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KRASTING and COBERLY in COMPLETE AGREEMENTWell not exactly. But I think that Coberly has done a good job of making my case. I will go through some of his latest comments todemonstrate how we agree. But first I have to try to insert into thisdiscussion another of those “facts” that I rely on. This “fact” is outsideof Coberly and Webb’s understanding, or if they understand it they failto see the significance of it. In plain language:

If the US bond market becomes unstable all of the lights willgo out. Including the lights at SS.

Angry Bear readers may not agree with that statement, they may thinkit another lunatic assertion by me. But this time I am right. If youdisagree you are not well read on the issues of the times and you areliving in a cave. There are endless academics that would agree withthis and there is a very large chunk of the folks at the Federal Reserveand Treasury that would agree with it. Suspend your disbelief for amoment. Assume that this law of nature is in fact correct.What might cause the bond market to become unstable? Many factors.Almost all of them are in place today. Crazy excessive deficits that areprojected to exceed $1 trillion a year for the next decade are front andcenter to the problem. The dollar’s status as a reserve currency isanother. Sentiment on this critical issue is very fickle, when it goes, itcauses problems. There are a host of other issues including America’scronic current account deficits.

But now there is another factorthat is not now being considered, and that is the status of theSocial Security Trust Fund.

I ask Angry Bear readers to consider the implications of this headlineshould it ever occur:“CHINA TO STOP BUYING US TREASURY DEBT. WILL SELL THEIRHOLDINGS OF $1 TRILLION OVER THE NEXT DECADE.”We will not see that headline. China is not stupid. They know that if they took action like this it would have a devastating affect on the UScapital markets. Interest rates would soar. The bond market wouldbecome unstable. Our ability to finance ourselves in an orderly waywould be impaired. Interest rates would rise and the economy wouldsuffer. China would suffer as well from their actions. Man Bites Dog. There would be one of two results from this. Either it would precipitatea very rapid collapse or it would result in a slower pace (2-3 years) of collapse. Let me be very clear. The US can’t afford 8% interest rates.

The cost of the deficit would eat us alive. We would not be able to sellnew debt at a cost we could afford. These conditions would certainlycause a severe recession (or worse). In my opinion a failure of the bondmarket would be the mother of all systemic risks. Housing wouldcollapse if mortgage rates went to 10%. Banks would be closing leftand right as the economy loses jobs. Unemployment would explode. The number of workers contributing to SS would fall by as much as20%. The ratios of total income (including the tax on benefits) wouldcollapse. Large annual deficits would be the result to the Fund. Theywould have to sell back to Treasury their IOU’s to raise the necessarycash. But what would Treasury do? At the time this is happening Treasury will be in a desperate battle to sell the debt that is necessary just to avoid a functional default. The result would be that the checkswould not go out as planned. Mr. Webb has said that in a worse casesituation like this that is exactly what would happen. SS would waituntil it has collect sufficient taxes to make the benefit payments. Theimplication of that is that we would be in a very dark and deepdepression.So if you buy into the consequences of China selling off its Treasuryholdings how would you react to this very similar but more significantannouncement:SSTF TO STOP BUYING US TREASURY DEBT. WILL SELL THEIRHOLDINGS OF $2.5 TRILLION OVER THE NEXT DECADE.I think we will get that headline. I think we are much closer than peoplethink to getting that headline. I think we will get this news sometimein the next three years. When we get this headline it will make adifference, it will destabilize the bond market. It will be moresignificant than if China stopped buying (and started selling) ourbonds.Mr. Coberly agrees with my assertion that the economics of the Fundhave been hit very hard as a result of the 08 and 09 recession. Wedisagree on what are the implications, and what should be done aboutit. For example:Coberly:I made a clear enough case that the cost increasing faster than theincome was well understood and predicted a long time ago. that iswhat the trust fund was designed to take care of. it was alwaysintended to "run out of money" to be replaced either by increasing thetax or cutting benefits.

BK: Yes Dale the Fund was always intended to run out of money. Youare 100% correct. But no one anticipated that the ‘tipping point’ forthis to happen would be 2009. We thought it was 2016. The recessionof 08 has excellerated the time frame dramatically. That has been mypoint from the get-go.Coberly:what you are saying here is that the government has to pay back themoney it borrowed from Social Security. what is there about payingback money that you borrowed that you don't understand?I understand completely. But what you fail to understand is that to doso in the context of the other pressures on the bond market will resultin a systemic problem. These are very big numbers we are talkingabout. Were it not for the other pressures on us fiscally I would not beso concerned about the SSTF becoming a seller of Bonds versus thetraditional buyer. But those other pressures do exist. They are with ustoday and we can’t shed them. SS is going into deficit at a veryinconvenient time.On the critical issue that I have been trying to make re the bondmarket and the inter-relationship to the SSTF Coberly says:

You may be right. the Bond market may have put itself into astupid position. This does not give you the right to crippleSocial Security. What you are proposing is theft.Okay, so finally I am right about something. Coberly is spot onwith this observation. Forces far outside of SS have put thebond market (aka the entire economy) in a ‘stupid’ positionand this is in no way the fault of the Fund. But unfortunatelythe Fund will find itself being in the position of contributing tothe instability that will follow from their actions. It can’t andwon’t be allowed to happen.Coberly:

Note that Krasting keeps making the same argument. He hasn't evennoticed the argument against him. He keeps arguing that the TrustFund has gone cash flow negative, and may do so even more in thefuture. He keeps ignoring that it was designed to do that. It wascreated as a "rainy day fund." He is complaining because his bondtraders have been counting on it never being used. Because he forgotthat's what it was created for.Again 100% correct. I have made the case again and again that whatwas supposed to be happening in a decade or so is happening ‘today’.

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CoRev

Bruce, you use of "fact" in the 1st paragraph is only another strawman and not a fact! These are SSTF facts: 1) it is in excess of $2.5T today; 2) That $2.5T is drawing interest; 3) It is in the closest thing we could possibly devise as a"lock box" ; 4) It is in place to pay for the baby boomer demands (a hard fact of SS); 5) The Fed treasuries that make up the SSTF are already counted as part o

reply01 / 15 / 2010