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How to profit from U.S. sovereign debt default?
Sovereign nations can default on debt by refusing to pay or by debasing their currency. What is the best way to protect from inflation?
One method Keynesian central bankers use to disguise debt default is by “lowering interest rates” by monetizing or buying sovereign debt with fiat money. Postwar inflationists have developed all manner of intellectual justification for soft money and increased government spending. One argument is the “Phillips curve“, which asserts more inflation leads to less unemployment. In truth more inflation eventually culminates in high inflation and high unemployment or stagflation. French economist Jean Baptiste Say formulated Say’s law, which states, “production leads to consumption“
Federal Reserve chairman Ben Bernanke has stated the United States can avoid a recession by dropping money from a helicopter or expanding the monetary base. Currently the Federal Reserve is purchasing $40 billion dollars in mortgage-backed securities per month, until they decide the economy is in good enough shape to stop. This open-ended QE3 will create $120 billion new dollars by December, 2012. The Fed also has Operation Twist in progress which purchases $45 billion in long term government bonds and currently sells short Treasuries. The Fed is burning through its inventory of 3-month to 3-year Treasury notes. If it runs out of short term notes by the end of the year, and wants to continue to monetize the national debt, it will have to stop sterilizing its monetization, and start increasing the money supply by another $45 billion a month, or a total of $85 billion per month. If it monetizes debt at the rate of $85 billion a month, it will increase the monetary base by $1.02 trillion next year. These two programs could increase the Fed balance sheet by $1.122 trillion by the end of 2013.
The Fed balance sheet had assets of $886 billion in December 2007. It currently has assets of $2.6 trillion in November, 2012. The Fed balance sheet could reach $3.7 trillion by December, 2013. That would an increase in the monetary base by over 300%. Some people have noticed the Fed balance sheet has not expanded much since the announcement of QE3 in September of 2012. However, settlement day is 60 days for mortgage backed securities. The increase in the monetary base, and the resulting inflation, from QE3, is not projected to show up until after the election. Operation Twist does not increase the Fed balance sheet until it runs out of short term securities. If the Fed stops sterilizing it purchases, by selling short term Treasuries, the balance sheet will expand an additional $45 billion per month.
If the Democrats and Republicans can solve the looming fiscal cliff, the national debt ceiling will eventually be raised. It can be assumed Republicans will oppose significant tax increases, and Democrats will resist limitations on government spending and significant entitlement reform. We can probably expect continued $1 trillion dollar deficits in the second Obama administration term. It is projected at this rate the U.S. national debt will reach $20 trillion by 2016, or 130% of GDP. By 2020, the cost of entitlements will equal national revenues. The U.S. Government will continue to default on its sovereign debt by debasing its currency. These projections do not include a war in the Middle East, and or a break up of the Euro currency, in 2013, in which case the Federal Reserve could be expected to respond with more money printing.
Fed Chairman Bernanke’s term ends in January 2014. If he turns down a third term offered by President Obama, his replacement is expected to be Janet Yellen, who is currently Vice Chair of the Board of Governors at the Federal Reserve. She is considered a dove, and has supported QE3 as a means to stimulate the economy. Many prudent investors who want to preserve their purchasing value have invested in gold coins or gold and silver bullion ETFs. Disclaimer, I am long gold and silver.
For more information on the economy and the culture war in the United States, go to:
Youtube: Stephen Johnston “Tea Party Culture War”
Page Updated Last on: Nov 19, 2012