The U.S. May Engineer A “Soft Default” – Here’s Why and How (+2K Views)

When government is wounded, trapped and desperate, it lashes out like a wild animal. Survival in the political class is just as strong a drive as it is in the wilderness. I don’t know how government will lash out, but you are likely to see laws, restrictions and behavior you never imagined…. Washington has demonstrated it will “print money” in whatever quantities necessary to stave off a sovereign bankruptcy and a Great Depression but this strategy cannot work forever because existing debt is already too high to be serviced. It is only a matter of time before the U.S. economy succumbs – unless it engineers a ‘soft default’ [which will save it’s ass and get you shafted! Let me explain.] Words: 1394

So says ”Monty Pelerin” (a pseudonym derived from The Monty Pelerin Society) in edited excerpts from his original article* as posted at www.economicnoise.com .

Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.

Pelerin goes on to say, in part:

• It controls the world’s currency, the dollar. So long as this lasts (and it lasts only until an alternative is found), it has more wiggle room in terms of its ‘extend and pretend’ options. The dollar will likely be a short-term beneficiary of the disruptions in the Euro as capital flees out of Europe into whatever is considered a safer haven. Ultimately, the dollar will weaken when it becomes apparent that the political class in Washington is jeopardizing the dollar and U.S. solvency. The U.S. political class has no way of solving the country’s problems. They have chosen to sacrifice the dollar in order to extend their time in power.
• Its fiscal condition is not quite as bad (yet!). At current government spending rates, that differential is disappearing rapidly.

Washington has demonstrated it will “print money” in whatever quantities necessary to stave off a sovereign bankruptcy and a Great Depression. This strategy cannot work forever because existing debt is already too high to be serviced. It is only a matter of time before the U.S. economy succumbs. Easy money will not produce an economic recovery, nor will it avoid another Great Depression. It is a last gasp strategy to defer the inevitable rather than to face up to the problem(s).

If this strategy is continued, the dollar will eventually decline toward Voltaire’s definition of fiat currency’s intrinsic value — zero. Before that, I suspect, the government will engineer a “soft default.” A soft default is one where obligations are honored in nominal terms, but not in real terms. It is easily done via high inflation.

I speculated elsewhere about the issuance of a new dollar as a means to achieve such an outcome. It is simple, quick and devastating. In such a scenario, the U.S. changes currency much like Greece. Here is how such a scenario could play out.

• The U.S. declares the old dollar null and void, requiring all old dollars to be converted into “new dollars.” This conversion is more dangerous to US citizens than it would be for Greek citizens for two reasons:
• All contracts and obligations in the U.S. are denominated in dollars. The government could easily mandate that all existing claims can be honored by payment in full with “new dollars?”
• There is no competing currency in circulation in the US. Citizens would not be able to arbitrage against a competing currency.

Let’s look at an example of one way this could happen. Government issues new dollars at the rate of 3 new for 1 old dollar. That is an immediate and massive devaluation of the dollar. In effect,

• all creditors would be harmed by being paid off with dollars now worth 33% of what was originally lent,
• borrowers would benefit to the degree that creditors lost. Real debt would effectively be reduced by 67%. Who would be the biggest beneficiary of such a ruling? Why the US government!
• all government promises like social security, welfare payments, medicare, etc. might also be deprecated. Who wins again? The US government! Is there a pattern here?
• Those harmed most would be lenders. In this case, it would be anyone holding US Treasuries like US citizens, China, Japan, etc. It would also be the U.S. banking system which could not survive without massive additional government bailouts but government has already shown its propensity to do whatever is necessary to keep the financial system alive.
• Apparent beneficiaries would be consumers and the housing markets. Real consumer debt and mortgages would be effectively reduced by 67% (as incomes would presumably triple). Of course they would be harmed by the bailouts necessary to make the banks whole, but many would not even see the connection.

If such a devaluation played out as described, the government would effectively “default” on two-thirds of its debt obligations while, almost assuredly, maintaining that it was honoring them. Government would lose credibility, and be accused of bad faith by credit markets, but time would eventually heal those concerns.

Voila! Debt problem solved, but not the economic problem.

• Inflation would at least triple, presumably raising many incomes and prices accordingly but price inflation is never uniform, so additional distortions and inequities would be infused into the economy.
• The strategy would not avoid a Great Depression. It might in fact bring one on sooner as the loss of purchasing power to the elderly (anyone dependent on fixed incomes), the poor and those on government assistance ripples through the economy.
• Further, such a strategy could trigger hyperinflation which would reduce markets to barter, essentially guaranteeing another Great Depression.

A massive wealth transfer would have been effected away from the productive sector toward the unproductive (government) sector.

The scenario just described might be considered unlikely, but it is exactly the strategy government has pursued since the economic crisis. Actually it is a strategy followed even before the current crisis:

• Since the formation of the Federal Reserve in 1913, 96% has disappeared.
• Since 1980 inflation has stolen 80% of the dollar’s purchasing power.
• Since 1980, the Fed has effectively given you new dollars for old dollars (at least in purchasing power value) at a ratio of 4 new for 1 old

so how far-fetched would it be for them to declare an emergency and repeat this action only in a shorter timeframe?

It is difficult to be specific regarding a currency default/issuance of new money in the U.S.. The possibilities are there, easily accomplished and done before, just in slower motion.

Two areas may provide signals that something is about to occur:

1. Markets: Markets often force action before it is politically desirable. Erratic movements, especially in exchange rates, might signal the imminence of such action. A rapidly rising price of gold would also likely precede such a currency event as the ruling class and their crony friends dump the dollar in advance and buy gold and other hard assets.
2. Politics: The political class will do what is in their interests and what they believe they can get away with. As sovereign bankruptcy nears, the courage to default via a currency event increases. What was considered politically impossible then becomes merely unpalatable. Further, as the country devolves further towards totalitarianism and away from the Rule of Law, those in charge will be more emboldened to act….

Conclusion

The world is headed for a debacle in financial markets and living standards. Both will be preceded by currency collapses. The declines in Europe and here will trigger conditions unlike anything before experienced on a worldwide basis. Greece is merely a small canary in a small coal mine. Pay attention to how this canary dies, because it may help you survive what is coming to your personal coal mine.

For me holding dollars and dollar-denominated assets is dangerous. Good luck and hunker down for some unbelievable times ahead.

*http://www.economicnoise.com/2012/02/23/new-currency-the-next-great-plunder/

Editor’s Note: The above article may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.

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