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The coming government debt default

Steve Saville
Jul 20, 2009

Below is an excerpt from a recent commentary posted at www.speculative-investor.com.

We have always assumed that governments would surreptitiously default on their debt via inflation, but recently we've come to the conclusion that a direct default is a distinct possibility. Here's why.

Under the current monetary system there is no limit to how much debt a government can take on, provided that the debt is denominated in its own currency. The reason is that the central bank stands ready, willing and able to be the bond-buyer of last resort, and the central bank's pockets are infinitely deep (there is no limit to the amount of new money that the central bank can create). As a result, if it chose to do so the government could continue to issue new bonds until the currency became worthless. At the point where the currency had lost almost all of its purchasing power the surreptitious default would essentially be complete because any debt denominated in this currency would be almost worthless.

But rather than continue the debt issuance and the associated monetary inflation to the point where the currency is worthless it could, at some stage during the process, become politically more feasible to default directly on a large chunk of the outstanding debt. The reason is that hyperinflation would destroy the economy as well as the currency, and would thus inflict large losses on almost everyone, whereas directly defaulting on the debt would only inflict large losses on the holders of government debt. In the US case it is not hard to envisage the Administration being faced in the future with the following choice: default on all Treasury debt except for the debt held by US government trust funds, or plunge into hyperinflation and wipe out the values of all bonds and all monetary savings. Given that the bulk of the aforementioned Treasury debt is held by foreign governments, a direct default will potentially be the natural choice of the politically astute.

The way things are going it will probably take less than three years for the US and many other countries to reach the point where it becomes necessary to completely abandon the pretense that the government's debt will ever be repaid legitimately (without inflating the currency into oblivion, that is). It will then be a matter of deciding on the method of default.

Steve Saville
email: sas888_hk@yahoo.com
Hong Kong

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