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XMFSinchiruna (27.09)

The $8.6 Trillion Question

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December 09, 2008 – Comments (11)

Just fanning the flames of that never-ending inflation / deflation debate. :)

And while I'm at it, correcting the figure to the more precise present potential outlay total of $8.6 Trillion.

http://money.cnn.com/2008/12/07/news/economy/bailout.question.fortune/index.htm?postversion=2008120812

The $7 trillion questionDo expansive federal bailout plans doom Americans to an inflationary future? By Colin Barr, senior writerDecember 8, 2008: 12:45 PM ET 

NEW YORK (Fortune) -- A billion dollars here, $7 trillion there: How long till Uncle Sam has to cry "uncle?"

For now, frightened investors worldwide continue to gobble up U.S. Treasury bonds, and they aren't much concerned about the impact of all the obligations the U.S. government is taking on to try and head off economic catastrophe.

But the government printing money, lending money to shaky corporations and guaranteeing debt that may never be repaid all could have troubling consequences in the not-too-distant future.

The No. 1 concern: Even if actions taken by the Federal Reserve and the U.S. Treasury succeeds at stabilizing the global financial system, and an economic recovery takes hold, a brutal inflationary spike will be right around the corner.

"Inflation is the 8,000-pound gorilla in the room," said Gary Hager, president of Integrated Wealth Management in New Jersey. "We're sitting in the room with the coffee cups vibrating."

In that environment, long-term interest rates would soar, the value of the U.S. dollar would plummet, policy makers would face a whole new set of challenges.

"Everyone is going to lose something," said Will Hepburn, president and chief investment officer of Hepburn Capital Management in Prescott, Ariz. "The winners will be those who end up losing the least."

Focus on deflation

Even those who have backed the blizzard of emergency spending on the grounds that it's necessary to prevent an economic catastrophe are worried about the size of the tab that will be left to taxpayers.

Hepburn gives federal officials "bonus points" for concocting innovative responses to the credit crunch. The ongoing collapse of U.S. stock market and real estate values, he said, has slashed U.S. household wealth by at least $10 trillion - and those paper losses could go much higher before the swoon ends.

So far, given the eye-popping sums being offered up by government officials, the markets have responded with surprising nonchalance. Yields on Treasury securities have tumbled to historic lows as investors fly to the safety and liquidity of U.S. government bond markets. The dollar has benefited from the move away from risky assets as well, trading at levels last seen earlier this decade.

Hepburn thinks the process of financial institutions and major investors unwinding massive bets may be further along than people believe. But while that could mean less volatility in the markets and a reduced risk of financial calamity, it could also whipsaw people who have moved their money out of stocks and into low-yielding assets like Treasury bonds.

"The capital preservation strategy will work till the recovery sets in," Hepburn said. "But we don't have the resources to pay off all these obligations - so the government's going to have to try to inflate it away."

An inflationary spike may seem unlikely, given that governments around the world are currently doing their best to head off the opposite threat - deflation, with falling price levels that would hamper economic growth by increasing real interest rates. The Bank of England and the European Central Bank slashed interest rates Thursday morning in a bid to bolster economic activity and prevent inflation from turning sharply negative in coming months.

Fast-changing climate

But Hager notes that it was only four months ago that oil cost $100 a barrel more than its recent $47, which shows how quickly market dynamics can change.

What's more, he said, while people are still struggling to figure out the costs tied to starting up and overseeing the government bailouts, no one seems to have put much thought to an equally important endeavor - how the government withdraws the massive support it has offered the markets in the event its efforts start to bear fruit.

While efforts to thaw the credit markets are taking effect slowly, Tom Sowanick, chief investment officer at Clearbrook Financial, sees a risk that they could suddenly become much more effective, leading to a jump in prices and a selloff in the dollar.

"The economy's in a bit of a slingshot," said Sowanick. "We are looking at a high probability of inflation issues ahead."

 

11 Comments – Post Your Own

#1) On December 09, 2008 at 9:49 AM, dangerfairy (< 20) wrote:

Again, there won't be any inflation. The money they printed is not entering the real economy because banks won't lend as it is too risky. And why should they when they can just hold onto the cash as it raises in value?

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#2) On December 09, 2008 at 10:07 AM, goldminingXpert (29.54) wrote:

danger, it has to enter the real economy at some point when things get better, banks don't want to just keep it in their vault earning no interest...

That said, anyone that thinks the US will continue to pay its debt is naive. The US will default, thus avoiding hyperinflation. 

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#3) On December 09, 2008 at 10:34 AM, saunafool (98.77) wrote:

gmX,

Can you please explain how defaulting on the debt would not result in some kind of financial catastrophe, hyperinflation or otherwise?

I don't think hyperinflation is in the cards. We're not Zimbabwe, yet. But, I'm keeping a small part of my portfolio in gold, just because I don't see how the U.S. gets out of the mess without the dollar (or whatever new currency it is replaced with) being worth a lot less.

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#4) On December 09, 2008 at 1:45 PM, oldfashionedway (35.42) wrote:

Mega banks' old business model: USURY  (+20% interest on credit cards, etc.)

Mega banks' new business model:  EXTORTION  (The financial system will collapse if you don't give us MORE money.)

I find it amusing that banks would claim to be reluctant to LOAN money to anyone, given it has been such a profitable enterprise in the past. 

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#5) On December 09, 2008 at 1:47 PM, johnw106 (63.14) wrote:

Its not the debt of the Government that is the problem. No one expects the US to pay it. They dont want the Government to pay it.
What matters is that we can continue to service the debt by making the interest payments due on the bonds that foreigners and private investors hold.

Its just like buying bonds in your personal portfolio. You dont buy a bond and sell it anytime soon. Its for income, the dividends. As long as we can pay the dividends we are ok. What is scary is we are moving ever closer to the point where we cant make the payouts.
If that happens it would be just like a bond issue in your own portfolio. If it stopped paying dividends would you hold it? Or if it was suddenly reduced from AAA to Bb? Of course not. You would demand your capital investment back. The USA doesnt have the cash or assests to redeem all the bonds.......which would make the dollar fall like a lead baloon if this ever happens...and we would have to declare ourselves bankrupt.

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#6) On December 09, 2008 at 1:57 PM, johnw106 (63.14) wrote:

And some people and sites who are much better than I at math think the sum is closer to US $ 14 trillion, not 8. Not that a few Trillion here or there makes a difference anymore.....

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#7) On December 09, 2008 at 2:23 PM, XMFSinchiruna (27.09) wrote:

johnw106

I'd love to see those numbers. :) Any particular sites / links? Thanks.

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#8) On December 09, 2008 at 2:45 PM, reepicheepo (49.07) wrote:

Correct me if I'm wrong here, but it seems like it would almost be impossible for the US gov. to default on its bonds/notes since it has a monopoly on the production of money. Because bonds are repaid in US dollars couldn't they just keep printing money indefinitely? While this would obviously still lead to inflation/hyperinflation, I just don't see how the government defaulting would be foreseeable.

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#9) On December 09, 2008 at 3:20 PM, BigFatBEAR (29.22) wrote:

Hey guys - I'm predicting...     may I have a drumroll please...      relative price stability! (gasp) (shock) (confusion) (dismay)  ...and a solid recovery within a few years.

My best guess is that the market mechanism, an amazing infrastructure, a large and educated workforce, and a monetary and fiscal policy that are doing all the right things will eventually pull us out of this. That being said, I am not comfortable with our levels of individual/state/federal debt - I have no idea what it will look like if/when the gov't goes bankrupt, and that sort of scares me. What I DO know, though, is that if inflation ever starts to get out of control, the Fed can make us swallow an anti-inflation pill Volcker-style - ie tighten the heck out of monetary policy. It worked in the 80s, and it could work again.

Therefore, a long and slow Japanese-style deflationary spiral is more scary to me than inflation or hyper-inflation. I just don't think it's all that likely.

Check out these surprisingly fun (and educational) economic games/simulators:

1) http://faculty.insead.edu/fatas/econ/Presidential%20Game.htm

2) http://www.theeconomystupid.eu/introduction.html

The first one is fairly simple, and gives you a good feel for how monetary and fiscal policy can affect the macroeconomy. I'm not going to lie - I played it a fair amount in college.

The second one is new to me, but looks along the same lines, just with different variables and set in Europe. Enjoy!

-BFB

PS. Try winning over a few ladies at a party sometime, by saying, "Check out these economic games/simulators.."

 

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#10) On December 09, 2008 at 3:42 PM, DemonDoug (32.29) wrote:

reep, you are correct.  I have no idea what GMX is saying, and anyway, defaulting on treasuries would be insanely hyperinflationary, because no one would be buying dollars anymore.  It would be easier to do what FDR did, just devalue the dollar by 50% in one shot, than to default.

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#11) On December 09, 2008 at 4:45 PM, RVAspeculator (29.77) wrote:

All roads lead to dollar devaluation.

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