How This All Ends

Monday, August 31, 2009

Executive Summary

• A funding crisis is in store for the US government and citizens.
• The “Fourth Horseman,” represented by the dollar going down while interest rates go up, will signal the start of the funding crisis.
• The Federal Reserve Custody Account has been growing faster than the Trade Deficit, a historical oddity.
• The custody account represents a grotesque imbalance with risks of its own. 
• The US will eventually face a funding crisis. For now, that crisis has been forestalled by willing foreign central banks.
• This end begins with the widespread recognition that the US is insolvent and that propping it up is a lost cause.
• It all ends with a vastly lowered standard of living.

In this report, I write about how the US debt machine will most likely meet its end and how we’ll know that this end is approaching.

In The Five Horsemen, I made the case that we have already seen the arrival of three out of the five signposts that will signal the end of US economic dominance and overconsumption. Those signposts are:

• The First Horseman (arrived):  New credit growth falls below interest payments.
• The Second Horseman (arrived):  The Fed monetizes debt.
• The Third Horseman (arrived):  Government deficit spending exceeds 10% of GDP.
• The Fourth Horseman (not yet):  The dollar goes down, while interest rates go up.
• The Fifth Horseman (not yet):  US debt becomes denominated in foreign currencies.

I want to examine the Fourth Horseman more carefully, because I believe it will arrive next and will trigger the subsequent arrival of the Fifth Horseman.

If we back up a bit and break out our wide-angle lens, two simple truths about our current predicament come sharply into focus:

1. The US is insolvent.
2. The US is utterly dependent on foreign loans and financing to fund its past, current, and future fiscal deficits.

Ignoring these simple truths because they are inconvenient, or because we’d prefer to focus on green shoots and other signs of ‘recovery,’ will not make them go away. They lurk like the proverbial 800-pound gorilla in the corner of the room.