Monday, October 20, 2008
Running on Empty: The Consequences of America’s Insolvency
Don’t let the good news fool you: the United States is bankrupt. We will be spending the next 25 years in a rolling Chapter 11. It will be painful.
Because we are currently the center of the world economy, and our currency is king, we can continue to indebt ourselves by borrowing money from the world, or simply by printing it. Because the dollar is the world’s trade and reserve currency, our neighbors accept it more readily than they would the currency of other bankrupts nations. But debts and money are promises to pay, and short of bombing our creditors into the Stone Age, they will be paid sooner or later.
Before discussing the possible consequences entailed in getting ourselves out of the immediate economic crisis, let’s look at some facts. Martin Wolf of the Financial Times (October 15, 2008) reports that financial losses beginning with the sub-prime mortgage debacle are estimated currently by the International Monetary Fund at $1.4 trillion dollars, an amount equivalent to 10% of US gross domestic product. Since Europeans participated in the massive debt pyramiding of the world economy originated by American and British banking houses, the direct hit for the United States thus far equals less than the full 10% loss, though more of the loss surely falls on us than the Europeans.
The United States according to the Treasury Department currently carries another $13.7 trillion dollars in debt, $10 trillion of which is government debt, held in the main by foreign governments, their firms and banks, and by our wealthiest classes via trusts, hedge funds, other investment vehicles. The current collapse is something of a climax as well as acceleration of the larger debt crisis that has been festering for almost two generations. Since the end of the Second World War, the world economy has needed dollars for trade and development, and finally for its enormous economic expansion. With the rise of China in the eighties, the demand for dollars soared, and the Federal Reserve, Treasury and US banks and investment firms obliged by creating the loans, bonds, and finally in the case of the Treasury the species necessary for growth.
Under the terms of the great shell game that is capitalism, as long as the world economy grew, and as long as the United States could lead or at least keep up, political and corporate leaders were free to imagine that the debts of today would be paid by growth tomorrow.
One problem, however, remained: with the world awash in dollars, and their number reaching fantastic proportions with the issuance of new debt and the creation of new debt instruments of the sort discussed by the media these past months, their value began to slip. Those dollar promises became more expensive to pay off, and the promise holders were receiving less in recompense.
Then, as by now everyone knows, people holding sub-prime mortgages began to default on their payments, and panic among bondholders holding securities based on the mortgages ensued, driving down the value of the bonds themselves. Housing prices, having been driven up by a flood of speculative investments, once again dollar-making investments on borrowed money, began to decline. The massive indebtedness of America, governments, citizens, banks, and firms, was exposed, and the panic spread more widely. Like the child’s game of musical chairs, each creditor now is desperately trying to avoid being left standing without a chair.
As the financial storm has hit, the American “debt dam” proved itself to be a New Orleans levee. Debts have poured over and out of it at all points. The balance sheets of US banks, firms, governments and citizens are inundated with debt. Frantic patching is occurring, though the damage caused – especially if the storm brings an economic cold front of recession and unemployment behind it will be massive.
What of the promises the debt and all of those dollars represent? The world, our massive creditor, will doubtless work hard to make us pay. Dollar devaluation and/or high inflation may cheat them of their total sum. But devaluation and/or high inflation will rob us of some significant portion of our standard of living.
And the greater degree to which the crisis, the adjustments, devaluation and/or inflation undermine the American economy, the more likely that we like other great debtor nations will be forced to sell off big chunks of our economic assets to pay off those trillions of dollars of promises.
This is what Chapter 11 bankruptcy for the biggest economy in the world could look like.
Posted by Michael Blim at 10:31 AM | Permalink