As the great machine called American Capitalism slides down the greasy rails toward The Trash-Bin of History, something is conspicuously absent …

Where’s Bernanke?

You would think Bernanke would be on teevee jumping up an down demanding citizens to call/write/yell at their congressmen demanding action. I’m going to do it! Let me do a bunch of other things first … such as pick my feet in Poughkeepsie.

Good job Congressional Republicans. Default by the US is energy conservation by other means. The nature- raping US economy will be less able to fund itself. A default will be good for the environment. Let’s all default tomorrow!

Where are all the other finance criminals? Where is Warren Buffett? William Gross? Bill Gates? Howcum the bigs are all sitting on their hands? Why?

We know what the Koch brothers want, their Tea Party underlings in Congress make non-negotiable demands. The brothers don’t have to say anything, they are lying with all the others, in wait with knives sharpened.

The wolves wait for the ‘flight to quality’ they believe they can provide absent any good government alternative. This is to answer the effects of a calamity they themselves have a hand in creating: Naomi Klein’s ‘disaster capitalism’ taking place in real time. The crooks are on both sides of the market as always, poised to profit regardless of what happens. A wrong word might trigger a ‘flight to sanity’ and put an end to their ‘short the entire United States’ trade.

 
They could do this by simply shutting in a bit of supply. If the US is going to renege on agreements, why not everyone else? Why not oil producers?
 

Nobody knows what will happen exactly when the US defaults but it won’t be Good News for debt-burdened private interests. Who or what is creditworthy when the US government becomes an instant deadbeat? Meanwhile, there is vast private debt service dependency. The hard liners want to direct all the Federal cash flow toward the private debt. They threaten to delever public debt to accomplish this, not realizing once the avalanche starts there might not be any way to stop it:

 

“liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”
– Andrew Mellon

 

A problem is the ‘US has never defaulted’ meme’ that circulates through media channels. This bit of propaganda, similar to the ‘US has never lost a war or a World Series lends and air of complacency to the debt negotiation exercise. People who make up the establishment don’t have to exercise themselves because of manifest destiny or Exceptionalism. The Magic Debt Fairy will drift slowly down from somewhere and make the needed debt agreement appear like he’s always been able to do in the past.

In reality, the US has defaulted over and over when convenient. The US defaulted when Treasury Secretary William McAdoo closed US stock markets in 1914 to prevent warring European countries from selling US stocks for gold and repatriating same to the Continent. The US defaulted when Franklin Roosevelt removed specie from circulation, ended the gold clause in private contracts and devalued the dollar 40% in 1933-34. The United States defaulted in 1971 when President Nixon closed the Treasury gold window effectively devaluing the dollar then one more time in 1979 when the Treasury Department’s trust department failed to issue government payments on time:

 

 

Ordinarily, countries won’t default ‘in a rush’ or to domestic creditors but will resort to currency inflation. Acute defaults tend to fall heavily on investors outside the defaulting country because most international deadbeats are small economies dependent upon loans or liquidity denominated in foreign currencies. The US defaults with ‘impunity’ because it is the world’s largest economy with the only realistic reserve currency. It’s too big to fail: it plays with default in 2011 because the establishment — as in 1971 — does not consider energy consequences, only political gains for its finance wolves.

When ‘foreign’ currency cannot be had affordably — because of a squeeze or finance-contrived ’emergency’ — the country has no option but to default. This is what happened in the US in 1933: the US was a relatively small economy that made itself dependent upon foreign exchange in the form of gold — for liquidity. Currently, Greece and the other PIIGS, are small economies dependent upon F/X in the form of euros — for liquidity. What is absurd and sinister about the ongoing slide is that there is no foreign currency dependence or a liquidity shortage in the US. The central bank can issue as many dollars as it pleases and has done so at small cost. The government itself can also issue as many dollars as it pleases as well. The ‘political issue’ hamstringing Washington is an abstraction: numbers on a piece of paper. None of the players mention the real economic issue in polite conversation — the US’ energy deficit.

When FDR defaulted in 1933, the government took liquidity provision away from stingy Wall Street financiers and European banks. Liquidity was directed toward commercial banks in the American heartland that had been staggering toward oblivion. Roosevelt’s didn’t ‘feel’ like a default to Americans mired in the Depression. Gold holders and foreign speculators were outraged when stiffed by the US government but there was nothing they could do about it other than move gold to Switzerland. They were in fact beneficiaries of the new liquidity that the Roosevelt government’s actions made available. Bankers found themselves earning more from financing business activities than they could ever have by speculating in gold arbitrage.

One of the beneficiaries of Roosevelt’s default/easy money was the new government in Germany which quickly followed Roosevelt’s example and defaulted on its debts and obligations in 1933.

When the US welshed on its international gold obligations in 1971 almost no one paid attention. “What’s a gold window?” asked most folks. They were more concerned with the Vietnam War. Few were interested in how that war — along with everything else — was supposed to be paid for.

The window was long forgotten a couple of years later when the gas lines formed after the OPEC oil embargo. Drivers never bothered to make the ‘gold-Saudi Arabia’ connection. The end of gold/crude exchange between the US and the Middle East as required by the Bretton Woods agreement left producers without the good they had bargained for. The Sheiks understood they would be paid with dollars convertible to gold at $35 dollars per ounce. If they could not gain gold at the discount they were entitled to, they would not discount their petroleum!

The US defaulted because the US needed dirt cheap petroleum. US crude production had peaked in 1970 and overseas replacement was needed take up the slack. The early 1970s was an era of gigantic cars with terrible gas mileage, proto-industrial agriculture and a petroleum- sucking war. Paying for oil with $35 gold would have bankrupted the US, particularly with French also demanding gold. Better to give the Saudis and other bits of paper for their crude. Policy makers assumed that because the US citizens were ignorant of gold politics, so would be the Arabs. Default held the promise to Americans of a friction-free escape from unserviceable obligations, after all, Americans were the ‘Exceptionable Ones’ who could rewrite agreements to suit themselves. Unfortunately for America’s motorists, the energy-lenders had other ideas.

The Saudis might have understood that gold was no more valuable than any other bunch of molecules. The US would not have traded the equivalent amount of stainless steel or aluminum to the Saudis for oil, either. The US defaulted because it was living beyond its material means just like the US is doing now, just like the Greeks and Irish and Chinese have been doing for decades. Countries default when they reach the point of having to offer abstractions such as ‘Freedom’ or ‘Greek Vacations’ or ‘Poison Dog Food’ in trade for something useful.

Should the US default next month, most people won’t notice immediately: we’ve been broke so long we’re used to it! Americans generally don’t buy or sell Treasury bonds. Unfortunately, the time period between default and consequences is shrinking from the disco era. Consequences of default will likely be felt by the public within a few days afterward.

Post- default, producers could decide — as they did in 1973 — to demand more ‘value’ from their ‘No 1 customer’. The producers might demand more dollars for their product or — more likely — demand a greater spread between their dollars and the Treasury debt the oil producers’ dollars buy. They could do this by simply shutting in a bit of supply. If the US is going to renege on agreements, why not everyone else? Why not oil producers?

An oil shortage caused by US default is not out of the question. This would in turn be a trigger for the dreaded ‘Double Dip’ recession. The Saudis might not like the loss of sales volume that would accompany a recession, but every dollar they gain post-recession would be more valuable. Since the true value of currencies is what they earn in crude, monetary policies are not crafted by central banks but by millions of drivers world-wide with ‘adjustments’ Made in Riyadh.

During the so-called ‘Credit Crisis’ in 2008, lenders could not trust the solvency of their counter-parties. The US stepped in to guarantee the counter-parties … at significant cost to the taxpayers, it turned out. Finance trusted the US government’s guarantee of solvency.

The problem in 2011 is the guarantors’ solvency is now under suspicion. Even if a debt deal is made in Washington tomorrow, the suspicion will remain. There will be increasing problems with markets that depend on government securities as collateral such as the repo markets. The Fed will have a dilemma once the debt limit raised and borrowing resumes: if it vacuums all the short-term government debt at par to re-liquify the Treasury, the default penalty will emerge in unrelated third party markets.

These markets will have an instant liquidity problem. A perfect liquidity storm is building around the world: there is the refusal by the EU to liquefy Europe’s deadbeats at anything near par, the rate tightening by ECB and in China along with Japan’s post- meltdown liquidity demand. A US default will remove billions from the economy every week. There will be a tremendous demand for dollars. Look for the money markets to ‘break the buck’ right away. Not because the government cannot guarantee them, but because any guarantee would not be worth as much as it was pre- bailout. Any US-derived collateral would be subject to a haircut.

As in 1933, if and when the US fails, Greece and perhaps other EU countries will default in turn. Everyone in the EU is looking for cover so that the first country to default won’t be blamed for the depression certain to follow. Keep in mind the Undertow has a slightly different definition of ‘Depression’: a recession is a recession is a recession but a depression is class warfare by economic means.

What to do?

Best to be mentally ready. Look for stocks and commodities to fall sharply over the next two weeks as ‘smart-ish money’ bails from the markets ahead of August 2. Listen for more ugly noises from China. Even if the US escapes the hangman, the Europeans will not and all the problems inherent in US default will reemerge. It’s going to be a long summer …