28 October 2008

In 2009 the US Will Be Forced to Selectively Default and Devalue Its Debt

We have seen estimates that next year the US will have to finance a $2 Trillion annual deficit. They may be able to push it further into the next Administration than that by the forbearance of the world, but not by much. We'd expect a significant drop in Treasuries by 2011 at the latest.

It should be obvious to anyone that we are approaching the apogee of the Treasury bubble, with the credit bubble having broken already.

When the Treasury says they are facing unprecedented challenges in financing the US public debt next year that is an understatement.

Once the deleveraging of the markets subsides, the dollar and Treasuries will drop, perhaps with some momentum, as the rest of the world realizes that the US has no choice but to default. This can be resolved in several ways, including continued subsidies from foreign sources in the form of virtual debt forgiveness, devaluation of the dollar, raising of taxes, and higher interest rates on debt.

The problem now is that the US has breached the point where it can service its debt out of real cash flows, and turning this around will require a severe devaluation of the US dollar.

Devaluation and selective default are the only foreseeable systemic alternatives. There are other exogenous paths of a more political nature such as consolidation and war that may color the default a slightly different color, but a selective default it remains.

This is the fundamental situation. Everything else is speculation and commentary.

Ryan Says Treasury Faces `Unprecedented' Financing Needs in '09

By Rebecca Christie

Oct. 28 (Bloomberg) -- The U.S. Treasury faces historic demands to fund a growing budget deficit and raise money for a $700 billion Wall Street rescue program the department's top domestic finance official said today.

``This year's financing needs will be unprecedented,'' said Anthony Ryan, the Treasury's acting undersecretary for domestic finance, at a Securities Industry and Financial Markets Association conference in New York, where he was a last-minute substitution for Treasury Secretary Henry Paulson.

To raise the necessary funding, the Treasury is looking at selling more long-term debt and possibly bringing back three- year note sales at the Nov. 5 refunding, Ryan said. The Treasury also is raising money to address ``many different policy objectives'' and reduce bond market disruptions and will try to keep its borrowing patterns as regular as possible, he said.

``We firmly believe that investors value greatly and pay a premium for Treasury's predictable actions,'' Ryan said. ``To the very best of our ability, we intend to stay the course.''

Ryan also said the U.S. government now ``effectively guarantees'' debt issued by mortgage companies Fannie Mae and Freddie Mac, the government-sponsored enterprises placed into government conservatorship on Sept. 7. The preferred stock agreement included in the government takeover means the U.S. now backs ``both existing and to be issued'' GSE debt.

``The U.S. government stands behind these enterprises, their debt and the mortgage-backed securities they guarantee,'' Ryan said. The GSEs have almost $6 trillion in outstanding debt and mortgage securities.

U.S. equity and credit markets remain under ``considerable strain'' and face ongoing challenges, he said. That said, Federal Reserve efforts to backstop commercial paper are ``helping'' to stabilize markets, he said.

To contact the reporter on this story: Rebecca Christie in Washington at Rchristie4@bloomberg.net;

Last Updated: October 28, 2008 10:47 EDT