How To Waste Money
from Peter Radford
Just a very quick note today. We have a long holiday weekend ahead of us here in the US. But I couldn’t pass this up.
You all remember those notorious credit default swaps? Those nasty little, or not so little, pieces of paper that the boys and girls on Wall Street play with. Like matches near gasoline. In the right hands they appear very sensible and so, so, safe. Sometimes they end up in the wrong hands, and blow up in our faces. The idea is that a CDS is a piece of insurance against another piece of paper. So if a bond I own becomes worthless I collect on the CDS – insurance – and am none the worse for wear. It’s even more fun if you can buy insurance on something you don’t own. That way you collect cash and have no offsetting loss. That was made illegal centuries ago in life insurance, it offends simple ethics, but on Wall Street anything goes. They love cheating. They do it all the time. It’s called being innovative. It’s why our factories have no up to date equipment. All our capital is being sucked out so the traders can play games. But, let’s ignore that for the moment.
So.
Here we are all atwitter about the impending end of the earth. Judgement day is upon us. No, not that judgement day. The other one. The one that arrives when the US hits its debt ceiling. On that day, plus one, the US has no cash to pay back its debt – this is hypothetical – and so the potential for default rears its ugly head.
So, what do the boys and girls do?
They buy CDS insurance against US treasury default. Yes. Even though the US treasury has defaulted there will be US banks, presumably more secure than the Treasury, left who can make good on the insurance. Forget that these banks rely on the Treasury to survive – that spoils the story the boys and girls tell each other.
OK. Stop laughing. Here’s the problem:
The US can’t default on its debt. Not unless it wants to for some obscure reason. Read that again. It is not possible for the US to default. As is: it cannot happen. Never. Never. Not ever.
Now I may sound a little sure of myself there, so I owe you an explanation. Let’s go through what happens:
Judgement day: the US hits the so-called debt ceiling. Whoops.
J-Day +1: Bond holders ask for payment. Double whoops. Tim Geithner looks around. He cannot issue more debt, since that would violate the law. He shakes his wallet. It’s empty.
So what does he do?
He gets on the phone.
Tim: “Is this the print shop”
Printer: “Yes it is. Hi Tim, how are you?”
Tim: ” Hey, I have a bit of a problem. I need to pay off some bonds and have run out of cash. Could you help me out here?”
Printer: “Sure. How much should I print?”
Tim: ” I’m not sure. There are a lot of these bonds. You’d better run the press non-stop.”
Printer: ” No problem Tim. You’re a good guy. The press is all yours.”
Tim: “Thanks. You’re terrific. Such a patriot too.”
And that’s it.
You see, any country that owns its own printing press cannot default. You simply swap bonds for freshly minted cash. The only time a country can default is when the bonds it owes money on are not denominated in its own currency. This is basic stuff.
Now, back to those geniuses buying those CDS’s.
What about the above conversation do they not understand?
I don’t know. But they sure look stupid.
Why do they persist in this pointless exercise?
Traders are paid to churn portfolios. Their bonuses depend on volume, not intelligence. Which is good, because that is in short supply.
In fact, given the last three years I think you could make a fortune shorting Wall Street’s collective IQ.
Then again, how can you be bearish about something already rock bottom?
Peter, your analysis is sound, but it assumes that the state is rational and motivated by the welfare of its citizens, and therefore misses one very crucial point, namely that Tim’s primary allegiance is to Goldman Sachs and not to the state.
I therefore would not want to bet that he would do the right thing and call the press if that had to become necessary for the state. Perhaps a better predictor of what will happen lies in what Goldman Sachs is doing. If it is buying CDSs, then it means that it will eventually pay off and that some excuse will be found for the state not to print the money.
Here’s the part of the deus ex machina that I’m still missing schematics: I thought the Fed Res cannot directly purchase Treasuries; so the “printing” must be circuitously done through intermediaries (the primaries) who then sell to the Fed Res; but if there is a debt limit, then no debt can be first put for sale. There’s MMT thinking writ large, and then the actual historical, chronological order of things. So without recourse to the analogy, how does it work? …
Is it: the primaries borrow from private banks, who borrow from the Fed Res, and then the primaries buy the Treasuries from the Fed Gov, and then sell them to the Fed Res, and then the primaries back pay their lenders … who had generated the reserves to borrow by loaning to them in the first place?
I dunno ….
Nah, that can’t be it, contradicts the first assumption that no new debt may be created…
Mao said: “Political power grows out of the barrel of a gun.”
Whoever owns the fastest and deadliest gun can print any money needed for anything, and have that money accepted by potential victims of the gun.
That’s the role the Oligarchy in the US see themselves filling at this time.
And good paying jobs in the US will be (and are) likely created in industries and services involved in bullying the rest of the world, including China, into submission, starting with the Middle East and North Africa, as can be seen at present.
From working on the drone factory floor to holding the joystick (pun intended) of one, there will be jobs for everyone.
Congress can enact a law authorizing the US Treasury to create legal-tender money to spend. Also the Fed can “buy” non-bond assets from the U.S. government and pay for them by raising the reserves of the US Treasury account at the Fed.
Legal tender money as in Greenbacks? Would such a law in these times get as much deference as Obamacare does in court?
But that is a different solution than the other you suggest, which is really intriguing – what is the dollar value of all Federal Parks and reserves and unsold mineral rights and monuments and a combat brigade in Europe and …. Why, it’s whatever those with “money” to spend will pay for them, I suppose…
Hold on, didn’t Russia default on the GKO’s back in 1998? They were denominated in roubles no? So in the extreme case a sovereign state with debt can default on it even though it is in the domestic currency, which it can print (not like the EUR of the Eurozone countries today).
Or am I getting this wrong with the GKOs?
It is true that Russia defaulted 1998 also on rouble-denominated debt. BUT: Russia was running a tight peg against the US dollar and had accumulated huge foreign-currency debt exposures. They lost billions in foreign reserves trying to defend the parity when energy markets collapsed. The Russian decision to also default on its rouble-denominated debt an act of madness aided-and-abetted by genius advice given to them by the IMF.
Peter’s advice to Tim is to the point. Tim should call his buddies at the Federal Reserve and ask for an overdraft facility for Treasury’s reserve account. Let’s say infinity – 1US$. He can also present some collateral to make his banking buddies feel more comfortable. How about the federal income tax payments for the 1.000 years.
I think you and Fred Folvary have managed to scrape most the scales from my eyes. But there are still a few flakes making me blink. Each of you implies some kind of distinction between “debt” in the legal sense of the law which Congress has given itself/us with the debt ceiling, and debt in an “ordinary”, Webster dictionary sense. Posting collateral does not mean there is no debt, so I do wonder and do not know what exactly the law does allow. I don’t mean to be a pedant or suggest an overwhelming respect for positive law (as distinguished from a respect for the concept of the rule of law over the rule of men), but the prospect of the Fed Res and The Treasury in cahoots regardless of what Congress says gives us a whole new range of possible experiments to run. As it was, I was looking for the opportunity to observe what would happen – to the economy, to our politics – if the debt-ceiling were not raised. Red Res and Treasury collusion to run outside the base lines could prove just as entertaining. I’m thinking that the people who regularly warn us that the Fed Res is a conspiracy of bankers to enslave us all will make the most out of such moves.