the anatomy of a u.s. debt crisis

8/9/2019 The Anatomy of a U.S. Debt Crisis

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The Anatomy of a U.S. Sovereign Debt Crisis

The End of the Greatest Bull Market in American History

A Working Paper for a Better Future, Never Forgetting Our Historical Inferences

Joseph T. French


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The Greatest Bull Market

This weekend, as we go on about our normal deeds, watching the NCAA Basketball

tournament, or whatever your weekend status quo entails, the mother of all the markets in the

world is on the verge of a secular shift. For the past 29 years (October 1981 to December

2009), the United States Treasury Bond Market has been on a continuous grind lower in yields,

higher in prices, further perpetuating the socialist state to spend more than it has brought in via

taxes. During the Volker era, the Federal Reserve was forced to hike interest rates to stop the

inflation of the 1970s. During the recessions of 1990 and 1991, the Fed enacted an interest rate

policy of reducing interest rates to alleviate the pressure of the economic downturn. Lowering

the interest rates enticed consumers, businesses, and the government itself to take our loans to

make purchases, in turn healing the economy, temporary at least.

This policy was the number one tool of the Federal Reserve for the past 20 years as they

have a tool to rig the system and force interest rates lower, artificially: The Fed Funds rate. This

is the interest rate that financial institutions lend their excess reserves to other financial

institutions. When the Fed Funds rate increases, it decreases the money supply. When it

decreases, the money supply increases.

Before I go further into the Fed Funds rate, it must be understood how money comes

into existence. There are two main ways money is created. First, the U.S. Government issues

Treasury Securities (Debt) directly to the Federal Reserve, in turn the Federal Reserve prints up


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Federal Reserve Dollar Notes (Money), creating money. Then the U.S. spends the money into

the economy, where it is deposited into commercial banks. Commercial banks hold a fraction

of the deposit in reserve, and loans out the rest. Then the person who receives the loan spends

it into the economy, and the others receive the money and deposit it into commercial banks.The commercial bank then lends out the new deposit to different borrowers. However, notice

that the original deposit is no longer backed by any tangible dollars. This practice is known as

fractional reserve banking. The current system allows for a 10% Reserve Ratio, wherein $1,000

in deposits can back $10,000 in loans. Thus, money is always and everywhere created through

debt!

The Fed Funds rate plays a role in this game by instructing the actions of the Federal

Open Market Committee. This group of twelve decides what the FOMC must do to maintain

the desired Fed Funds rate. Their choices: sell treasury security or buy treasury security. When

the FOMC sells treasuries, they obtain Federal Reserve Dollar Notes and take it out of the

money supply. This raises the Fed Funds rate as dollars become scarcer. When they buy

treasury securities, they issue brand new Federal Reserve Dollar Notes to buy these off the

open market. These notes can be creates by digital dollars (never actually printed), printed

Federal Reserve Dollar Notes, or a combination of the two. This increases the money supply,

making dollars more abundant in the economy and benefitting the people who have first access

to these dollars, the financial institutions themselves. The FOMC has the power to expand or

contract the money supply by controlling the Fed Funds rate.

The inverse of

the Fed Funds rate is

a reflection of the

desired first

derivative ofmonetary growth as a

higher rate indicates a

desire to slow

monetary growth


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(1/.185 = 5.4), and a lower rate indicates a desire to rapidly increase the monetary growth

(1/.0025 = 400). To the right is a graph of the Fed Funds rate since 1955. It is at an all time low

of0% to .25%, indicating the desire to rapidly increase the money supply to offset the

deflationary forces of loan defaults (loan defaults result in a reduction of the money supply).

Increasing the money supply has been the customary action of the Fed every downturn in

business activity, in turn lowering interest rates in the Fed Funds market, and perpetrating

throughout the economy in borrowing costs for consumers, businesses and the government. The

lowering of the Fed Funds rate from 8% to 3% in the 1990-1991 recession spurred the first leg of

the dot com bubble. The continued lowering of the Fed Funds rate from 1995 to 1998 from 6%

to 4.75% further added fuel to the fire, when they should have been contracting the money

supply to slow the economic growth to avoid a bubble. However, we know what happened as a

result. In March 2000, the NASDAQ topped and began a slowdown in economic activity. Alan

Greenspan made his boldest move ever after the dot com bubble burst, he decided to lower the

Fed Funds rate even more from 6.50% to 1% from 2000 to 2003. As we know, this created the

American property owning bubble, full of rampant speculation from cheap money in which

effective inflation was nearly outpacing the interest rates on loans. Finally, this bubble popped

in 2007, and the Fed again lowered this rate from 5.25% to 1% from 2006 to 2008. As a result,

the Fed Funds rate currently sits at an effective range of0.00% to 0.25%, or free money.

At first glance, the actions of the Fed have created a desired result in the economy as weare still functioning at a

reasonable pace of economic

activity that has kept

unemployment at reasonable

levels compared to historical

recessions of the past.

However, what the majority of

people dont realize, the men at

the Fed fail to disclose to keep

the public confidence in the

institution sustainable, this has

paper over the problems of the


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past, transferred them to different entities, all with future repercussions on the economy.

This is where the demise of the 29-year treasury bull market comes into perspective. As

the Fed has lowered interest rates upon each economic downturn, it has effectively lowered the

borrowing costs of the United States Federal government. This has allowed the Federal

government to become exponentially active in nearly all facets of the economy. From

agricultural subsidies, to housing subsidies, to tax cuts during times of deficits, to perpetual wars,

to a world-wide military presence, to a lender of last resort for emerging economies, banks,

automakers, insurance companies, amongst others, to a cradle to risk inheritor, to a domestic and

international spy corporation, to a socialist economic giant that has its tentacles in every aspect

of business activity. Our Federal government has become massive and because the politicians

have been reluctant to create a balanced budget in light of this spending, our issuance of

treasuries has increased substantially to fund the socialist octopus.

The ability of the Fed to keep interest rates so low for so long has been such a

phenomenal accomplishment for economic growth, however the cost is an over indebtedness of

the consumers, businesses, and our government. The Fed desires to keep this status quo enact by

keeping the Fed Funds rate at 0.00% for the past year, keeping interest rates for debt within the

economy at sustainable levels to keep the economy chugging, despite this over indebtedness.

The invisible hand of the market has done what it can to resist this by ruining the value of the

dollar, increasing our costs of raw materials, while wages have been flat. This Fed createdbusiness cycle has increased in intensity and volatility upon each new crisis, reflective of the

underlying massive problems with our economy.

However, the cracks in this 29-year status quo are on the verge of breaking the

manipulative levy; as a result, we are on the verge of a United States Sovereign Debt Crisis,

similar to that which we have seen in Greece and Dubai as of late. This will cause ripples

throughout the economy, as the invisible hand of the market will finally break free of the

manipulative forces of the Fed. When the invisible hand finally breaks from such a rigged

market, it will come with a vengeance and an utterly destructive demeanor through which the

Greatest Depression will begin.

The Anatomy of a Sovereign Debt Crisis

Public finances are of a relatively basic formulation: Government Surplus (deficit) equals

Net Revenues minus Net Expenditures. Net Revenues include all taxes in the forms of personal,


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corporate, Social Security, Medicare, Fees, tariffs, and any other form of cash receipts to the

government less refunds. Net Expenditures are all the various things that the government

sticks its tentacles into the economy. The most important of all Expenditures is Net Interest on

Debt, which I will touch on later. All these government expenditures can be easily seen bytaking a peak at the 2011 budget. The government has some form of expenditure related to

nearly every form of economic activity and the multiple and various stimulus plans and bailouts

are an ever-expanding portion of these expenditures. Just look at the vast and expanding

agencies within the bureaucracy. In addition, just last week a projected $2 trillion dollar

spending plan was passed, increasing projected expenditures into the future. When Net

Revenues is greater than Net Expenditures, the government is running a surplus and creates

public savings. When Net Expenditures are greater than Net Revenues, the government runs a

deficit. Since we operate within the Federal Reserve System, we must issue debt when the

Federal government runs a deficit. This is opposed to just printing new treasury issued dollars

or mandating a balanced government budget of immaterial surpluses or deficits.

As a result, our most

conservative measure of debt

to GDP has now reached

100%, which as of historical

precedent represents an

impending crisis when in a

relative peacetime economy.

This is a very saddening state,

as if you count the unfunded

liabilities and other

accounting tricks and

gimmicks, the landscape is an utter disgrace. It is also worth noting that this has been on an

exponential rise, accelerating since the 1970s. When a government traditionally gets to a 100%

debt to GDP, the debt level becomes unsustainable, as taxation cannot increase too fast

without damaging the economy, and thus GDP. Either way, the cost of debt continues to rise,


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further perpetuating the debt levels. Due to the 29-year, greatest Treasury Security Bull Market

and Federal Reserve manipulation of interest rates, our government has been able to keep the

cost of debt low, regardless of the ever rising principle level of Sovereign Debt. However, if

interest rates on this debt begin to rise, more money must go to payment of this debt.This is the fear of hyperinflationists that they continually print money to make interest

payments. However, I challenge this decades long contention as no different than real estate

prices will always rise, and the sustainability of the NASDAQ bubble, the current Chinese and

American stock exchange bubbles. The current monetary regime is that of the Federal Reserve,

who have issued debt based currency, in turn have purchased large sums of the treasury

holdings and other loan obligations in the American economy. The Federal Reserve System is

made up of member banks within the twelve Federal Reserve Districts. They are the ones

holding a large portion of the loans made to Americans. First, it would not be in their best

interest, as a private quasi corporation to hyperinflat theircurrency, deeming all loans made

in the currency worthless, as all banks holding loans would be holding worthless obligations. At

this point an extreme distinction must be made between U.S. Treasuries and Federal Reserve

Notes, as these are from effectively two different institutions, representing two different

classes of people. Second, it is not feasibly possible to do so, as it would take an unimaginable

increase in the money supply to deleverage this economy. Finally, during a deflationary spiral,

loan principle amounts would be worth more in relative dollar terms due to an increase in the

purchasing power of the Federal Reserve notes. When a bankruptcy occurs, the debt does not

just vanish, rather it is usually rescheduled, and all assets are liquidated furthering this spiral.

Banks have been reluctant to liquidate assets, as they would be forced to take a write down

due to a hit on their loan loss reserves. Banks have spent the March 2009 rally recapitalizing

their equity bases to prepare for the coming losses, in an attempt to weather the hurricane that

lurks over the horizon.

Granted that my deflationary premise is correct, a decrease in the money supply will

become self-reinforcing, which began for the first time in many decades in late 2009. This is a

very important point that is not immediately obvious due to the Feds failure to disclose M3

money supply statistics. Luckily, we have many bright minds in our information society that can


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create models to fulfill the lack of

reporting. Shadow Stats reports that

M3 is decreasing year over year,

reflecting this deflationary force. Thisdecrease in money supply is further

proof the free market invisible hand

breaking the conventional

manipulative forces of the Federal

Reserve.

The impending deflationary forces originally took a toll on consumers and businesses

during the first leg of the financial crisis due to a decrease in their credit expansion. However,

government picked up the slack in credit expansion as deficits grew exponentially to cope with

the downturn. At the same time, there was a flight to U.S. safety assets during the downturn,

further lowering borrowing costs, and encouraging Federal spending. Regardless of the

massive increase in spending, interest rates hit an all time low in December 2008.

Now, we face the pinnacle of this bull market as bond prices on U.S. Treasury Securities

are set to break this 29-year bull market trend. This will be the first time investors flock to

assets other than U.S. Treasuries during a time of crisis. Instead, treasuries will be the root of

the problem, as investors will begin selling their holdings to demand a higher rate of return to

compensate for the uncertainty regarding the payment of interest of these securities. Instead,

the flock to safety will likely be the Federal Reserve Dollar Note, which surprisingly will become

scarcer as people start demanding them to pay off debts. Since a large amount of debts around

the world are denoted in Federal Reserve Dollar Notes, including U.S. Treasuries, the Federal

Reserve System has created a system of forced reliance on their currency.

The Federal Government will be in competition for Federal Reserve Notes as well for

taxation purposes. We have already begun to see the first of a series of major tax increases in

the form of a health care reform act that is completely unconstitutional regardless of any way

you spin it. When the low costs of debt begins to increase for our Federal government whom

has a 100% debt to GDP, the taxation will increase and services or at the least service quality,


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will decrease substantially. However, this will not even begin to fix the massive underlying

problems which will become exposed more so when criticism is increased by the bond

vigilantes.

Many have warned about this Anatomy of a U.S. Sovereign Debt Crisis; however, ourpoliticians believe they are stronger, better, and faster than the invisible hand. They believe

they can fix problems by creating new unsustainable programs that further perpetuate the

problem. The dogmatism of the ignorant politicians has led to the demise of the greatest

superpower the world has ever seen. The demise will come when we are unable to service our

debt load. The point at which the United States actually defaults on debt could happen

conceivably at any point in the near future. As we have seen with the financial institutions and

other sovereign debt crises, it becomes a drawn out process of how to deal with the underlying

problem. There are proposals of extreme expenditure cuts, bailouts from the International

Monetary Fund, and other absurd proposals that actually never come to fruition.

However, the trends have been established that the U.S. Sovereign Debt Crisis will begin

in the next few months. This means much higher interest rates, an end to the March 2009 to

present reactive really, and an imminent collapse in the global economy. I am not going to be

plush with the facts, expect the worst. This is going to be the Greatest Depression as it is an

inevitable outcome from the Greatest Boom in economic activity and technological

advancement. We allowed our economy to grow on an unsustainable path for far too long, the

invisible hand must correct the imbalances that we have created.

If we allow this destructive force to constructively clean the excess from the economic

system, we allow a quick liquidation of assets and debt, and prepare a new system in which we

can grow prosperously and sustainably, the creative destruction will deliver us from the evils of

a debt saturated world. However, there are many evils out there that do not wish for this to go

about constructively. These people must be eliminated from power through a populist

uprising that would satisfy the objectives of William Jennings Bryan established in his original

populist movement 100 years ago.

Creative destruction was Joseph Schumpeters theory of continuous progress within an

economic system. We will be faced with the opportunity to embrace it, which comes with


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much uncertainty, but will entail a better future, or a path of continuation in the debt based

monetary regimes that have been wrecking economies one by one, annexing the natural

resources and fundamental labor force of countries across the world. Could it be that the

Economic Hitman actually has taken out the United States? Indeed, it has, and whoever thenew default lender of last resort becomes, it will be with complete certainty that this institution

will deprive us of liberty into eternity.

Treasury Market Technical Analysis

The Greatest Bull Market of the 20th Century was the U.S. Treasury Security Market where

prices have been in an uptrend for the past 29 years, as seen above. There is an imminent

breakout of this trend, leading to much higher interest rates. Projected interest rates on long

30 year bonds are expected to reach 7.0% in the next few months to years. It depends on how

rapid of a transformation takes place. However, the passage of the U.S. health bill ensures

that higher interest rates are coming as it will prove to be the catalyst for the coming treasury

market crash.


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The 5-Year Note yield is about to break out of its downtrend, the projected upside is 4.8% in the

next few months to years.

The 10-Year Note has an upside target of 6%, which is a proxy for the risk-free rate on

investments. The rapid increase in the 10-Year Yield will destroy valuation models, and will be

the catalyst for the coming crash in the equity markets. When firms cannot proxy their

investment projects due to rapid changes in interest rates, investments will slow to a trickle.


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This is a perfectly defined inverse head and shoulders pattern, clearly illustrating the intense

nature of the invisible hand on this bond. The last time 30-Year Treasury Bond yields were at

7%, we were in the middle of a massive bull market in equities. Can an extremely fragile global

economy take on interest rates that high, when a powerful economic boom could not maintain

it, requiring a reduction in the fed funds rate throughout this time? Remember, these targets

are just for the first major impulse of the treasury market collapse. It is more than likely that

treasury yields will far exceed these estimates once the debt crisis becomes self-evident and

defaults begin to occur.

the anatomy of a u.s. debt crisis

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