What Will the Next Debt Default Crisis Bring?

Back in 2008, when Lehman Brothers failed, Merrill Lynch was taken over by Bank of America, AIG was nationalized, and Reserve Primary Fund's (a large money fund) price dropped below one dollar, the Fed came to everyone's rescue with cash.  Since then, the world's debt levels have increased, as have the number of U.S. dollars in circulation (QE 1, 2, 3, etc.). In other words, because too much debt was the source of the problem in the first place, the world is coming ever closer to another 2008-style meltdown.  Only the next meltdown will be much larger.  So, let's just imagine for a moment, what that meltdown will look like.

It could be some under-funded bank that collapses, a stock market crash that sends some major corporation into bankruptcy, or, perhaps, a central bank that defaults on its debt that initiates the next crisis.  It’s hard to know.  As we've seen, however, the Feds' inclination (along with the U.S. Treasury Department and U.S. Congress) is to step in and bail out pretty much everyone (except Lehman Brothers) who needs cash.  Last time, they even set up a “Commercial Paper Funding Facility” to accommodate the needs of cash-strapped businesses and households in the United States.

This time around, however, there are additional options.  The Fed has learned from other experiments around the world: you have Japan that has printed more money in an attempt to lift itself out of its funk, there was Iceland, which let its banks fail, and then there was Cyprus that forced bank depositors to become bank shareholders by seizing savings in return for bank stock.  And let's not forget about Poland, which seized half the private pension funds in Poland.  One or more of these options may be added to the Fed’s bag of tricks.

We may also have to consider the fact that, during the past seven years, we've had low interest rates, low savings rates, and continuing money printing.  More people have turned to higher-risk investments to compensate for the lower return on savings.  Higher-risk investment means less stable investment in times of turmoil.  In short, we're building a riskier economy with more debt, lower savings, less capital accumulation, and riskier investments.  When the next crisis hits, we'll be further out on the limb than we were the last time; i.e. the crisis will be worse than last time.

Ok, so that means more businesses will fail, more funds will be seized by governments (private pension plans, 401k, etc.), there will be a greater cash crunch (more money market funds going below $1.00), and more bail outs (large U.S. banks and corporations, and other central banks around the world).  We may also see more bail-ins like Cypress had, where the depositors become the shareholders (but lose their cash savings).

Furthermore, I believe that, because the world is still on a U.S. dollar reserve standard, the rest of the world will experience worse problems than they did last time around, too.  When the Fed bails out more entities, more dollars will flow around the world, decreasing the value of each dollar.  All the dollars being held in reserve will become worth less, if not worthless.  In the world's mad search for liquidity; i.e. cash, everything will be up for sale. Just like last time, people will need to sell things to pay off their debts.  Prices will drop and the dollar will decline in value.  The only question left, in my mind, is, will the Fed print enough dollars in an attempt to bail out the world, or will it allow the world to sink in the sea of debt that it has accumulated?

I believe they will print whatever it takes to provide the liquidity the dollar-dependent world demands, making the U.S. dollar ultimately worthless.

Robert F. Sennholz

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