Tag Archives: Default

When The U.S. Government Defaulted, by Global Macro Monitor

Every gold bug worth his or her salt knows when the US defaulted, but many non-gold bugs are not aware of it. From Global Macro Monitor at macromon.wordpress.com:

One of the most pervasive myths about the United States is that the federal government has never defaulted on its debts. There’s just one problem: it’s not true, and while few people remember the “gold clause cases” of the 1930s, that episode holds valuable lessons for leaders today. – Sebastian Edwards, Project Syndicate,  May 21, 2018

My friend, UCLA professor,  Sebastian Edwards, is out with a must-read summer book, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold.

 

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Sebastian has also published an excellent synopsis of the the book, Learning from America’s Forgotten Default, on the Project Syndicate (PS) website.   It is an excellent introduction to the subject material but only scratches the surface and should not be a substitute or excuse for not purchasing the book.

Money quotes from the Project Syndicate  piece:  

  • There was a time, decades ago, when the US behaved more like a “banana republic” than an advanced economy, restructuring debts unilaterally and retroactively
  • In April 1933, in an effort to help the US escape the Great Depression, President Franklin Roosevelt announced plans to take the US off the gold standard and devalue the dollar. 
  • …this would not be as easy as FDR calculated. Most debt contracts at the time included a “gold clause,” which stated that the debtor must pay in “gold coin” or “gold equivalent.” 
  • These clauses were introduced during the Civil War as a way to protect investors against a possible inflationary surge.
  • …the gold clause was an obstacle to devaluation. If the currency were devalued without addressing the contractual issue, the dollar value of debts would automatically increase to offset the weaker exchange rate, resulting in massive bankruptcies and huge increases in public debt.
  • Congress passed a joint resolution on June 5, 1933, annulling all gold clauses in past and future contracts.
  • Republicans were dismayed that the country’s reputation was being put at risk, while the Roosevelt administration argued that the resolution didn’t amount to “a repudiation of contracts.”
  • On January 30, 1934, the dollar was officially devalued. The price of gold went from $20.67 an ounce – a price in effect since 1834 – to $35 an ounce.

To continue reading: When The U.S. Government Defaulted

Cataclysm, by Robert Gore

Collapse generally comes as a surprise, even to those who predict it.

The USSR didn’t just fail one day, as does a person who dies of a sudden heart attack or stroke. It was more like a wasting illness brought on by an unhealthy lifestyle. A physician tells a morbidly obese patient: “Your daily consumption of twelve cocktails, three packs of cigarettes, and 4,000 calories, and your refusal to engage in exercise more strenuous than walking to the refrigerator will kill you, but I can’t say when.” For both individuals and governments, certain choices are incompatible with continued existence, and the Soviet government made plenty of those.

Very few people foresaw its failure when it was imminent, even purported experts. The small group who said Soviet communism wouldn’t work because it couldn’t work were disparaged right up until it didn’t work. However, the deck is always stacked in favor of those predicting this or that government will fail. Ultimately they all do because they all come to rest on a foundation of coercion and fraud, which doesn’t work because it can’t work.

There is both a quantitative and qualitative calculus for individuals subject to a government: what the government takes versus what individuals get back. Government is a protection racket: turn over your money and it promises physical security from invasion and crime, and adjudication and restitution in the event of civil or criminal wrongs. The quantitative calculus: am I getting more back than I put in? The qualitative calculus: what activities and people does the government help or hinder?

Need a good laugh before the shtf?

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Protection rackets are often indistinguishable from extortion rackets, the “protector” a bigger threat to the “protected” than the threats against which they’re supposedly protected. Such is the case with the US government, as it was with the former Soviet government. Blessed with naturally defensive geographies and huge nuclear arsenals, the chances of the US being attacked are (or were, in the case of the former Soviet Union) remote. The cost for actual protection provided by those governments has been a tiny fraction of what’s been extracted by force or fraud from their citizenries, the very definition of an extortion racket.

Freedom militates against stupidity; coercion compounds it. Competitive markets and a wide-open intellectual climate either kill the worst ideas or impel their improvement. Power corrupts so completely because those who hold it rarely face negative feedback or consequences. Critics are mocked, stifled, imprisoned, or murdered. The costs of failure are borne by the victims. The perpetrators blame those failures on lack of funding or authority and receive more of the same.

Nothing succeeds like failure in coercive systems. Just look at the US governments “wars” on poverty, drugs, and terrorism. For rational people in free, competitive systems an ever-expanding gap between shining intentions and dismal reality prompts psychological turmoil. The powerful salve outbreaks of cognitive dissonance with arrogance, which expands apace with their failing programs. Just look at Obamacare, which its progenitor hails as his greatest accomplishment.

As the protection racket and its sub-rackets expand, the “protected” receive less and less, but pay more and more. By now, both the quantitative and qualitative calculuses are clear to productive Americans: they’re being reamed by people they despise, who in their arrogance and willful blindness despise them. The government steals trillions directly, but still resorts to financial sub-grifts—debt, fiat money, and central banking—to feed its insatiable money-lust. Like the government’s debt, stupidity compounds exponentially and rational people wonder how long unsustainable rackets can persist. The racketeers, if they realize their rackets can’t last, don’t care; they’re going to milk them as long as they can.

With the world’s most powerful military, largest nuclear arsenal, and most intrusive surveillance apparatus, the ostensible power of the US government is daunting. Yet, if a tenth of the US population ran up their debts, withdrew their funds from the financial system, and then stopped making debt service payments for a few months, it would propel a run on the banking system, choking the government’s financial lifeline and exposing its worthless fiat debt scam. Thus, the government is hardly invulnerable. As stupidity compounds, so too do its vulnerabilities.

The foundation of the global economy and financial system is interlinked debt. Anyone paying attention during the last financial crisis recognized that it took surprisingly few defaults—debt markdowns that marked down the value of the corresponding credit-assets—in a highly leveraged and interconnected system before that system unraveled and imploded. Anyone with a modicum of analytic ability and intellectual integrity realizes that the “solution” to that last financial crisis—more government and central bank debt—was another instance of stupidity compounding itself. Now, there’s more craziness in the debt asylum than there was in 2007.

There probably won’t be a voluntary debt payment moratorium, although for anyone asking how “we the people” can throw off the burdensome yoke of “our” government that would be a fine place to start. There doesn’t have to be; the mechanics of debt implosion guarantee the same result. Most of the world’s financial assets are debt or equity claims. Equity has a lower legal right to a debtor’s assets than debt. A debt collapse will leave the world impoverished, and so too its governments. Many real assets will be tied up in creditors’ squabbles. Governments’ and their central banks’ vaunted abilities to drive interest rates to subzero, go further into debt, and exchange their pieces of paper or computer entries for other pieces of paper or computer entries will mean little in a world submerged in debt, worthless paper and computer entries.

Those who scoff at the notion of cataclysmic collapse ignore ubiquitous signs of deterioration and recent history. Real economic growth and incomes have been trending downward since the turn of the century, even by official statistics. One has to question how much of the growth in either is the product of statistical legerdemain—government statistics leave much to be desired—and debt. If debt grows at 5 percent and the economy and incomes grow at 2, is the economy actually growing? Should some present value accounting be made of the fact that the longer debt growth exceeds economic growth, the greater the burden that debt imposes on the economy?

Some say the last financial crisis proved that governments and central banks can prevent a debt implosion. They’re drawing the wrong conclusion. It “proved” that massive injections of fiat debt defibrillated the patient, and it still serves as essential life support. However, not even life support will keep the patient alive the next time the EKG flatlines. All governments will then have are lots of weapons, worthless debt, millions of angry beneficiaries, and whatever loyalty they can still command, literally, from the police-military-surveillance complexes.

At which point, the calculus becomes intolerable for those long milked and bilked by governments, and offering them only further pain with no gain. Inevitably, they will consider their options: flight, secession, devolution, or revolution. Governments are only temporary arrangements and pendulums swing. Cataclysm should afford, for those inclined, opportunities—if they’re willing to fight for them—to live under arrangements more conducive to individual freedom and voluntary interaction.

THE PINNACLE OF OPTIMISM

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What’s Next With America’s Enormous $20 Trillion Debt?, by Simon Black

If the US government’s debt is not as dire as SLL and other critics assert, then what do those who downplay the debt think would happen if the government defaulted? From Simon Black at internationalman.com:

Thousands of years ago, as far back as 3000 BC, the ancient Egyptians had developed a highly advanced system of writing using hieroglyphic symbols.

The used hieroglyphs for numbers as well.

A single line, for example, represented the number 1. Two strokes represented 2. Nine strokes for the number 9.

Since the Egyptians had not yet invented the “zero” in 3000 BC, representing the number 10 required a new symbol– a sort of upside down horseshoe.

So the number 99, for example, required eighteen different symbols: nine upside down horseshoes for the number 90, and another nine strokes for the number 9.

There was another symbol for 100, another for 1,000, and so forth.

The largest number in ancient Egypt was 1 million. As historian Will Durant wrote,

“The sign for 1,000,000 was a picture of a man striking his hands above his head, as if to express amazement that such a number should exist.”
Today the national debt in the Land of the Free is just shy of $20 trillion.

It makes me wonder what symbol the ancient Egyptians would have used to represent such an absurd figure. Hope and change?

Even the concept of trillion is difficult for our minds to fully grasp as there is very little within our physical human experience which relates to it.

“Trillion” almost seems like a fantasy… a made-up number like “a bajillion” or “zillion”.

And yet, the debt is very real.

Of course, we’re told that the debt isn’t important.

Modern “experts” who win our society’s most esteemed prizes for intellectual achievement tells us that the debt doesn’t matter “because we owe it to ourselves.”

This is pitiful logic.

It’s true that “only” $6 trillion– 30% of US debt is owned by foreigners.

The rest is owned primarily by the Federal Reserve, Social Security trust funds, US banks, large US companies, and the federal government itself.

But I fail to see how this is relevant. A debt owed is a debt owed.

To continue reading: What’s Next With America’s Enormous $20 Trillion Debt?

Puerto Rico Nearing Historic Default, by Michelle Kaske

SLL holds a simple belief: if you spend more than you take in for long enough, you will go broke. Puerto Rico confirms this simple truism. From Michell Kaske at Bloomberg Business via davidstockmanscontracorner.com:

Even if Puerto Rico manages to strike a last-minute deal to defer bond payments due in three days, the commonwealth’s financial collapse is about to enter an unprecedented phase.

Anything short of making the $422 million payment that Puerto Rico says it can’t afford would be considered a technical default. More importantly, it opens the door to larger and more consequential defaults on debt protected by the island’s constitution, and raises the risk of putting efforts to resolve the biggest crisis ever in the $3.7 trillion municipal market into turmoil.

Nearly 10 months after Governor Alejandro Garcia Padilla said the commonwealth was unable to repay all its obligations, Puerto Rico has failed to reach an accord on a broad restructuring deal presented to bondholders. During that time the administration has delayed payments to suppliers, postponed tax refunds, grabbed revenue originally used to repay other bonds and missed payments on smaller agency debt. With its options drying up, no bondholder agreement in sight and Congressional action delayed, defaulting may be the next step for Puerto Rico.

“It’s a game changer because it starts an actual legal process with teeth on both sides that can finally advance settlement negotiations,” said Matt Fabian, a partner at Municipal Market Analytics, a research firm based in Concord, Massachusetts. “Pre-default negotiations are really not going anywhere. Post default might have a better chance.”

Puerto Rico and its agencies racked up $70 billion in debt after years of borrowing to fill budget deficits and pay bills as its economy shrunk and residents left the island for work on the U.S. mainland.

The island’s Government Development Bank, which lent to the commonwealth and its municipalities, is in talks with creditors to avoid defaulting on the $422 million that’s due May 1. The commonwealth may use a new debt moratorium law if it cannot defer that GDB payment, Jesus Manuel Ortiz, a spokesman for Garcia Padilla, said Wednesday during a press conference in San Juan.

While a GDB default would be the largest yet by Puerto Rico, a missed payment on its general obligations would signal to investors that the commonwealth is finally executing on its warnings that it cannot pay its debts. Puerto Rico and its agencies owe $2 billion on July 1, including a $805 million payment on its general-obligation bonds, which are guaranteed under the island’s constitution to be paid before anything else.

To continue reading: Puerto Rico Nearing Historic Default

DEUTSCHE BANK: A wave of defaults may be just around the corner, by Matt Turner

From Matt Turner at business insider.com:

The credit markets have been showing signs of contagion, as Chinese growth concerns and slumping commodity prices lead to widespread selling.

That has Deutsche Bank wondering if there is likely to be a wave of companies failing to pay interest on their bonds.

It said in a note Friday: “With the recent back-up in both IG [investment grade] and HY [high-yield] spreads to their respective 3.5-year wides, a discussion has emerged about whether the market is sensing the next default cycle around the corner or is simply “overreacting” to some exogenous but ultimately irrelevant events. At 570bp ex-energy spreads, the market is well ahead of what would normally be considered sufficient compensation for defaults that are still tracking sub-2% in this segment of our markets.”

Strategists Oleg Melentyev and Daniel Sorid looked at six leading indicators to judge whether the credit market has over-reacted, and found that two are flashing red – meaning they are “at levels consistent with where previous credit cycles have started.”

The two signals flashing red are volatility shocks, and spreads on the highest rated corporate bonds. As the chart at the bottom of this page shows, the Vix and spreads on AA-rated corporate bonds are moving in a similar fashion to the late 90s and the years leading up to the financial crisis.

Two other indicators – financial stocks and monetary policy – are flashing yellow, meaning they have shown some signs of deterioration but are not yet at stressed levels. Two other indicators – volatility in Treasuries and issuer fundamentals – are sending no warning signals.

“So where does all of this leave us, in terms of our outlook for the timing of the next default cycle, and perhaps more specifically, our outlook for default rates next year?” Deutsche Bank said in the note.

“Our view is that default cycle is likely to be closer than consensus seems to believe, and its early stages may arrive as soon as next year, although at this point there is not enough evidence to make it a base case scenario, so we are keeping it as a risk to our outlook.”

To continue reading: A wave of defaults may be just around the corner

Crisis Progress Report (12): Zero Will be King, by Robert Gore

THERE IS A NEW TAB AT THE TOP OF THE PAGE: DEBTONOMICS ARCHIVE. IN RESPONSE TO POPULAR DEMAND, READERS WILL HAVE A LINKED LIST OF ALL OF ROBERT GORE’S ARTICLES ON ECONOMICS SINCE SLL MOVED TO THE WORDPRESS PLATFORM LAST YEAR. AS YOU MAY SUSPECT, IT IS NOT BEING POSTED BECAUSE HE HAS BEEN WRONG.

“Markets make opinions” is a psychological truism. Current financial turbulence is putting investors and speculators on notice of economic perturbations that can neither be ignored nor remedied with the standard debt-based pixie dust. Even the permabulls are hedging their public comments and predictions, especially after both dovish and hawkish utterances from ringmaster Yellen sent markets reeling. The punditry and media deal in stories, which the unfolding debt deflation and depression are throwing off abundantly: China, Brazil, crashing commodities, big moves up and down (mostly down) in stock markets, credit spreads blowing out, bankruptcies, possible bankruptcies (Glencore) and Wise Men and Women from finance and governments opining on developments.

What the punditry, with some exceptions (see Blogroll), and the media don’t do is offer much in the way of analysis that either explains causes or predicts effects. They are a mirror into prevailing crowd psychology and emotion, but their so-called causes are generally superficial and don’t stand up to empirical verification. Their predictions are usually straight-line projections of more of whatever happens to be the current same.

That is not because the root causes of the present turmoil are too complicated and complex to ascertain. Quite the contrary, the explanation is simple. As SLL has stated since last year (see “Debtonomics: Robert Gore’s Economic Archive,” SLL) an unwind and contraction of a massive and unprecedented multi-decade debt expansion is underway. It takes no acuity to reach that conclusion, indeed it requires more effort to avoid reaching it.

Complex mental gymnastics are performed and transparently fallacious public statements are made, either to explain why what is obvious to many is not really happening, or to divert attention to irrelevant considerations. People tie themselves up in mental knots to evade reality for psychological reasons. It is not hard to understand why most avoid the debt contraction conclusion. Debt contractions, especially those that run their full course, are economically, financially, socially, and politically painful.

Debt contraction has not been allowed to run its full course since the Great Depression. Governments and central banks shot their wads rescuing the global financial system from the last one, consequently, this one will run its full course. Markets, at least in the short term, are exercises in crowd psychology. Two virtues are required for successful longer term investing: independence and patience. Although the crowd is starting to question, albeit not discard, what has passed for wisdom the last few years, the abandonment of complacency and capitulation to fear won’t happen until markets are much closer to an ultimate bottom. Indeed, such a herd reversal will be one of the telltale harbingers of that bottom. Independent and early recognition of what is transpiring—a full-fledged debt contraction—entails recognition that it will be a lengthy process.

One of the best analysts of stock market dynamics is John Hussman, of the Hussman funds. SLL has posted some of his weekly letters, most recently, “Valuations Not Only Mean-Revert; They Mean Invert,” 9/29/15. The upshot of his analysis is that markets not only revert to a mean, or average, level of valuation after a period of extreme overvaluation (e.g. the current stock market, even after it’s recent fall), but that they overshoot to a state of undervaluation, what he calls mean inversion. Markets being markets, their paths are not straight lines, but rather jagged, negatively-sloped progression within which there are substantial bear market advances, subsequently reversed. Historically, the entire progression from extreme overvaluation to extreme undervaluation can take almost two decades.

The recent demise of former market darlings health care and cable—industries encased in the government cocoons of Obamacare and net neutrality respectively—confirms that even the “best” companies, which in the crony capitalistic economy means most succored by the government, will succumb to the burgeoning debt contraction. However, both the dynamics of such contractions and Hussman’s analysis suggest that we are a long way from anything approaching a true “buying opportunity” for long-term investors. Prices have fallen and an estimated $13 trillion of global wealth has vanished. However, as Hussman notes, prices have not fallen nearly enough in percentage terms to create undervalued bargains, and there are more bankruptcies to come in commodities and across the rest of the economy. Any price above zero is too much to pay for companies whose equity is wiped out.

At this point, assuming your selling is done and you sit mostly in cash, with perhaps a little on the side for speculative shorts, the best investment advice is to be patient. It will probably take appreciably more opinion-making market downside before prominent permabulls switch to the bearish camp, the mainstream media proclaims a long running bear market, and the news is filled with dire headlines. The gloom will get so thick and one-sided that when nobody expects it, a rally will ignite. It won’t be a one-day or one-week wonder, either, it will span a month or two and will recoup a substantial percentage of the losses. The last crisis is instructive. The S&P index topped in October of 2007 and dropped for five months until a rally began, in March of 2008, that retraced half the drop. Such rallies are almost universally disbelieved when they start and almost universally embraced as the beginning of a new bull market when they end. Bullish belief had been restored in May of 2008 when that rally ended. The rest of the year was tears.

Catching the falling dagger has skewered more speculators than Vlad impaled Turks. If you are positioned correctly, stay away from nonstop news and market updates. Obsessing on the short term and watching screens tick by tick will distort or destroy your essential long-term thinking and planning. Use the time and psychological energy saved to write that great novel that everyone has inside them, or get to know your wife and kids. Assume a rally like the one in 2008 is in the offing. If the 2008 rally’s timing is any guide, this one will start between now and New Year’s, but there are no assurances; it may begin next year. While you will want to take profits on your speculative shorts, use the rally as an opportunity to reset those shorts at higher levels and avoid the temptation to try to scalp a few trades from the long side.

We are still at the beginning of this debt contraction and the first big move down is incomplete. Not until the next big move down, after the coming head fake rally, will recognition become almost universal that we are in a severe bear market. If you patiently preserve your fire power by ignoring the day-to-day squiggles and jiggles, your virtue will be rewarded. The invested herd will discover that there is something worse than the zero returns they so decry when they mock cash: negative returns. Deflationary depressions reprice virtually every asset class, real and financial, bestowing jaw-dropping bargains on those few who can plunk down cash on the barrelhead when the time is right. In the land of negative returns, zero will be king.

WHEN WAS THE LAST TIME YOU STAYED

UP ALL NIGHT READING A NOVEL?

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Waiting for Collapse: USA Debt Bombs Bursting, by William Edstrom

A handy shopping list for short-sellers and a nice checklist for investor asset disposals (see also”Neither a Borrower Nor a Lender Be,” SLL, 8/26/15). From William Edstrom at counterpunch.org:

It’s been so easy the past 15 years for local governments in the USA, state governments, government authorities, corporations, banks, hedge funds and the US Federal government to simply say how many millions, billions or trillions of dollars they wanted, pay some high priced call accountants to fill out some paperwork with fine print and voila, millions, billions and trillions of dollars in borrowed money simply appeared. It has been that easy!

Now, the government in the USA owes $46 trillion, US corporations owe $15 trillion, US individuals owe $13 trillion plus there are $315 trillion in outstanding Wall Street derivatives. (Few Americans know what a derivative is, but we as a nation are on the hook for up to $315 trillion in additional debt because of these derivatives.) These debt figures continue to escalate with each passing month.

Detroit and Puerto Rico have only just begun the debt bombs bursting in the USA, the USA’s slow motion economic collapse. Who’s next? I’m going to tell you about some US local and state governments that have too much debt and are ripe for debt collapse along with a few US government authorities and corporations that borrowed too much money and are also ripe for debt collapse.

Mr. Dudley of the New York Federal Reserve Bank recently warned of a wave of US municipal debt collapses coming soon. The problem is bigger than solely US municipalities as Mr. Dudley no doubt is aware. Chicago or LA, which one is more likely to collapse first? Chicago. Kanakee County IL or Perry County KY? Kanakee County is more likely to go belly up first. Atlantic City (AC) or Yonkers? AC is more likely to bite the dust first. 1 out of 25 states are ready to collapse within months, as are 1 out of 20 US cities, 1 out of 15 US government authorities and 1 out of 7 US corporations. Within a few years, many US cities, counties, authorities, states and corporations will have debt collapsed, before the USA as a nation debt collapses. A tsunami of debt collapses is hitting the USA. The causes are government officials and corporate executives who borrowed too much easy money plus Wall Street bankers and hedge fund vultures who lent too much easy money.

Besides city, county and state collapses, there will also be school debt collapses, hospital debt collapses, government authority debt collapses, individual bankruptcies, corporate debt collapses and finally the nationwide debt collapse of the USA. If change cannot be brought about fast – like increasing revenue (e.g. raising taxes on the rich) or cutting spending (e.g. ending endless war, cutting military/intel spending) or both – then, the best way forward may be to evacuate. Get away from the places about to collapse as quickly as you can. If you find your home is burning to the ground, as I discovered one Sunday evening in New York City in the Summer of 2011, what are you going to do? Evacuate.

To continue reading: Waiting for Collapse: USA Debt Bombs Bursting

Three Reasons Why the U.S. Government Should Default on Its Debt Today, by Doug Casey

From Doug Casey at theburningplatform.com:

The overleveraging of the U.S. federal, state, and local governments, some corporations, and consumers is well known.

This has long been the case, and most people are bored by the topic. If debt is a problem, it has been manageable for so long that it no longer seems like a problem. U.S. government debt has become an abstraction; it has no more meaning to the average investor than the prospect of a comet smacking into the earth in the next hundred millennia.

Many financial commentators believe that debt doesn’t matter. We still hear ridiculous sound bites, like “We owe it to ourselves,” that trivialize the topic. Actually, some people owe it to other people. There will be big transfers of wealth depending on what happens. More exactly, since Americans don’t save anymore, that dishonest phrase about how we owe it to ourselves isn’t even true in a manner of speaking; we owe most of it to the Chinese and Japanese.

Another chestnut is “We’ll grow out of it.” That’s impossible unless real growth is greater than the interest on the debt, which is questionable. And at this point, government deficits are likely to balloon, not contract. Even with artificially low interest rates.

One way of putting an annual deficit of, say, $700 billion into perspective is to compare it to the value of all publicly traded stocks in the U.S., which are worth roughly $20 trillion. The current U.S. government debt of $18 trillion is rapidly approaching the stock value of all public corporations — and that’s true even with stocks at bubble-like highs. If the annual deficit continues at the $700 billion rate — in fact it is likely to accelerate — the government will borrow the equivalent of the entire equity capital base of the country, which has taken more than 200 years to accumulate, in only 29 years.

You should keep all this in the context of the nature of debt; it can be insidious.

The only way a society (or an individual) can grow in wealth is by producing more than it consumes; the difference is called “saving.” It creates capital, making possible future investments or future consumption. Conversely, “borrowing” involves consuming more than is produced; it’s the process of living out of capital or mortgaging future production. Saving increases one’s future standard of living; debt reduces it.

If you were to borrow a million dollars today, you could artificially enhance your standard of living for the next decade. But, when you have to repay that money, you will sustain a very real decline in your standard of living. Even worse, since the interest clock continues ticking, the decline will be greater than the earlier gain. If you don’t repay your debt, your creditor (and possibly his creditors, and theirs in turn) will suffer a similar drop. Until that moment comes, debt can look like the key to prosperity, even though it’s more commonly the forerunner of disaster.

To continue reading: Why the U.S. Government Should Default

“Why Commodities Defaults Could Spread”, UBS Explains, by Tyler Durden

Anybody who was around for the last financial crisis knows how this one will go: defaults spreading out to “unrelated” areas as debt unravels, a process misnamed “contagion.” UBS has gotten the message. From Tyler Durden at zerohedge.com:

UBS has been keen to warn investors about just how perilous the situation in high yield has become – which works out nicely, because we’ve been saying precisely the same thing ever since it became readily apparent that between investors’ hunt for yield and energy producers’ desire to take advantage of low rates and forgiving capital markets in order to stay solvent, the market was setting up for a spectacular implosion.

Lots of supply (hooray for record issuance!), a gullible retail crowd (bring on the secondaries and find me a junk bond ETF!), and a lack of liquidity in the secondary market (down with the prop traders!) have conspired to create a veritable nightmare scenario and with commodity prices (especially crude) set to remain in the doldrums for the foreseeable future, the question is not whether there will be defaults in HY energy, but rather what the fallout will be for the broader market.

Or, as we put it in “The Junk Bond Heat Map Has Not Been This Red In A Long Time,” at some point, investors (using other people’s money) will tire of throwing good money after bad hoping to time the bottom tick in oil just right (and if oil tumbles in the $30, that may be just that moment) at which point the commodity capitulation which we noted previously, will spread away from just commodities and junk bonds, and spread to all sectors and products, including stocks.

Here with more on the contagion risk from commodities defaults is UBS.

* * *

From UBS

Credit contagion: why commodity defaults could spread

In the wake of the commodity price swoon one of the recurring questions is will the stress in commodity markets spillover to other sectors?

First, regular readers will recall our HY energy default forecast of 10-15% through mid- 2016. Simply framed, the commodity related industries total 22.8% of the overall HY market index on a par-weighted basis. In our view, sectors most at-risk for defaults (defined as failure to pay, bankruptcy and distressed restructurings) total 18.2% of the index and include the oil/gas producer (10.6%), metals/mining (4.7%), and oil service/equipment (2.9%) industries.

How large are contagion risks to the broader HY market? And what are the transmission channels? Historically, investors in the limited contagion camp would probably point to the early 1980s. In this cycle commodity price defaults spiked with the drop in oil prices yet average default rates (IG & HY) increased only moderately amidst a favorable economic environment. In our view, however, the parallels in terms of the credit and asset price cycles are a stretch versus the current context. In the last three cycles, commodity price defaults have either led or coincided with a broader rise in corporate default rates.

But why should there be contagion from commodity sectors to other segments?

There is a clear pattern of default correlation dependent on fluctuations in national or international economic trends. Commodity price weakness is symptomatic of weak economic growth in China and emerging markets – with possible spillover risks for commodity related sovereigns (oil exporters) and corporates.

In addition, distress in one sector affects the perceived creditworthiness as well as profits and investment of related firms in the production process. For example, exploration and production firm defaults could negatively affect suppliers and customers which would include oil equipment and service, metals, pipeline, infrastructure, and engineering firms. Furthermore, related literature points to the significance of the supply/demand balance for distressed debt; our theory is that there is a relatively finite pool of capital for distressed assets, implying greater supply of distressed paper pushes down valuations of like assets. Unfortunately, a rise in the supply of stressed bonds typically coincides with a decline in demand for such assets. This self-reinforcing dynamic historically leads to a re-pricing in lower quality segments.

http://www.zerohedge.com/news/2015-07-30/why-commodities-defaults-could-spread-ubs-explains

How a Greek Default Could Hammer Bonds, by Carl B. Weinberg

The first indications are that the Greeks are voting No, but that outcome is not assured and SLL is always skeptical of the integrity of elections and vote counts. From “Crisis Progress Report (8): Acceleration,” SLL,  7/2/15:

Regardless of how the Greek situation resolves, Greece cannot repay all its debts on their present terms. Most of the losses will be borne by the constituent nations of the IMF (including the US), the governments of the EU, and the European Central Bank. The losses will undoubtedly be “socialized,” in other words, paid for by taxpayers. Even if they are just added to the debt pile, with debt’s current negative marginal return, more debt will be economically and financially contractive, in Europe and beyond.

The following article by Carl B. Weinberg from online.barrons.com fleshes out the institutions who will be left holding the bag if Greece defaults, and one almost inevitable consequence: European governments will have to borrow more money, and interest rates will continue their recent rise. Higher interest rates mean that debt will be even more “economically and financially contractive, in Europe and beyond.” From Weinberg:

Euro-zone governments will have to cover some $370 billion in losses if Greece rejects a bailout.

Greece is on the verge of defaulting on 490 billion euros ($540 billion) in loans, bond obligations, central-bank liquidity assistance, and interbank balances. Who will bear those losses? Greece’s creditors, which are all public entities across the euro zone, and that are on the hook for some €335 billion in loan guarantees. How will those losses be covered? Bonds will have to be sold that will roughly equal the increase in annual debt purchases by the European Central Bank announced last January.

This is a hit to the European financial system nearly as big as Lehman Brothers’ balance sheet was in 2008.

There are precious few alternatives left for Greece or Prime Minister Alexis Tsipras. His government has walked out of talks with its creditors, and he has called a national referendum for July 5. Its choices are to accept “help” in the form of new loans to replace old loans (and accept austerity conditions), negotiate a debt restructuring with creditors, or default. The government has said it doesn’t want new loans—it wants debt relief. An International Monetary Fund report on Thursday said that without at least $36 billion in new money over the next three years, Greece can’t meet its obligations without debt reduction. The government appears ready to renege on its debt obligations.

So Greece’s creditors are going to lose money—a lot of money. Since these creditors are public entities, the losses will be borne, initially, by the public.

You can’t find public-sector exposure in the national accounts of lending governments because they are off-balance-sheet contingent liabilities that don’t exist until they are needed. But they add up to hundreds of billions of euros in guarantees for everything from the European Stability Mechanism, or ESM, to the ECB, to the interbank clearing system. Bonds will have to be sold to cover those markers. Issuance on this scale promises to be a blow for a market already vulnerable to a price correction.

TALKS BETWEEN THE GREEK government and its creditors have nothing to do with saving Greece or bailing it out. This crisis is about managing the resolution of bad Greek assets in a way that inconveniences creditor governments the least, forcing the least net new public borrowing, and minimizing financial system risks. The best way to do that is to avert a hard default, even if it means kicking the can down the road.

Consider the ESM, Greece’s biggest creditor. Under its previous name, the European Financial Stability Facility, it loaned Greece €145 billion. If Greece defaults, the ESM, a Luxembourg corporation owned by the 19 European Monetary Union governments, will have to declare loans to Greece as nonperforming within 120 days. Accounting rules and regulators insist that financial institutions write off nonperforming assets in full, charging losses against reserves and hitting capital.

Here’s the rub: The ESM has no loan-loss contingency reserves. Its only assets—other than loans to Greece—are loans to Ireland and Portugal. Its liabilities are triple A-rated bonds sold to the public. How do you get a triple-A rating on a bond backed entirely by loans to junk-rated sovereign borrowers? Well, the governments guarantee the bonds, and because they are unfunded off-balance-sheet liabilities, they aren’t counted in their debt burdens—unless borrowers default.

If Greece defaults hard, governments will be on the hook for €145 billion in guarantees on those loans to the ESM. We expect credit-rating agencies to insist that these unfunded guarantees be funded. After all, unfunded guarantees are worthless guarantees.

THE STRENGTH OF THESE guarantees is untested. Would the German Bundestag vote tomorrow to raise €35 billion by selling Bunds, the government debt, to cover Germany’s share of ESM losses on Greek bonds? That seems improbable. Bund sales of that scale, if they did occur, would flood the market, raising yields and depressing prices. If, instead, the Bundestag refused to cover its guarantees, then we would see a legal dust-up on a grand scale. With the presumption of valid guarantees, credit raters would have no choice but to downgrade ESM paper. Then losses would be borne by bondholders, and the ESM—the euro zone’s safety net and backstop—couldn’t raise money in the capital markets.

A hard default would produce other losses to be covered. The ECB would have to be recapitalized after it writes off the €89 billion it has loaned the Greek banks to keep them liquid. The ECB would need to call for a capital contribution from its shareholders—the governments.

And don’t forget that Greek banks owe the Target2 bank clearinghouse, a key link in the interbank payment system, an estimated €100 billion. The governments are on the hook to make good that shortfall, too. The cash required to cover these contingencies would have to be funded with new bond sales.

So the ultimate loser in a Greek default would be the euro-zone sovereign-bond market, which is already vulnerable. Yields are near all-time lows, and durations are high. Even small fluctuations in yield mean a volatile response in prices.

This explains why euro-zone governments are so engaged in talks with the Greeks. Higher bond yields mean higher borrowing costs. Higher borrowing costs and less investment will delay the euro zone’s recovery from its seven-year depression. Public money raised to cover these markers is cash that could have been used for productive public or private investment.

What if a downgrade of ESM paper causes a hedge fund to fail, which triggers the demise of the bank that handles its trades? The costs of fixing failed institutions will also, of course, fall on governments. The ultimate cost of Greece’s default is yet to be seen, but it is surely larger than it seems.

Link: How a Greek Default Could Hammer Bonds