Credit Crisis Oct 08 – The U.S. may run out of Money!

By Marco Pietropoli, 9th October 2008

The general economic situation is deteriorating fairly rapidly. We are in a financial crisis of a scale that has not been seen maybe since the Great Depression. The excesses in the financial institutions are falling apart like a house of cards. We are all likely to pay for it through higher inflation and higher lending rates. The worst is yet to come and the recovery will take time.

The U.S. , UK , Japan and many of the European countries are either in recession or are about to be. We have to assume a global recession within 12 months even though, at present, the Emerging Markets show some resilience [1].

The Credit Crisis is set to continue for many months, maybe years. This is mainly due to investor risk aversion, poor bank balance sheets and ever increasing debt defaults by individuals and companies. The economic downturn that started in the U.S. housing market will now become a consumer led recession as global credit dries up and household budgets continue to be squeezed by higher inflation and expensive lending rates.

Relatively speaking, the U.S. has got itself into an awful mess and could be facing a total collapse, if the rest of the world should decide to stop supporting it. I have come to believe that the U.S. is likely to run out of money in the next 6-12 months, maybe even sooner.

The financial crisis resulting from this would be catastrophic as global liquidity would grind to a complete halt, commodity prices would rise dramatically and inflation would grow completely out of control. As the U.S. is still by far the largest economy in the world, this situation would affect us all.

Traditionally, the financial world has been based on a single reserve currency not only for liquidity and trade, but also as a safe haven for investors. As we move away from the U.S. Dollar, maybe an approach based on a ‘basket of currencies' may be a safer option for the future. At present, there is no template for this.

The U.S. Federal Reserve has extended its Balance Sheet enormously already [2] and simply does not possess the liquidity needed to keep the financial system going. Other Central Banks in the world have played their part to try and assist [3]. European governments have bailed out [4] or nationalised [5] some financial institutions in their countries. Many Central Banks are now cutting rates [6]. International consensus seems to be a growing that a lot more needs to be done in order to restore confidence in the Global Financial Markets [7].

The Government of the U.S. has stepped in, but does not have any money either. The U.S. Budget Deficit for the next fiscal year (2009 – starting 1 st Oct 08) is presently at $482 billion (July 08 Whitehouse estimate) [8]. To put this in perspective, the current projected tax receipts for fiscal year 2008 is $2.553 trillion [9].

With a rapidly slowing economy, the tax receipts for 2009 are likely to be significantly lower. There is no better way of understanding the trend than to look at the employment numbers. In August 08, the US lost 84,000 jobs 8 . In September 08 this number grew to 159,000 [10] , an increase of 89%. This is a significant acceleration compared to previous months 8 .

Current projected spending on Defence and the Wars for the U.S. amount to $585 billion for fiscal year 09 [11] (included in the current Budget Deficit prediction).

This is before you count all the additional spending that the US has embarked on recently. The July 08 housing aid package was approved by Congress and cost $300 billion and gave the U.S. Treasury the authority to bailout Fannie and Freddie [12].

The Fannie and Freddie nationalisation will cost the U.S. Treasury at least $100 billion [13] in the short-term. This is of course an ongoing commitment as the companies have approximately $6 trillion [14] in debts that need to be serviced and refinanced on a regular basis.

The government assisted merger of Bear Sterns and JP Morgan Chase has cost the U.S. taxpayer $29 billion. The AIG bailout cost $85 billion [15]. The recent Wall Street bailout, officially known as the Financial Market Rescue Plan, will cost $700 billion [16] for now.

Congress has agreed to give $25 billion to Detroit to try and keep Ford, GM and Chrysler going for a little longer [17]. They even managed to find $1 billion to give to Georgia [18] after the Russian invasion.

The Federal Deposit Insurance Corporation (FDIC) [19] set up 75 years ago to protect savers, will secure up to the first $100,000 on deposit. It used up 10% of its assets recently when it had to come in after the failure of California bank Indymac in July 08 [20] . At the time, the FDIC had 90 further banks on its watch list, now it has 117 [21]. The FDIC may need a great deal more money to keep providing this depositor protection [22].

The individual states in the US are struggling to refinance their debts and also need a bailout [23]. The new U.S. president will be expected to have a plan to help the economy when he takes office. This will of course cost something too.

It is disgraceful that the U.S. does not provide medical care for all. Democrats will continue to push for a universal healthcare system which is going to be an extremely costly endeavour.

As the U.S. carries on spending the money they don't have at an alarming rate, it will be raised by issuing more government debt in the form Treasury Notes. In other words they are borrowing all the money that has been pledged.

Due to the nationalising of the debts of Fannie and Freddie, plus all the additional spending, the U.S. has more than doubled its national debt in recent months to $11.3 trillion [24]. What is effectively happening is bad debt in the private sector is being put into the public purse. The principle is that of “Borrowing from Peter to pay Paul”.

The U.S. government had survived for years on borrowing from the rest of the world [25]. The world now has its own issues as the global economy slows.

How can you borrow all this money in a Credit Crisis when you are not even giving investors a real return? Investors may simply not be willing to take the risk, given the volatility of the Dollar over the last few years. Where are they going to get all the money that is needed? The moment one Treasury action fails and all the Treasury notes are not sold, the only option will be for them to print more money!

I believe the Dollar is a flawed currency. There is a significant negative real yield (rate of return after inflation) on all U.S. Treasury Bills and U.S. deposit accounts [26]. Negative real yields on these investments are likely to persist especially as the Federal Reserve look set to cut interest rates again at the next meeting this month [27] and inflation is not likely to come crashing down anytime soon due to historically high commodity prices.

Money supply in the U.S. has been increasing very rapidly anyway compared to the growth of the economy. This pressure will devalue the currency[28].

It is by no means certain that the proposed Financial Market Rescue plan will work. Much more money may be needed in the coming months to keep the global financial system liquid and to protect depositors. I believe Central Banks and Governments around the world will continue to provide the much needed liquidity into the markets.

There is no such thing as a free lunch! All this money that is being pumped into the markets will have to be paid back through higher taxes or by higher inflation.

As the situation in the U.S. deteriorates rapidly, the possibility of significant civil unrest increases substantially. As the Bush presidency is unravelled in the coming months, the public will come to discover what has happened to all the money. Anger against Washington for driving the country into bankruptcy and having started two unpopular and unfinished wars, may mean that a united Union of States will be difficult to maintain in the future.

The Holy Roman Empire, the French and the British were all the economic and military superpowers of their time and all lost their standing.  History teaches us that the US will share this fate at some point, and the developments discussed in this article suggest that that point may be sooner rather than later.

References:

[1] China May Maintain Fast Growth Amid Crisis, Premier Wen Says, By Paul Panckhurst, Bloomberg, 06 th Oct 08 http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ag1ECpvzG4vI
[2] Fed Balance Sheet Worries Volcker, The Wall Street Journal, 15 th May 2008, http://online.wsj.com/article/SB121080882056793481.html?mod=hpp_us_whats_news
Federal Reserve Statistical Release 2 nd October 2008 http://www.federalreserve.gov/releases/h41/Current/
[3] Press Release, 29 th Sept 2008, Board of Governors of the Federal Reserve system http://www.federalreserve.gov/newsevents/press/monetary/20080929a.htm
[4] Fortis Bail-out Hits Stocks, AOL Money, 29 th Sept 2008
http://money.aol.co.uk/fortis-bail-out-hits-stocks/article/20080929092926618380706
[5] Northern Rock to be Nationalised, BBC 17 th February 2008. http://news.bbc.co.uk/1/hi/business/7249575.stm
[6] Bernanke's Push for Global Cut Began With Trichet, King Talks,By Scott Lanman, Bloomberg http://www.bloomberg.com/apps/news?pid=newsarchive&sid=adHTHvaLrgi0
[7] Europe Summit to Focus on Oversight, Accounting Rules (Update2), By Sandrine Rastello, 4 th Oct 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=aTfIHXpnoqHM&refer=home
[8] Treasury to Hire Asset Management Firms to Jumpstart Rescue, By Rebecca Christie and Robert Schmidt, Oct. 4 (Bloomberg) http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aVVOrzOIBedo
[9] Mid-Session Review, July 08. US Government. http://www.whitehouse.gov/omb/budget/fy2009/pdf/09msr.pdf
[10] Economic Calendar. Bloomberg News http://www.bloomberg.com/markets/ecalendar/index.html http://www.bloomberg.com/markets/ecalendar/index.html
[11] Record U.S. defence spending, but future budgets may decline. By Gordon Lubold | Staff writer of The Christian Science Monitor, February 6, 2008 edition

http://www.csmonitor.com/2008/0206/p02s02-usmi.html
[12] Key Provisions of U.S. Housing Rescue Bill, Reuters 27 th July 08 http://uk.reuters.com/article/burningIssues/idUKN2430986620080727?pageNumber=1&virtualBrandChannel=0
[13] Fannie, Freddie rescue binds taxpayers to housing market, By Mark Trumbull,

Cristian Science Monitor 9 th Sept 2008
http://www.csmonitor.com/2008/0909/p01s01-usec.html
[14] What Fannie and Freddie Mean to You, by Lynette DeNike, All Business, 12 th Sept 08 http://www.allbusiness.com/banking-finance/banking-lending-credit-services-payment/11542203-1.html [15] The Wall Street Bailout Plan, Explained, by David Stout, The new York Times 20 th Sept 08 http://www.nytimes.com/2008/09/21/business/21qanda.html
[16] Bush Signs $700 Billion Bank Rescue to End `Threat to Economy', By Christopher Stern and Laura Litvan, Bloomberg, 4 th Oct 2008-10-04 http://www.bloomberg.com/apps/news?pid=20601087&sid=ag5kGMI47syY&refer=home
[17] Detroit Bailout Can't Solve Credit Crisis, by Douglas A. McIntyre, 24/7 Wall St., 1 st Oct 08
http://www.247wallst.com/2008/10/detroit-bailout.html
[18] Cheney Promises Georgia 1 Billion More Indebtedness to USA, by Rev. Jermano, Now Public 3 rd Sept 08
http://www.nowpublic.com/world/cheney-promises-georgia-1-billion-more-indebtedness-usa-0
[19] FDIC - http://www.fdic.gov
[20] IndyMac Bank seized by federal regulators, Kathy Kristof and Andrea Chang, LA Times 12 th July08 http://www.latimes.com/business/la-fi-indymac12-2008jul12,0,6071779.story .
[21] FDIC Warns of More Bank Troubles, By SCOTT MAYEROWITZ, ABC News 26 Aug 08 http://abcnews.go.com/Business/story?id=5660122&page=1
[22] FDIC May Need $150 Billion Bailout as More Banks Fail, By David Evans, Bloomberg News 25 th Sept 08
http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=amZxIbcjZISU
[23] Schwarzenegger Says Federal Loan to State an Optio, By Michael B. Marois, Bloomberg News 3 rd Oct 08
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a_oBWWaczaiA
[24] $10.1-trillion National Debt? Let's cut taxes!, by David Lazarus, LA Times 5 th October 2008 http://www.latimes.com/business/la-fi-lazarus5-2008oct05,0,3237664.column?vote42728595=1
Who are the largest holders of U.S. public debt? (July 2005), by Dr. Econ
http://www.frbsf.org/education/activities/drecon/answerxml.cfm?selectedurl=/2005/0507.html
[25] The yield on a 2 year Treasury Note is currently 1.58%, a 10 year Note yield 3.60% and a 30 year note is 4.09% (Source Bloomberg, 4 th Sept 08). www.bloomberg.com Best Interest rates Bankaholic.com - GMAC bank 4.26% Rate, 4.35% APY, 4 th Sept 2008 h ttp://cdrates.bankaholic.com/ . Inflation 5.4% (All Items non-adjusted 12 months to Aug 08) source US Labour Department.
[26] Treasuries Gain for Sixth Week on Speculation Fed to Cut Rates, By Dakin Campbell, Bloomberg, 4 th Oct 08
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=av6n4Ox5e9XA
[27] Money Stock Measures, Federal Reserve Statistical Release, 2 nd Oct 08 - M2, 12 months to Aug 08, 5.4% (seasonally adjusted)
http://www.federalreserve.gov/releases/h6/Current/
US GDP grow running at an Estimated 2.8% and slowing. U.S. Economic Growth Slower Than Initially Estimated, By Timothy R. Homan, Bloomberg News 26 th Sept 08 http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aVHc9CsDO_Xw
[28] Money Stock Measures, Federal Reserve Statistical Release, 2 nd Oct 08 - M2, 12 months to Aug 08, 5.4% (seasonally adjusted)
http://www.federalreserve.gov/releases/h6/Current/
US GDP grow running at an Estimated 2.8% and slowing. U.S. Economic Growth Slower Than Initially Estimated, By Timothy R. Homan, Bloomberg News 26 th Sept 08 http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aVHc9CsDO_Xw