt AND the fact that this debt is denominated in foreign currencies, notably in Swiss Francs and Euros. The interest on this debt has not greatly increased, but the Hungarian currency (the Forint) has plummeted against both the Swiss Franc and the Euro. That makes servicing, let alone repaying, this debt a very difficult proposition indeed.

Since 1944, the US has never had this problem. That is what has enabled it to run both government and trade/current account deficits without a break for half a century. Does the Fed stand ready for this?

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William (Bill) Buckler
Captain of The Privateer
email: capt@the-privateer.com

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