A Run on the United States Government

by Michael S. Rozeff

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A run is a mass withdrawal of cash funds from a borrower. We are in the midst of a continuing worldwide credit crisis, punctuated by "runs" of varying prominence and publicity.

These runs are rational, not panics and not due to quirks of psychology. They occur when investors realize that their funds are endangered in an institution. They try to get them out before they lose them.

The danger comes when the institution no longer is getting cash inflows in sufficient amounts to pay off all its obligations. In businesses, this comes about through sour investments. In governments, it comes about through wasteful spending that fails to be recovered in tax revenues.

In the year 2008, we saw runs on major Wall Street investment banks, money market mutual funds, domestic banks and foreign banks. Now we are seeing runs on governments in Europe such as Greece and Portugal. Sovereign debts are being sold down hard as investors flee from them, converting their bonds into currency.

Three years from the 2008 credit crisis, the Federal Reserve is still providing massive credit to U.S. banks. This props them up against bank runs. Every so often, the FED extends credit to foreign central banks to prop them up so that they can prop up their financial institutions. These are stopgaps. All of this propping up depends on faith in one currency: the U.S. dollar.

Runs on various institutions often show up as a flight into short-term U.S. treasuries, i.e, the dollar. This is because the treasury market is deep.

Since the dollar is also a credit instrument, it is subject to credit risk. What happens when trust in the dollar drops sharply? What happens to all these financial institutions being propped up by creating dollars when trust in the dollar fails? That is when the financial system cracks wide open. That is when governments will be tempted to freeze funds in banks and prevent withdrawals the way that Argentina did. That is when the FED will be tempted to guarantee almost any institution against cash withdrawals, but when such a guarantee will be ignored. That is when gold will soar in price against the dollar and all other fiat currencies.

I am describing a run on the United States government. This will be a withdrawal of cash financing from the U.S. government. This is the ultimate credit crisis upheaval. This will be accompanied by mass social unrest and political reorganization. Stock and bond prices will fall sharply. The S & P 500 will lose at least 60 percent. Government bonds will yield at least 10 percent. This event is foreseeable. It is also avoidable, but not without much pain and travail. Hence, although foreseeable and avoidable, it may still occur.

Whether we like it or not, we are all currency speculators now. This is hardly a burden we can relish.

Whether or not a run on the United States government occurs is in the hands of its creditors. It depends on their trust in the dollar. Their trust depends on their understanding of America’s political economy.

Anyone who looks objectively at actions being taken by the U.S. government to bolster its credit or cause its credit to deteriorate has to reach a very negative conclusion. Why? Simply because the country’s leadership has been taking it downhill for decades on end. America is like a bright and fresh red apple in which rotting has been proceeding inexorably. The apple still has some edible portions but large parts of it are gone. The seeds need to be planted and a new tree grown.

Dagong Global Credit Ratings Co. Has 15 categories of ratings of sovereign debt (AAA, AA+, AA, AA-, A+, A, A-, BBB, BB+, BB, BB-, B+, B, B-, CCC.) The U.S. has a rating of A+. Dagong lowered it from AA- to A+ in November 2010 after the FED announced a new QE program.

In a remarkable statement made in mid-June 2011, Dagong’s president said "In our opinion, the United States has already been defaulting." Dagong has spent $1 million to enter the U.S. market, but the SEC has so far turned it down.

The debate over the debt ceiling, like all Washington debates, is throwing off negative signals about U.S. credit. Obama is the key person. He is airing various proposals in public in press conferences. If he were serious about any of them, he’d be working closely with key Congressmen in private behind closed doors. He would not be trying to box in Republicans or embarrass them in public or score political points. He would have been working on controlling the budget long before this. He would have shown leadership on this long ago. One does not place multi-trillion dollar proposals on the table and expect them to be taken seriously, debated and acted upon within 2 or 3 weeks. Obama’s credibility on serious budget control is nil. The Republicans and even members of his own party have little reason to trust him when he paints himself as on a high road and willing to compromise. Any compromise will be on his terms to further his agenda. The debate, such as it is, can’t be taken seriously.

Did the near-miss of the 2008 credit crisis prod the U.S. government into corrective action? Sure, bailouts and wars and deficits and the absorption of Fannie Mae. The U.S. government has had three years to enact measures to revive the economy, clean out the bad debts in the banking system, and get the U.S. budget under control. Make that thirty years or more. At this moment, I can’t think of one good step it has taken. Look for yourself. Do I see healthcare in there as the centerpiece along with Wall Street reform? Don’t make me laugh.

The U.S. government has no credibility in terms of restoring America. The government is living off its past reputation, like a once great entertainer grown tired and going through the motions.

Under these conditions, trust in the dollar and all the other fiat currencies that are linked to the dollar will continue downwards.

Unless there is a change in these conditions, someday there will be a run on the United States government. I see nothing that suggests a change in these conditions.