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By
now, everyone knows that S&P downgraded the debt of the USA from their
top rating, AAA, to their second-highest grade, AA+. Most of the commentary
has been of the pin-the-blame-on-the-donkey variety. For all most
people know, this is the collapse of the currency and the financial system
and their biggest concern is that Obama not win the 2012 election. If
this were truly the collapse, I submit for your consideration that we will
all have bigger things to worry about!
So,
I thought I would look at this from a different angle. My conclusion is
simple. On the one hand, there is no question that the US dollar will
collapse. This is not only inherent in any irredeemable paper money,
but also the inevitable result of any government and financial system that
runs perpetual and accelerating deficits. But this is not what S&P
is considering! If it were, they would re-rate all dollar-denominated
debt at their lowest level. They would then look at the dollar
derivative currencies (e.g. eur, gbp, yen, etc.) and realize that a
derivative cannot survive the destruction of the underlying currency.
So they would do the same to the sovereign debt of the issuers and all debt
denominated in those currencies. Then they would lay off their staff,
awaiting the return of gold-denominated bonds.
Dollar
collapse aside, consider that in 1913, when Wilson created the Federal
Reserve, a dollar was worth roughly 1/20 ounce of gold. In 1933,
Roosevelt devalued the dollar to 1/35 of an ounce. In the 1960’s,
the US government was obliged to give up more and more of their gold hoard to
“defend” this level, because by then the real value of the dollar
had fallen well below 1/35 ounce. We can’t know how much it had
fallen because the government interfered with the process of price discovery.
After
Nixon officially defaulted on the gold obligations, the dollar’s
collapse accelerated. By 1981, the dollar was worth 1/600 ounce
(ignoring the spike into what turned out to be a mania). Today, the
dollar is worth less than 1/1700 ounce of gold.
I
am not aware of anyone who thinks that the government will get the
dollar’s fall under control. Any Keyesian or Monetarist will even
tell you that it’s good for the dollar to fall. And we
Austrians are saying that not only is it bad, but it’s happening and
it’s accelerating.
If
the S&P rating was intended to account for the value of the currency that
the debtor uses to repay its bonds, then how could S&P give the USA an
investment-grade at any time under any circumstances? If the dollar is
losing 5 to 15% of its value per year, this represents a significant default
over the duration of a 10-year bond!
And, for that matter, the same dilemma would apply to corporate bonds,
municipal bonds, etc. Obviously S&P does not look at the dollar,
and its constant propensity to fall, as part of its rating process.
To
summarize my points so far, the dollar has been steadily eroding for 100
years and this is a trend that those in charge defend as being good and
necessary. And the dollar will collapse under the weight of unpayable
debts. This is the fatal flaw of an irredeemable debt-based currency,
and the end is in sight if not imminent (see my paper on gold backwardation).
In
this light, the S&P downgrade is meaningless.
On
the other hand, in the world of the irredeemable currency, what does it mean
for a bond to be paid back? It means that the debt is transferred from
one party to another party. If a corporate bond is repaid, the
corporation redeems it using dollars (i.e. Federal Reserve Notes).
Dollars are the liability of the Fed. The debt is simply
transferred. First, the corporation owes you. Then the Fed
owes you.
This
is an insane system, but at least there is an arms-length transaction between
unrelated parties. It is possible to discuss default, attempt to
qualify (if not quantify) the risks of default, etc. Default or
non-default: these are the only two possible outcomes for the bond at
maturity. One of them will occur, and which one occurs is of utmost
importance to the bond buyer. The goal of the ratings agency (assuming
repeal of the 1970’s era law making them work for the bond issuer) is
to assess the risks of a bond being paid or not.
However,
Treasury bonds are payable in Federal Reserve Notes which are backed by
… Treasury bonds. It’s circular, it’s a check-kiting
scheme, and it’s a Ponzi scheme.
There is no risk that there won’t be Federal Reserve Notes to pay the
bond holder. Both the bonds and the notes that are used to pay them off
are inextricably tied! The point I am making here is that the very
concept of “rating” such bonds is meaningless. There is no
objective (or otherwise) standard of measure to use in rating them.
It
would be like asking how much gold is an ounce of gold worth? How many
dollars is a $100 bond worth? These are tautologies.
This
is just one of the perverse “unintended” consequences of trying
to use irredeemable paper currency. Government debt paper is debt
paper. Money (gold) is money. The two are the same, like oil and
water are the same.
The
world needs to return to a proper, unadulterated gold standard including
bonds redeemable in gold. And this must include repealing the laws that
grant a cartel to the three ratings agencies (S&P, Moodys, and Fitch), so
investors can hire any firm to help them with due diligence on the bonds they
buy.
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