U.S. Government May Default On Its Debt

The banks are under pressure. The retailers are under pressure. The miners are under pressure. Everybody’s under pressure in Australia to keep profits up as the economy turns down. Naturally, stocks rallied.

The All Ords were up 3.9% on the day and the ASX/200 jumped 4.3%. The rebound we’ve been looking for in the over-sold blue chips looked a little bouncier yesterday. And today?

Well, a quick survey of the papers shows that NAB’s cash-earnings fell by 10%. Gerry Harvey says retail margins at his stores are, “under pressure.” And China announced third quarter GDP growth of “just” 9%the first single digit growth rate since the resource boom really started booming in 2002.

Yet for all the anxiety over an even greater slowdown in China, BHP’s U.S.-listing rallied 12%. Rio’s listing was even better, up 15.4%. Are investors following Warren Buffett’s lead and cheerfully ignoring the facts of a global slowdown? Or is it really time to buy?

One possibility here in Australia is that the selling has exhausted itself. If, as we suspect, a lot of the selling in the resource shares was indirectly caused by leveraged foreign hedge funds raising cash to meet third-quarter redemptions, then perhaps there just aren’t many investors left to sell. And since ASIC has extended the ban on short selling, the professional short sellers can’t go short, even if they wanted to.

Would you want to at this point? Our friend Doug Casey says the sell-off in the miners reminds him of the same situation in the 1970s. He says that at that time, the sell-off allowed him to re-load on miners who were selling for less than cash.

That sounds familiar because our own Al Robinson at Diggers and Drillers has been scouring the Aussie juniors to see who has cash and a heavily discounted share price. Part of the argument is a simple exercise in valuations. If you can buy a company selling at or below its cash on hand, you usually do okay.

The other part of the argument is that the tectonic shifts that will result from the Financial Panic of 2008 are better for Asia in the long run and worse for America. Sure, the developing world is currently caught out in a wave of defaults. Unlike the American government, foreign governments do not have the luxury of printing the money in which their debts are denominated. But as the global economy shifts towards the East, the developing world will invest more of its savings in itself, and a lot less in U.S. bonds.

For now, the fact that a lot of national borrowing is denominated in U.S. dollars is leading to what we call trickle-up wealth destruction. Pakistan, Ukraine, the Baltic states, Hungary, all of these Nation States are forced to go to the IMF and borrow money to meet their sovereign obligations. They don’t have the foreign currency reserves and can’t borrow in current market conditions.

You see, not all governments are big enough to guarantee their largest banks without putting their own credit ratings at risk. And not all governments are well capitalised, or have big tax bases upon which to securitise future borrowing. The credit crisis, then, is bringing not just private sector institutions, but governments too.

Eventually, the U.S. government itself may default on its debt. Since the British invention of a funded national debt in the 17th century, governments have been able to run perpetual debts by funding the interest payments on borrowed money with tax revenues. You simply keep rolling over the debt, using taxes to pay the interest and principal to bond holders.

America faces a situation where tax revenues are declining as the economy shrinks. Payments to the Baby Boomers are about t rise as a percentage of Federal spending. The Congress and the President and the Fed have added trillions on to the long-term liabilities side of the government balance sheet.

How will Americans ever pay off all that debt? And won’t creditors begin to ask the same question? The easiest way to pay off the debt, if you can’t raise taxes or borrow any longer, is to simply print more money. That’s inflationary.

And by the way, we’ve showed a chart in the past depicting the maturity of schedule of U.S. sovereign debt. It used to be most of it was 30-year debt, and not interest rate sensitive. But the U.S. has shifted most of its borrowing to ten year bonds and three- and five-year notes. These are a lot more interest rate sensitive. So what?

If the Fed doesn’t “sterilise” its credit creation and inflation catches fire in the U.S. and globally, short-term interest rates will move up (as they generally do with inflation). The cost of refinancing America’s huge debt will go up. Ouch.

Despite the bleak long-term picture for the U.S., the politicians in Washington pressed Ben Bernanke yesterday on whether he’d support more stimulus for U.S. consumers. He said yes, but in more words. He said it was, “not totally inappropriate given the nature of the emergency that we’re facing and not totally avoidable given the loss of tax revenues.”

“Quick, we’re broke. Spend more money!”

Speaking of central bankers, the Reserve Bank releases the notes from its meeting earlier this month where it astonished and delighted observes by cutting the cash rate by one percent. But just as newsworthy is the question of whether everything friendly between the RBA and the Rudd government?

Today’s Australian reports that the RBA strongly disagreed with the government’s recent decision to slap a blanket guarantee on all deposits with banks, credit unions, and building societies. The RBA, the story reports, says this has caused large institutional investors to exit any financial instrument or near-cash security and head for government-guaranteed deposits.

So what was designed to prevent a bank run may have precipitated a mini-one, according to the Aussie financial community. Someone tells Comrades Rudd and Turnbull!

According to the Australian, invest banks say their ability to source funding in the Australian market is compromised by the guarantee. Not that we have any tremendous sympathy for the investment banks at the moment. But if a move is designed to ensure the orderly operation of financial markets and does the opposite, it’s not a good move.

There’s plenty of reader mail in the inbox about what to add to our list of the best deserted island stocks to own in the Crusoe Portfolio. More on them tomorrow.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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6 Comments on "U.S. Government May Default On Its Debt"

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Charles  Norville
When Aus Govt makes promises to the plebs the Treasury tells the Govt how the promise can be kept and its usually taking money away from somewhere else. I would hazard a guess that the Treasury was NOT happy about the 10 odd billion cash bonanza to the plebs, so that they can spend it on keeping people employed in other countries, as well as the smokes, grog, pokies and overpriced petrol. Aus deindustrialised and so giving vouchers to buy Aus goods to keep aussies in jobs cannot apply and we are clearly in trouble following an ideology of not… Read more »
Greg Atkinson
Charles I cannot work out what the RBA is fighting these days, inflation or slowing growth. Earlier in the year the RBA said that inflation was enemy number one and they kindly raised interest rates too far. Now they seem to be in rate cutting mode but the latest inflation data suggests the inflation genie is out of the bottle again. (and the weak Australian dollar is not going to help that problem) Now we have Rudd wanting to pump 10 billion into the system and so that will give inflation another little nudge. I wonder if the RBA’s and… Read more »
Charles  Norville
Greg they have already given up on health, education and in particular the medieval practice of apprenticeship trade training we should have full time trade training to satisfy the real market demand for skills shortage. It has become bipartisan policy to bring in people from other countries instead of training Aus. To this we have dysfunctional employer/employee job matching marketing the ‘middle man’ employment agency system is a self serving obsticle to employment. Hence unemployment is unwitting bipartisan policy, with the labor party being involved with global socialism and the liberals into global corporatism both parties just wanting lower wages… Read more »
Greg Atkinson
Charles I started my working life as an apprentice and remember a time when Australian had plenty of skilled technicians,boilermakers,and electricians etc. But then it got hip to be a white collar worker and as a nation we took our eye off the ball. We then found ourselves with two main two sources of wealth, the financial companies and the mining companies. Now that both of those sectors have taken a beating we suddenly realize we do not have a world class technology sector of any size, we are not master ship builders, automakers and you will not find people… Read more »

At the end of the day, the taxpayers will have to pay the ultimate price for their ‘dog & phone’ shows. The worst is yet to come from this soap opera.

Read the latest report today at http://www.telegraph.co.uk/financeGLG-chief-Emmanuel-Roman-warns-thousands-of-hedge-funds-on-brink-of-failure-financial-crisis.

“Thousands of hedge funds on brink of failure…. We’re now paying the price for the biggest asset and credit bubble in history,” Professor Nouriel Roubini, a former US Treasury and presidential adviser.

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