If the US experiences a depression on the order of the 1930's, then, I can say with certainty there will be not enough economic activity to support the current quantity of either public or private debt. In those circumstances, most of the financial institutions of the US will be nationalized as all of their assets will go bust. But since they can only be nationalized and kept afloat with further money creation, I would think this would have an impact on the USD. Also, in a depression, with most of the financial institutions nationalized, the government will then decide how the private debt is to be ultimately mitigated. I would expect that most mortgages, commercial loans and credit card debt would be forgiven using a percentage. We are, for example, already seeing the model here as Fannie and Freddie are clearly going to be used as vehicles for loan modification. In a depression, with the nations financial companies nationalized--with all the shareholders having their common stock destroyed--there would be no sense for the country to have people trying to pay the debt from what would be known as "the previous era." There would be no way the country could emerge from depression then, unless the debt was essentially forgiven.
Under these circumstance, foreign holders of the USDollar will be toast. And the governments of the world with strong balance sheets will see massive inflows.
I think CAD and AUD could be Swiss Franc like currencies in a global depression. Both countries would hate it and would fight the inflows, but I don't think there's much they could do. Besides, exporters of raw materials could always cut the price as it passes through the strong currency. And the governments could help exporters hedge on the way up--as they already do in Australia.
Here is my USA Flow Chart from this point forward: The US attempts to hobble though the next 2 years with a combination of massive Keynesian spending, partial reflation, a weaker USD for exports, continued losses in the financial system but not alot more nationalization or failures, and lots of loan modifications on mortgages. If this fails, then one of the following must happen: 1. The aggregate debt of the US both public and private is reflated away via a strong inflation that is at least as bad as the late 70's, and there is an open devaluation of the USD. 2. The same quantity of debt is deflated away through total outright default of the kind that is associated with collapse or seizure of the system.
While I don't know the outcome, I am certain that the Hobble Through attempt is already underway, and that number 1. will be chosen before number 2.
Final thought: consider all those currently advising Obama, including his new Treasury Secty. Then let's hear what Obama said today in his Saturday radio address:
“And now we risk falling into a deflationary spiral that could increase our massive debt even further,” the president- elect said.
Seems pretty clear to me that Obama has already been made to understand (Volker, Buffet, Rubin, Geithner, Reich, etc) that the Debt is a bomb already and that it goes nuclear if deflation takes hold. As you may have seen in my other post on this topic today, Summers is being brought in to serve in the role of Spending Advisor. This guy has been very clear the last 6 months about his solutions. He is FDR Jr. but the magnitude is going to be even larger.
G |
