For those of you who are unfamiliar with how international bond markets work, let me quickly explain why the following comments by foreign banks should have you extremely worried.
When the Fed and Treasury get together to print money, they do it by issuing trillions of US treasury bonds. The Treasury prints up the bonds and hands them to the Fed. The Fed then sells them off to foreign banks. So what ends up happening is the US exports its inflation to foreign countries. We give foreign nations treasuries, while they give us dollars to spend in return.
This process of printing money and exporting inflation by getting foreign nations to buy our crappy bonds can continue on for a while, but eventually our creditors will cut us off if they don’t think we are going to repay them with dollars that are worth anything.
If foreign nations think we are going to devalue our dollars (which is exactly what happens when the Fed inflates its balance sheet with treasuries) they might dump all the bonds they are holding back on to the market in order to minimize their exposure to a US default. Such an action would be catastrophic for the dollar as a currency unit.
Rates would necessarily skyrocket in order to entice people into buying the bonds since there would be so many of them up for sale. If rates were to skyrocket, the US government would become totally insolvent because there is no way it could even make the interest payments on that debt with the taxes it is collecting. Once it became apparent that the US could not even make its interest payment obligations, no foreign nations would lend to us and the run on US treasuries would accelerate.
The Fed would most likely print the money to buy the bonds in a desperate attempt to keep rates low (which is what they are doing now), but what ends up happening is all that inflation which we exported to foreign nations comes back home to roost. The dollar becomes worthless as the Fed hyper-inflates the currency by printing money to buy up all the treasuries.
This death spiral can be abrupt and catastrophic. All that has to happen is for one major bond holding country like China to say they have had enough and sell off all the bonds they are holding in one shot. The dollar would explode nearly instantaneously in a Wiemar Germany style hyper-inflation.
But lets say the Fed simply doesn’t buy the bonds and lets interest rates explode. The US would be forced into a structured default. All the banks would be wiped out, the US government would not be able to pay its workers, interest rates would make it impossible to get a loan, mass bankruptcies across the entire economy, etc.. etc.. Of course the Fed would never do this because such an action would hurt the rich bankers and government the most. In fact the Congress would most likely dissolve the Fed if it refused to hyper-inflate.
No foreign nations would accept dollars for goods or services, and anything that is not produced in America would become exponentially more expensive. All the Chinese goods in Wal Mart would cost more than any average American could afford. The Chinese would demand real hard goods in exchange for their goods or services. Dollars would be useless for the purchase of foreign goods.
That said, here are the comments:
The German rating agency Feri has downgraded US government bonds from AAA to AA.
“The U.S. government has fought the effects of the financial market crisis primarily by an increase in government debt. We do not see that there is sufficient attention being paid to other measures, “said Dr. Tobias Schmidt, CEO of Feri Rating & Research AG. “Our rating system shows a deterioration in economic health, so the downgrading of the credit ratings of U.S. is warranted.”
Chinese rating agency Dagong has released a statement stating:
“‘In our opinion, the United States has already been defaulting.…Washington had already defaulted on its loans by allowing the dollar to weaken against other currencies – eroding the wealth of creditors including China, Mr Guan said.”
The Chinese State Administration of Foreign Exchange released (and later retracted) a statement saying:
“We must be alert to economic and political risks in excessive holdings of US dollar assets,” said Guan, head of the international payment department at SAFE, in the article on the website of China Finance 40 Forum, a Beijing-based think tank of Chinese economists, bankers and officials.
“The United States has taken an expansionary fiscal and monetary policy to stimulate economic growth, and the United States may find it hard to resist the policy temptation of weakening the dollar abroad and pushing up inflation at home,” he said.
Mark Carney, the Bank of Canada Governor, recently made remarks at a fund raising event that America’s deficit troubles could threaten Canada’s economy.
“[Carney] doesn’t see the U.S. as addressing its fiscal issues until after 2012, and is concerned that the bond market isn’t sending America the signal that it needs to act due in part to huge central bank holdings of Treasuries,” Avery Shenfeld, the chief economist at CIBC World Markets, said in the widely circulated note.
“The tone was generally pessimistic on developed economy prospects, saying that we are still in the financial crisis (likely alluding to the hangover from fiscal stimulus in terms of sovereign debt, and the U.S. housing mess), and that judgments on how well Canada came through it should probably not be made until we can look back five years from now.”