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:
- The third game of the triple header.
Game 1: Credit/Financial Crisis
Game 2: Economic/Jobs crisis
Game 3: Funding Crisis
- When Ben Bernanke gets the printing press taken away!
- When foreigners dump bonds and dollars en masse.
- 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:
- The CB does nothing. In this case, we have a funding crisis as nominal rates skyrocket higher, and there is a
depression.
- The Central Bank tries to fight the upward pressure on yields by buying the government debt, one of two things can happen:
- 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.
- 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.