Sunday, September 21, 2008
One question being raised in recent days regarding the Treasury Department's plan to save the world, but one that has received far too little attention in the media due to the stark choices that are now apparently on the table is, "Who will pay for this massive bailout?"
The $700 billion estimate was roughly the mid-point of the optimistic total of $500 billion and the pessimistic view of an even one trillion dollars, but, if the last year has taught us anything, it is that we've been way too optimistic about the credit crisis so far.
To this $700 billion figure can be added more than $600 billion which has already been made available for bailouts of Bear Stearns, AIG, Fannie Mae, Freddie Mac, the economic stimulus, foreclosure aid, and the guarantee of money-market funds. This puts the total bill at a minimum of $1.3 trillion with the real possibility that it could go much higher. Factor in the rising costs of funding Medicare and Social Security as large numbers of baby boomers begin to retire, and the U.S. government faces a daunting challenge of securing financing via Treasury sales in the years ahead.
The debt ceiling is about to be raised to $11.3 trillion with far higher levels expected in the next decade.
What is a debtor nation to do?
Some argue that Japan navigated their post-bubble period by going further and further into debt and that the U.S. could do this too, however, the big difference between Japan in the 1990s and the U.S. today is that Japan had a trade surplus. The U.S., on the other hand, has a trade deficit, in large part financed by capital inflows into Treasurys and GSE debt, which are now essentially the same thing.
More than ever before, the U.S. has become reliant on the kindness of foreigners (which, in and of itself is bad enough), but in their absence, there is only one real alternative - monetize the debt. The period ahead holds the real possibility that a significant amount of these Treasury purchases will be made by the Federal Reserve which is, in effect, "printing money".
What does this mean for gold?
All other things being equal (e.g., no massive government intervention in the gold market), it means a much higher gold price.
Truth be told, there isn't much happening in the world today that doesn't mean we're looking at much higher gold prices in the future. As Citigroup put it in a report last week, we are now looking at a "grand battle between hard assets and paper assets".
The events of the last week have taught us a very important lesson, one that I have been sure of for years, but now, about which there is little doubt - the government's resolve. That is, the U.S. government will do "whatever it takes" to avoid a financial market and economic meltdown, and "whatever it takes" is sure to involve debasing the currency on a grand scale.
In the world we live in today, there really is no other reasonable choice for governments as the lessons of the Great Depression are not lost on today's policy makers. We may end up with a different kind of Great Depression in the next decade, but we certainly won't end up with a "deflationary" depression (at least not at first) as long as the U.S. government can still borrow or print money.
UPDATE: Monday, Sept 22nd, 5:40 PM PST
Reader DU has pointed me to this report at Reuters where the total bill comes to $1.8 trillion, not $1.3 trillion as stated above.