US Default and Dollar Devaluation

The government poured billions of taxpayer dollars into the banks and the GSEs to keep the credit markets working. Not only are credit markets still dysfunctional, but we are on the deflationary expressway to depression.

WPA: unemployed shown at Volunteers of America Soup Kitchen: Washington, D.C. (Circa 1936). Courtesy of the Franklin D. Roosevelt Library Digital Archives, National Archives and Records Administration. http://www.fdrlibrary.marist.edu/images/photodb/27-0637a.gif

The latest idea for greasing the rusty credit system came out of Washington yesterday, as Jon Hilsenrath and Damian Paletta of the Wall Street Journal reported in Fed Weighs Debt Sales of Its Own. The Fed is considering asking Congress for permission to directly issue its own debt, not tied to Treasuries.

The prospect of another source of US debt issuance has naturally raised a lot of eyebrows. For example, Jesse's Cafe Americain was asking Is the Fed Taking the First Steps Toward Selective Default and Devaluation?

What an image. The NY Fed as a GSE, the new and improved Fannie and Freddie. Zimbabwe Ben can simply print a new class of Federal Reserve Notes with no backing from Treasuries. BenBucks. Federal Reserve Thingies.

Perhaps we're missing something, but this looks like a step in anticipation of an eventual partial default or devaluation of US debt and the dollar.

It is prudent to consider this risk. In an earlier posting, Will Quantitative Easing Crater the Dollar?, we have seen Nouriel Roubini's warning that the Fed's quantitative easing

... will eventually leads to much higher real interest rates on the public debt and weaken the US dollar once this tsunami of implicit and explicit public liabilities and monetary debt driven by rising twin fiscal and current account deficits will hit a world where the global supply of savings is shrinking – as most countries moves to fiscal deficits thus reducing global savings – and foreign investors start to ponder the long term sustainability of the US domestic and external liabilities.

But when will this "eventually" occur? There are good reasons to believe that the big risks lie rather far in the future.

So far, money injected by the Fed seems to be falling into a deflationary pit ... that is, it is not effectively offsetting money lost as the private financial system deleverages. And borrowers and lenders are all extremely risk averse right now.

So, the risks of default or dollar devaluation appear to be mainly in the future -- after the financial crisis ameliorates, credit starts flowing, and the economy shows some signs of life again.

Kill the Canary

Once the Arsenal of Democracy, Michigan has suffered from a weak economy for years now. Now that the depression is approaching, things are worse than ever with the cyclical economy of Detroit.

Congress only wants to dribble out the money, maybe to keep Big 3 from immediate bankruptcy.

Wake up, Congress. Detroit is the canary in the coal mine. After it fails, the rest of the dominoes are falling too.

If the auto industry goes under, so many other businesses will fail that we won't have to guess about the start of the depression. It will be here with a vengeance.

Paulson Should Wake Up and Fight the Depression

Robert Reich has joined the ranks of those saying that the economy is falling off a cliff. His latest blog entry, "Shall We Call It a Depression Now", takes note of Friday's alarming unemployment report -- the US has lost nearly 1.2 million jobs in the past three months -- and makes the appropriate conclusions about where the economy is headed. With consumers cutting back spending in the face of historically high indebtedness, tightening credit, and failing job prospects, there are very real risks that we are heading toward a depression. Someone needs to be bailed out, but who is it?

If the heart of the economy is the consumer, government's response should act directly to help the consumer. It's that simple, and Robert Reich's prescription is exactly in that direction, with this two-pronged approach:

First, the massive Treasury bailout of the financial industry must be redirected toward Main Street -- loans to small businesses, distressed homeowners, and individuals who are still good credit risks.

Second, a stimulus package must be enacted right away. It needs to be more than $600 billion -- which is 4 percent of the national product.

Stimulus Should Include Essential Services

Robert Reich's prescription for avoiding depression (see preceding post) includes an important point about the composition of the necessary stimulus package:

Construction jobs are critical but so are elder care, hospital, child care, welfare, and countless other services that are getting clobbered.

As I have said before in "Policy for Financial Crisis Should Target Those Most in Need", those who suffer most in this downturn will be those who are already most in need. Reich's prescription will help to meet those needs. It will also be the most effective solution for the whole economy . . .

This is supposed to be a service economy. It isn't going to be stimulated if service jobs aren't included in the stimulus package.

Lots of infrastructure is decaying in this country, and that includes the people and systems that comprise our social, educational, health and other kinds of human infrastructure. It isn't just a matter of bricks and bridges. We need to nourish and grow our human capital if this company is going to face the future as a thriving enterprise.

Depression Level Unemployment

Mish Shedlock has a thoughtful posting about trends in unemployment and their likely effects on the deflationary trajectory of the economy. In Prepare For Depression Level Unemployment Mish estimates:

Given that job losses are accelerating and that unemployment is a lagging indicator (unemployment is expected to rise for some number of months after the economy bottoms), it is not unreasonable to be talking about 10% unemployment sometime in 2010, with 8.5% to 9% or higher extremely likely.

8.5% or higher unemployment is enormously deflationary with the current backdrop of consumer debt and huge numbers of people underwater on their homes.

Unemployment was much higher during the Great Depression, but these are sobering estimates nonetheless.

Source:
"Prepare For Depression Leel Unemployment"
Mish's Global EconomicTrend Analysis
http://globaleconomicanalysis.blogspot.com/2008/12/prepare-for-depression-level.html

The Great Crash

Finally a noted economist says outright that the markets have experienced a crash. In The Great Crash of 2008 Robert Reich points out that, as of the close on December 1, markets have dropped 47 percent since the peak of last year, which is in the range of the Great Crash of 1929.

Reich also is right that more credit won't solve the problem, because debt loads are unaffordable relative to stagnant incomes ... and now we are hit with a severe economic downturn. That's what you get when the nation's resources have misallocated for years on end -- a bubble economy, bubble markets, and a Great Crash.

Look for the bad news to continue.


Source:
"The Great Crash of 2008"
Robert Reich's Blog, Monday, December 01, 2008
http://robertreich.blogspot.com/2008/12/great-crash-of-2008.html