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To: NOW who wrote (250891)	7/17/2003 7:19:53 PM
From: UnBelievable	Read Replies (4) \| Respond to of 436258

I Don't Think They Thought Thru The Implications Of Intervention In The Long Term Debt Market In many ways the US is like any very large company that is essentially bankrupt but who is too big to fail. Other countries, and their citizens are our creditors. The creditors have an interest in maximizing the value of the debt that they hold. The problem is that any one creditor can probably do that by dumping the debt first, which screws the rest of the creditors. So what has to happen is a solution has to be developed which provides each of the creditors with sufficient reason to believe that the make out well enough by cooperating rather than pre-empting. Essentially the decline in the dollar is the way in which this bankruptcy gets worked through. Each creditor is holding debt worth current dollars. As we print more of them and they become less the real value that the creditors are going to receive is reduced. Since all of the creditors know the dollar is going to be devalued most of them might make out better dumping the US debt. The risk is that in attempting to liquidate their holding they could set off a rush by all of the creditors to try to get out which would have as a consequence the dumping of US assets and dollars on the market which would cause to receive less than they might if they cooperate with the “work out” So the question becomes how quickly does the US intend to devalue (which is just another way of looking at the question of just how many more dollars is the US going to print. They will go along with more gradual devaluation if it appears that they will get more (both in terms of the real value for the debt which they already hold and in terms of the ongoing trade advantages which a strong dollar provides them on an ongoing basis). At some point though if they think the US is going to hyper inflate thereby radically devalue the dollar they will perceive that they may as well dump first and fast and hope for the best. I think sometime over the last month the cost of holding long-term interest rate down in terms of the amount of dollars that would be required, and the consequence of so many additional dollars on exchange rates became more fully understood. While it is true that the Fed could hold long-term rates down, they cannot really do so by just printing more dollars, as is the case with short-term rates. The reason for that is that long-term rates take into account expectations about inflation. Therefore at some point printing more dollars increases expected inflation and therefore actually drives the long-term interest rate up. To the extent that the Fed wants to lower long term rates it has to actually intervene in those markets and effectively make such debt available at “below market” rates. The only problem with that is at the point that they are effective at doing so all other sources of funds for withdraw from the market. So effectively the Fed cannot do this unless they are willing to become the only lender. Which would place them in the position of making all of the capital allocation decisions within the economy, which just isn’t very Capitalistic. There doing so has another consequence which I believe is the one that really caused them to back off. To bring down long-term rates means they have to print lots more dollars than they originally realized. Which means that the holders of debt are considerably impaired. So I think that at some point a “Foreign Creditors Committee” met with AG and told him that a devaluation of the scale implied and necessitated by an attempt by the Fed to lower long term rates was so disadvantageous to them that they had concluded they my as well take their chances with a rapid liquidation in the market. Hey probably some rich Americans called up and told him they didn’t like the fact that they were not going to be able to get a return on investment greater than, or even equal, to inflation. While the US has spun dollar devaluation as being in our interest it is very much tough love. The more the dollar devalues the more expensive everything we buy which is imported (which is most of what we buy) more expensive. And the greater the rapidity of the devaluation the tougher love it becomes. The noise that our Senators made at AG’s recent hearing about how terrible it is that China, Japan and other countries act to prop up the value of the dollar (because it exports jobs) will be nothing compared to how they react when they start hearing from their constituents about the increased price of the stuff they buy which has been imported (i.e. almost everything). So the US cannot afford to have all the creditors rush to the exit and risk a worthless dollar. And therein lies the rub. Suppress long-term interest rates and risk having the dollar, and as a result the economy, really trashed. Actually I am surprised that the bond traders took it at face value as long as they did. Once again we get to the end of the story, and once again the Emperor has no clothes. I was talking to my wife yesterday about AG’s testimony and she asked me who I thought was going to replace him. After I thought about it for a few seconds I told her I didn’t know but whoever did has to have a death wish. Either they do what has to be done to fix things and they get stoned to death, or they do what the people want, which does not fix anything, and they get stoned to death.