$700B Bailout Is Not Enough, and The Risks and obstacles of Bailout Plan To The U.S dollars

Sep.22, 2008 in Investment Opinions, Market Outlook

Risks of the debt to the U.S. dollar

By definition, international trade is the exchange of goods and services across national borders. Historically the currencies of nations involved were backed by precious metals (typically using some form of Gold Standard), which would cause a nation operating under a trade imbalance to send precious metals (economic goods in and of themselves) to correct any trade imbalances. In the current scheme of fiat money, the U.S. government is free to print all the money it wants. Consequentially, the government cannot technically go bankrupt as any debtor nation can just issue more money through a practice known as seigniorage.

If there is a gross imbalance between the amount of new money being brought into circulation and the amount of economic goods that are represented by an economy, then there is an unstable situation that can lead to hyperinflation. This has been observed in smaller nations such as Argentina in 1989; the International Monetary Fund and World Bank try to end such crises by working with the problem country to institute sound economic policies and restore faith in the international community that the country can again service its debt with a stable currency.

The interest rate offered on new bond issues is the one that clears the market. On December 13, 2006, the U.S. 30-year treasury note had a rate of 5.375%. Were investors to become concerned about the future value of the US Dollar, they would demand a higher interest rate on US bonds to compensate them for the risk they are assuming.

Pushing The Bailout To $2 Trillion

Paulson, Bernanke & Co. are learning just how diabolical the legislative process can be. Their $700 billion financial rescue program is meant to buy toxic assets from US banks and financial companies.

Since the bill was sent up to Capitol Hill as the weekend began, members of Congress have asked that individual mortgages be propped up under the legislation. Paulson has requested that foreign banks with US operations be included. Some representatives and senators want executive compensation at bailout targets curtailed

In a move which could push the value of the assistance program well above $1 trillion, Paulson is considering casting an extremely wide net of salvation. According to Bloomberg, “The change to potentially allow purchases of instruments such as car loans, credit-card debt and other devalued assets may force an increase in the size of the package as the legislation proceeds through Congress.”

The terms “increase in size” lacks the hyperbole to describe the size of the tent that will be erected if everyone’s interests are included.

The sad part of this mess, is that the money required today to fix this system, which has too many moving and broken parts will still be inadequate.

One of the most obvious and frequently mentioned problems with the new the Paulson-Bernanke reconstruction is that as banks sell mortgage-backed paper below market, they will be forced to write down the assets and take new, and perhaps significant charges. That will cause losses, probably into the tens of billions of dollars. To offset this, the financial firms will have to raise more money, dilute shareholders, and drive down their stock prices further. What was meant to save the system could undermine it, especially if banks cannot find the new investment they need. Sovereign funds have sworn off investing in US banks.

If the mortgages of every man, woman, and child are to be saved along with their credit card debt and car loans, and new bank losses are to be financed as well, the size of the pool of capital required could move closer to $2 trillion.

If housing prices, at the core of the disintegration of the system, do not rise, even this amount of medicine won’t save the patient.

Douglas A. McIntyre

Long-term risks to financial health of federal government

Several government agencies provide budget and debt data and analysis. These include the Government Accountability Office (GAO), the Congressional Budget Office, the Office of Management and Budget (OMB) and the U.S. Treasury Department. These agencies have reported that the federal government is facing a series of critical long-term financing challenges. This is because expenditures related to entitlement programs such as Social Security, Medicare, and Medicaid are growing considerably faster than the economy overall, as the population matures. These agencies have indicated that under current law, sometime between 2030 and 2040, mandatory spending (primarily Social Security, Medicare, Medicaid, and interest on the national debt) will exceed tax revenue. In other words, all discretionary spending (e.g., defense, homeland security, law enforcement, education, etc.) will require borrowing and related deficit spending. These agencies have used such language as “unsustainable” and “trainwreck” to describe such a future.

While there is significant debate about solutions, the significant long-term risk posed by the increase in entitlement spending is widely recognized, with health care costs (Medicare and Medicaid) the primary risk category.If significant reforms are not undertaken, benefits under entitlement programs will exceed government income by over $40 trillion over the next 75 years.According to the GAO, this will cause debt ratios relative to GDP to double by 2040 and double again by 2060, reaching 600 percent by 2080.

In 2006, Professor Laurence Kotlikoff argued the United States must eventually choose between “bankruptcy”, raising taxes, or cutting payouts. He assumes there will be ever-growing payment obligations from Medicare and Medicaid. Others who have attempted to bring this issue to the fore of America’s attention range from Ross Perot in his 1992 Presidential bid, to investment guru Robert Kiyosaki, and David Walker, former head of the Government Accountability Office

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