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Fleck's Thoughts

Funding Crisis

Thanks to everyone for taking the time to send in your entry for this contest.
From Bill Fleckenstein, March 28, 2009:

Now I'd like to make a comment about the funding crisis -- the third in the three-baseball-game analogy that I dreamed up last fall as a way to be able to think through all the enormous problems we faced. The first and second games (crises) -- financial and economic, respectively -- were pretty easy for folks to understand, as they were front and center to the news.

Essentially, the financial crisis now lies behind us (with the economic crisis in full bloom, the recent economic "bounce" notwithstanding). That, due to all the moves put together by Hank Paulson and other government officials -- which, as those actions stopped the vaporization of the financial system -- essentially gave everyone a do-over. But therein lay the seeds for the funding crisis, if the dollar is called into question (as now appears to have begun) and if the Fed's monetization cannot lower rates (and in fact causes them to rise, due to the consequences of money printing), then the Fed is trapped. The more it tries to solve the problem with money printing, the worse it all becomes.

Now here are the best reader definitions:


A funding crisis happens to a country when other nations or institutions believe that the value of its sovereign debt or the value of its currency will decline significantly over time due to poor fiscal or monetary policies.

When that happens, fewer and fewer people are willing to purchase the sovereign debt of that country, leading to a sharp increase in interest rates and greatly increased difficulty in the ability of that country to raise new debt.

A funding crisis thus refers to the inability of a country to finance itself without resorting to outright money printing. This can lead to a vicious cycle of currency depreciation, rising interest rates, poor economic performance and poor investor sentiment, all of which feed on each other in a downward spiral.

A funding crisis can only end when proper monetary and fiscal discipline is restored, usually at the expense of severe economic hardship.

This one earned a tie as it was almost as good AND the author used the search so well:

In gentle criticism to the Rap Reader who inspired this little exercise, it may be useful and prudent to read a majority of those "so many references" pertaining to the "Funding Crisis." I searched "Funding Crisis" and read everything that had a score of over 25. In this review, I discovered you started describing the "Funding Crisis" in the middle of 2006, but you did not give it a "handle" until late 2008. I am glad I participated in this exercise as I learned a great deal and have a more clear financial picture of where we have been, where we currently are and where we may be going.

A Funding Crisis: the successor to the financial and economic crises, created mainly as a result of Federal Reserve policy over the last twenty years. A funding crisis occurs due to a lack of credibility in the Federal Reserve (and, the United States) to instill confidence in the value of the U.S. dollar and repayment of current and future liabilities. The result of a U.S. funding crisis is: a declining value of the U.S. dollar and rising interest rates in debt markets.

The rest all made good points but slightly misssed the winning mark for one reason or another (i.e., a bit incomplete, too binary, slightly wrong conclusion, etc.), but I felt they would be useful food for thought for everyone:
Funding Crisis:

The inability of the government to finance its current obligation at current market rates which will lead to:
a. Higher interest rates, higher unemployment and a recession, or
b. the government will print money to fund these obilgations, which will lead to higher inflation and a devaluing of the dollar, or
c. a combinatiion of both, which will lead to stagflation.

Funding Crisis:
  1. The third game of the triple header.
    Game 1: Credit/Financial Crisis
    Game 2: Economic/Jobs crisis
    Game 3: Funding Crisis
  2. When Ben Bernanke gets the printing press taken away!
  3. When foreigners dump bonds and dollars en masse.
  4. When a Treasury bond auction fails.

Funding Crisis:

That time when we the U.S. Government is no longer able to borrow money, except at extremely high interest rates, or where borrowed money re-payment would be required in a currency other than U.S. dollars. This currency could be gold, or any other currency the lender viewed as sound or at least not able to be created by the entity borrowing the money. An early indicator of such a crisis could be a failed U.S. Treasury auction, in that there were few or no willing buyers of U.S. Treasury notes, other than the Federal Reserve (either directly or indirectly) buying the debt. In such a crisis, a possible outcome could include an extremely weakened dollar, high or extremely high interest rates for all who borrow in U.S. dollar terms and monetary inflation and or stagflation.

Funding Crisis:

When money is printed with reckless abandon (monetary inflation), it eventually leads to price inflation. This price inflation tends to put upward pressure on nominal yields and/or downward pressure on the currency.

The Central Bank then has two choices:

  1. The CB does nothing. In this case, we have a funding crisis as nominal rates skyrocket higher, and there is a depression.
  2. The Central Bank tries to fight the upward pressure on yields by buying the government debt, one of two things can happen:
    1. The currency starts to spiral lower as investors flee the country and the currency. The Central Bank accepts defeat and interest rates skyrocket (funding crisis) until a level is found where investors are willing to risk buying the debt again.
    2. The CentralBank keeps buying debt and the currency continues to spiral lower. Eventually, the Central Bank owns all the debt of the country. At this point, new govt debt is printed and ALSO monetized, and the currency keeps falling. This leads to hyperinflation — but no funding crisis — a pyrrhic victory for the Central Bank.

Funding Crisis:

As the U.S. government deficit continues to grow, foreigners become less willing to fund our increasingly bloated government spending at these ridiculously low real interest rates (after accounting for inflation), which are in turn the result of downward manipulation by Federal Reserve "stimulus" (QE1 and QE2). As the foreign countries fund less and less of our annual deficit, the Federal Reserve responds by plugging the hole via purchasing the Treasury debt themselves. The Federal Reserve effectively becomes the buyer of last resort and funds the purchases by printing more and more money. This leads foreigners to purchase even less of our debt in an ever declining spiral until ultimately the Federal Reserve is purchasing theoretically the entire annual deficit. Hence we have the essence of the "funding crisis."

No one in the rest of the world wants to fund our deficits at these low real rates nor hold a U.S. dollar that is effectively being devalued by the Federal Reserves’ never ending cycle of money printing. That leads to a declining dollar exchange rate in the international currency markets, which may cause the currency wars being discussed. Every other country may have to follows suit in money printing to prevent their respective currency from appreciating relative to the dollar, which will damage their export/import balance and effectively their respective economies.

To prevent the currency war sparked by the "funding crisis," the U.S. has only two options. First, significantly raise real interest rates to attract foreign buyers of our deficit funding requirements. Or second, significantly reduce the federal deficit by cutting spending. Of course, both options can be done concurrently in some combination. The "funding crisis" simply put, is the failure of foreigners to buy some of our annual deficit funding needs because the yield is insufficient to offset the expected inflation from all that money printing.

Funding Crisis:

The third crisis in the three-baseball-game analogy. The first and second games (crises) were the credit meltdown and the economic downturn. At some point, the U.S. will not be allowed to finance all of its debts in dollars. Foreigners will not continue to fund trillions in dollars in spending in our currency. Somewhere down the road we might have to borrow in foreign currencies which will cause another set of problems.

Funding Crisis:

When government finally realizes that they don’t have enough money to pay their bills because they can no longer create enough government debt by issuing more government bonds.This happens because the buyers of bonds in the private sector begin to realize that the rate-of-inflation in the economy is greater than the yield being paid by the government on the bonds. The central bank can step in and buy the government bonds by printing new money, but this will increase the money supply, which increases inflation, thereby driving bond prices even lower and yields even higher. With higher inflation the government now has to pay a higher price to borrow less money. This cycle comes to an end when the government isn’t able to sell enough bonds to pay off recurring debt.

Funding Crisis:

Simply defined, the funding crisis will occur at the point where the government will no longer be able to sell debt (a.k.a., bonds) to the market. This will put the government in the untenable position of not being able to pay its bills to cover the budget.

The unitiated, non-Bill Fleckensten readers out there would say that that will not happen because the Fed can always just print the money and buy whatever bonds that the government cannot sell.

The trouble with that solution, however, is that, at some point, quantitative easing will cause a currency crisis. If the market becomes utterly convinced that the Fed will continue monetizing government debt ad infinitum, the market will sell dollars and dollar-denominated assets, crashing the value of the currency. At a certain point, the imploding dollar becomes an emergency, as American consumption is highly dependent upon imports.

So, the Fed will find itself in a terrible dilemma: buy off the government debt with newly created dollars and continue imploding the value of the currency, or stop monetization of the debt to save what value is left in the dollar. At that point, we will be in a full-blown funding crisis. There won't be enough buyers of the debt, and the Fed will not be able to monetize it without throwing the economy into chaos.