Guest Contributor: Bader A.

The Greeks are gone, Persians, Romans and many other Empires have come and go throughout history. However, does this mean that history will repeat itself ? Or is the global economy too interrelated that the US’s fall will be the end to us all?

The US are facing yet again, another crisis with debt. The US mentality is that of a spender rather than a saver, which works great in economic booms, but one day you will forced to repay that debt and that’s when things turn ugly.  The US have a dilemma on its hands, they either raise the $14.3 Trillion debt ceiling or default on their debt. To me the answer is obvious! Increase the debt ceiling, issue treasuries (the Chinese with their excess cash have to buy some), work on your budget deficit, keep rates low (as there is no immediate inflation threat) and pray for a recovery. However, we are thinking economically and clearly we shouldn’t undermine the political issues at hand. Elections are coming up and it’s time for every party to start showing off the guns. The different sections of the US structure must agree on a solution before August 2^nd to save the US from a default. The good news is both parties are working towards a similar goal of tightening the budget deficit by $2 Trillion. The Republicans want the savings to come from spending decreases and the Democrats from Tax increases, so they have different means towards the same end.

It is evident that the market is worried about the US’s debt rating and it’s long term ability to pay debt. CDS for the US have spiked to levels that have surpassed that of Brazil, rating agencies have added the US to many watch lists. The main issue of raising the debt ceiling or not is irrelevant, but the matter of long term solvency and liquidity is the key question. Economically, unemployment numbers will be the trigger that will help shed some light on the US outlook, but given recent data it looks like we are in for a long bumpy ride. 

At least we can all agree that the US is better off than Europe! 

As striking as the title may sound, I am not pertaining in any way that the U.S. government would necessarily go bankrupt, but I cannot conceive investing my life savings in the U.S. government.

By now it should be clear that being a long-term holder of U.S. treasuries is not a good idea. Bill Gross of PIMCO, who runs the world’s largest bond fund, has already dumped all his treasuries holdings, stating that treasuries “have little value” because of the growing debt burden and unprecedented spending by the U.S. government. Warren Buffet, along with other investors are either shifting their holdings to shorter-term debt, or moving to equities and higher yielding corporate debt.

The Fed has been pumping billions by purchasing treasuries, with no clear intention to reduce its soaring deficits, artificially keeping interest rates low with an eye closely monitoring inflation to perfectly achieve the devaluation formula. That is, devaluing the U.S. dollar to service the debt while bond holders lose purchasing power. But have they thought of the future buyers? Who will replace the Fed and buy treasury bonds once inflation kicks in, unemployment still at all-time highs, and investors lose faith in the economic future of the U.S.

 The 10-year treasury yields have come a long way down from a high of 15.8 percent in September 1981 to the low of almost 3%. Today, yields are artificially low and with inflation and uncertainty regarding the U.S. government deficit, investors are starting to question the sustainability of the recovery has been supported by the quantitative easing’s.

Since 1928, September has always been an ugly month for U.S equities, as it shed 1.3% on average. Yet, in every study you have your outliers and this year’s September was the latest to do so as the S&P500 recorded its best September on record since 1939 (+8.92%). Despite weak economic data releases, U.S equities rallied on the back of escalating hopes of a new round of Quantitative easing (QE). The months winners were investors who were long agricultural commodities, long precious metals, long Emerging markets currencies, and finishing it off by being long U.S. equities.

QE describes a monetary policy used by central banks to increase the supply of money by increasing the excess reserves of the banking system. That is done by printing money and using it to purchase financial assets from banks and other institutions, thus giving banks excess reserves required for them to create new money and hopefully stimulate the economy. It is important to note that this policy is usually used as a last resort, when normal methods to control money supply have failed, i.e. bank interest rate and interbank interest rates are at or close to zero.

Looking at the Japanese economy in the late 90’s, one can only conclude that the U.S is doomed to go through the same cycle, unless effective measures are taken. Japan underwent a decade-long odyssey with deflation and the zero interest problem. The Bank of Japan’s (BOJ) experience during this period offers an excellent guide for the U.S to divert from. In Japans case, the BOJ maintained short-term interest rates at close to their minimum attainable zero values since 1999. With quantitative easing, it flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves, and therefore little risk of a liquidity shortage. Quantitative easing was used unsuccessfully by the BOJ in the early 2000’s nor was it successful during the financial crisis of 2008 when the Fed balance sheets exploded from about .88 trillion in 2008 to 2.287 trillion today. Sadly, they’re even planning another round of quantitative easing, easy money, that will lead to further currency debasement and only solve problems in the short term.

The weak U.S. dollar which is expected to be there for a while has benefited exports, which increased by 2% and helped contribute to the big rallies across the commodity space with gold reaching new record highs during the month. A classic case of “buy the rumor, sell the fact” is that as long as markets expect QE, US equities should perform well. However, be cautious not to be caught in the middle as equities will likely correct if and when a QE announcement is made. Looking at the two graphs below, one can see that from the peak of 88.405 (spot price) on June 7th 2010, the dollar has lost 13% falling to 76.791 and approaching its low of 74.629 on November 2009. That led to a surge in all major currencies prices against the dollar.

In my opinion I believe that quantitative easing is THE time bomb, and it’s better to let the markets sort themselves out without government interference. What do you think?

- Ben Bernanke, Fed Chairman