• Is a Bond Crisis Inevitable?

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    Is a Bond
    Crisis Inevitable?

    With Christmas
    shoppers out in force and the stock market surging to a two-year
    high, talk is spreading that the long-awaited recovery is at hand.

    Perhaps.

    But gleaning
    the news from Europe and Asia as U.S. cities, states and the federal
    government sink into debt, it is difficult to believe a worldwide
    financial crisis that hammers governments, banks and bondholders
    alike can be long averted. Consider.

    Fitch and
    Moody’s have just downgraded the debt of Ireland, Greece, Portugal
    and Hungary. In Budapest, the politicians talk of default. Spain
    has been warned its debt and banks could be downgraded.

    The European
    Central Bank is buying up this paper to prevent panic selling by
    investors. There is talk of forcing bondholders to take a haircut.
    They would trade their suspect bonds for new euro bonds whose face
    value would be appreciably less.

    In the
    Latin American debt crisis, the United States bailed out its banks
    holding the bad paper by giving them U.S.-backed bonds, while forcing
    them to take a loss on their Latin bonds. Courtesy of Uncle Sam,
    Latin America walked away from a huge slice of its debt.

    The Japanese
    national debt is slated to pass 200 percent of gross domestic product
    this year, highest of any major economy on earth. Half of Japan’s
    spending is now financed by bonds. Tax revenues do not even cover
    50 percent.

    Nor is
    America out of the woods.

    Financial analyst
    Meredith Whitney told “60 minutes” we can expect 50 to 100 cities
    and counties to default on their municipal bonds. Though derided
    as an alarmist, Whitney was among the few who warned that U.S. banks
    were in treacherous waters before 2008.

    If anyone
    is an alarmist, it is The New York Times. In an editorial
    the day after Christmas, “The Looming Crisis in the States,” the
    Times writes, “Illinois, California and several other states are
    at increasing risk of being the first states to default since the
    1930s.”

    California
    and Illinois are to America what Germany and Spain are to the European
    Union — the first and fifth largest states.

    Illinois,
    writes the Times, “is faced with $4 billion in overdue payments.”
    The state “has lacked the money to pay its bills. Some of its employees
    have been evicted from their offices for nonpayment of rent, social
    service groups have laid off hundreds of workers while waiting for
    checks, pharmacies have closed for lack of Medicaid payments.” Illinois
    is also still borrowing to finance half of its budget.

    By Sept. 30,
    the U.S. government will have run three straight deficits of close
    to 10 percent of GDP. And Barack Obama and the GOP just passed $858
    billion in new and extended tax cuts and fresh spending.

    Yet many
    dismiss the threat of a series of defaults by European nations and
    U.S. states and cities leading to a financial crisis that could
    eclipse the one we have just passed through.

    What is
    the basis of this confidence?

    Germany
    dominates the European Central Bank and will not allow defaults
    by Ireland, Portugal, Greece or Spain. For that would imperil the
    One Europe project to which Germany has been dedicated since World
    War II. Berlin will do what is necessary to save the euro and prevent
    Europe’s monetary union from collapse.

    What is
    wrong with this thesis is that it is not Germany alone that decides
    on defaults. The weaker countries in the euro zone, like Greece,
    may decide they will not endure the agonies of austerity any longer.
    Street politics may force regimes to abandon the regimens imposed
    upon them as a condition of their bailouts.

    In America,
    it is the Fed that is the last line of defense and has shown a disposition
    to act in a financial crisis.

    Since 2008,
    it has doubled the money supply and taken a trillion dollars in
    bad debt off the books of U.S. banks. Secretly, it has lent trillions
    to banks and businesses all over the world and is now buying U.S.
    bonds to inject more dollars into the economy.

    But how
    does the Fed prevent a state like Illinois from failing to meet
    its debt obligations and defaulting? How does the Fed prevent a
    series of municipal bond defaults by cities and counties that lack
    the tax revenue to pay their bills and whose credit rating has reached
    a junk-bond status where they can no longer borrow?

    Congress
    would have to vote the bailout money. But will a House that owns
    its majority to the Tea Party approve half a trillion dollars to
    bail out Democratic-run cities or Obama’s home state or Jerry Brown’s
    California?

    This June,
    the stimulus money runs out, and as housing prices continue to fall
    across America, property tax revenue will fall.

    The Feds
    are about to stop bailing out the states, and the states, on shortening
    rations, will stop bailing out counties, cities and towns.

    We may
    be closer to the falls than we imagine.

    January
    1, 2011

    Patrick
    J. Buchanan [send
    him mail
    ] is co-founder and editor of The
    American Conservative
    . He is also the author of seven books,
    including Where
    the Right Went Wrong
    , and A
    Republic Not An Empire
    . His latest book is Churchill,
    Hitler, and the Unnecessary War
    . See his
    website
    .

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