It is amusing to listen to the dire saber rattlings coming from Moody’s and Standard and Poor’s about a threatened downgrade of the U.S. dollar by those two rating agencies. They can threaten until the cows come home and it can’t possibly compare to the what the Federal Reserve and offical Washington are doing to undermine the credibility of the dollar all by themselves.
The dollar would be slipping from its perch and rather quickly except for one thing, the rest of the world is in even worse shape than the U.S. It is just that their standard of living is so much lower than the U.S. standard, they haven’t felt it as much. China, the world’s No. 2 economy, and Japan, the world’s No. 3 economy, have their own troubles which should keep the U.S. atop the heap unless someone like Norway or Sweden figures out how to divest itself of its portion of the PIIGS’ debt. The PIIGS you might recall are the troubled Euro Union states of Portugal, Ireland, Italy, Greece and Spain.
But the dollar is slipping and you need look no further than the rates being charged for U.S. debt in the credit default swaps (CDS) arena. CDS is a means of the bond-buyer to get some insurance that the bond will actually be paid when it matures. There seems to be some doubt the U.S. is a good bargain anymore. Just like auto insurance goes up when a bad driver or a drunken driver try to obtain it, so CDS rates go up when some country has more debt outstanding than it can possibly pay like the U.S.
For a contrast in rates, look at Norway and Greece. Greece is one of the infamous PIIGS and has defaulted several times before. Greece has a CDS rate on its bonds 1000 times higher than Norway. While Greece and Norway have the same amount of issued debt each year, by comparing the countries’ GDP to the debt, the gap becomes unspannable for insurers. Greece’s annual debt is running 14% of GDP, while Norway’s debt totals less than 14% of its GDP. Greece could default as soon as the new bailout is spent. Norway isn’t going to have much trouble paying its debt until the North Sea oil is exhausted.
CDS rates on U.S. debt is higher than what Norway is being charged because the U.S. is close to 100% of its GDP in debt. But both Norway and the U.S. have AAA ratings from the two aforementioned agencies. But to show how little regard there is for the U.S. and its clueless band of leaders, Norway, Germany, Sweden, Switzerland Finland and the Netherlands all have lower interest rates on CDS than the U.S. This despite the fact all of those countries are facing the prospect of contributing to the bailouts of the PIIGS. How clueless does that make our merry band of leaders?
Another odd fact is the U.S. bond sales ratio of demand. Supposedly the U.S. has a 2.80 rating (meaning there are 14 bidders for every five bonds). This is a puzzle until you remove those agencies (banks, corporations, etc) which have an inside line on Treasury funds from Tim Geithner). When you remove those Treasury-aided bidders the ratio drops to 9:10, meaning some would go untaken and the U.S. would be in a deep pile of dung, forcing the rating services to immediately drop the U.S. status. In summation, the U.S. would like you to think the bond sales are going well but they, as the dealer, have stacked the deck. If you don’t believe this then please forward a logical explanation of the bailout repayment by GM when said company hasn’t been able to sell much more than 43% of the vehicles it has built over the past two years.
The impending debt ceiling fiasco also weighs in on CDS rates. America is just as unlikely to resist a raising of the debt limit as other countries so the CDS rate will keep rising until this issue is resolved either by Congress actually getting a grip on spending or the public passes an amendment forbidding our leaders from taking us into more debt.
What is fiction in the debt debate in Washington is the notion not raising the debt ceiling means default. Not raising the debt ceiling merely means Congress will have to live within its means and not spend more than it takes in taxes. Since maturing debt is already on the books as debt (unless those integrity-filled officials have figured a way to hide some of the debt) the Treasury can roll over new debt to take care of the old debt as this doesn’t raise the debt ceiling. What this cannot do is pay the interest on those maturing bonds. This has to be done within the tax collections. This is turn means a drastic cut in program spending for Congress because they will have to pay for over $800B in debt service without issuing new debt.
But the political bickering will mean U.S. CDS rates will rise because all that dirty laundry will be exposed for all to see. America’s creditors will see that America, like Greece or any other PIIGS, hasn’t the stomach to tackle its enormous debt issue.
This si the heart of the CDS problem. Government debt, no matter how high the rates go, is unstoppable. Just as a drunk will continue to drink and drive, so too will governments spend more than they receive. Insuring against the inevitable wreck means the rates have to become prohibitive.
U.S. debt is far worse than anyone in Washington will admit. Much like it juggles facts to arrive at unemployment levels or inflation rates that are as friendly to the current office holders as possible, so too is is the debt figure parsed out in such minute increments as to be ludicrous. Congress finally appears to be worried that national debt is surpassing GDP, as redefined from WWII GDP. But even using the new, expanded GDP as a base, U.S. debt is running about 14% or the same rate as Greece. But while Greece is slowing its rate, even with a declining GDP, the U.S. rate is increasing.
To get a glimpse of where the U.S. is headed with this fact-altering base, look to the Far East. China gives the appearance of a free market but the Chinese government has vastly inflated its GDP by building cities that no one lives in with a supporting infrastructure no one uses, just to boost GDP and give an appearance of a booming economy. China can’t even feed its swarming hordes and very few have even reached the comfort of the U.S. poverty line.
Japan’s once racing economy has been on the skids ever since the early ’90s and a “green economy” was tried. Japan is now skidding towards default, the brakes fully on the economy but Japan lacks the capacity to restrict its entitlement programs and the skid towards default continues. The sense of desperation coming from the Japanese economy is almost palpable.
The fundamental economic cycles require massaging every so often. But in the U.S. the massage need is growing more frequent as government interferes. From a 50-year cycle to a 30, from a 30 to a 10, from a 10 to a constant effort, the cycle has to be allowed to run its course. We now spend so much effort on the massage, we have nothing left for anything else. The sheer fatigue starts with a vicious ratcheting up of interest rates.
Like insurance actuaries know all about the risks of a drunk driver, so CDS gurus figured out the economic disaster the U.S. was headed for after the first returns from LBJ’s Great Society began trickling in. It is inevitable…the mail just came in and, rats, Uncle Sam’s CDS rate just ticked up again.
(Next Up: The 4th part of this series will look at the modern gold rush and probable government response.)
I am humbled by the tremendous response received back during the first two stages of this series. Thank you for your support.