Is America Too Big To Fail?

Good afternoon!

I put this article in the must read category. It appears that some economists are becoming increasingly concerned that countries will continue to buy our debt.

As I described yesterday, there may be a day of reckoning where Russia and China say enough is enough and stop buying our debt.

So the question must be asked? Is America too big to fail? According to this article, the jury is still out. Here is the link to the International Herald Tribune piece.

Here are some of the highlights in the article:

"NEW YORK: In the narrative that has governed American commercial life for the last quarter-century, saving companies from their own mistakes was not supposed to be part of the government's job description. Economic policymakers in the United States took swaggering pride in the cutthroat but lucrative form of capitalism that was supposedly indigenous to their frontier nation.

Through this uniquely American lens, saving businesses from collapse was the sort of thing that happened on other shores, where sentimental commitments to social welfare trumped sharp-edged competition. Weak-kneed European and Asian leaders were too frightened to endure the animal instincts of a real market, the story went. So they intervened time and again, using government largess to lift inefficient firms to safety, sparing jobs and limiting pain but keeping their economies from reaching full potential.

Today, among strict adherents of laissez-faire economics, the offer to bail out Fannie and Freddie is already being criticized as a trip down the Japanese path of putting off immediate pain while loading up the costs further along.

For one thing, this argument goes, taxpayers - who now confront plunging house prices, a drop on Wall Street and soaring costs for food and fuel - will ultimately pay the costs. To finance a bailout, the government can either pull more money from citizens directly, or the Fed can print more money - a step that encourages further inflation.

"They are going to raise the cost of living for every American," said Peter Schiff, president of Euro Pacific Capital, a Connecticut-based brokerage house that focuses on international investments. "The government is debasing the value of our money. Freddie and Fannie need to fail. They are too big to save."

Using public money to spare Fannie and Freddie would increase the public debt, which now exceeds $9.4 trillion. The United States has been financing itself by leaning heavily on foreigners, particularly China, Japan and the oil-rich nations of the Persian Gulf. Were they to become worried that the United States might not be able to pay up, that would force the Treasury to offer higher rates of interest for its next tranche of bonds. And that would increase the interest rates that Americans must pay for houses and cars, putting a drag on economic growth.

Meanwhile, as American debts swell and foreigners hold more of it, nervousness grows that, someday, this arrangement will end badly. The dollar has been declining in value against other currencies. Some foreigners have begun to hedge their bets by buying more euros.

"Obviously, this is going to come to an end," Schiff said. "Foreigners are not charitable organizations, and they're going to demand that we pay them back."

No single country owning large amounts of dollar-based investments is inclined to dump them abruptly; nobody aims to start a panic. But fears have begun to grow that one day a country may get spooked that another is about to dump its dollars - and that could trigger pre-emptive panic selling.

"Foreigners could decide it's just not worth the risk and sell," says Andrew Tilton, an economist at Goldman Sachs. "The really dire scenarios have become a lot more likely than they were a year or two ago."

The central truth of that logic still seems to be apparent as the Treasury keeps finding takers for American debt.

So the government offers its rescue of the mortgage companies, and foreigners keep stocking the government's coffers. "They don't want the U.S. to go into the worst downturn since the Depression," Tilton says.

But all the while, the debt mounts along with the costs of an ultimate day of reckoning. Debate grows about the wisdom of leaning on foreign credit, and about how much longer Americans will retain the privilege of spending and investing money that isn't really theirs.

Bailouts amount to mortgaging the future to stave off the wolf howling at the door. The likelihood of a painful reckoning is diminished, while the costs of a reckoning - should one come - are increased.

The costs are getting big."


Final Take:

Its looking more and more like we are about to take the same path that Japan did when their housing market collapsed. The banks were allowed to walk around like zombies without being forced to open their balance sheets. Japan had no confidence in its stock market as a result and it collapsed.

How bad was the collapse? Japan's stock market dropped from 38,000 in the late '80s down to its current levels of around 13,000.

The best case scenario here is we continue to find buyers of our debt. However, there are no free lunches. We will be punished for doing so in the form of higher taxes and a weaker dollar. Our standard of living will also diminish as inflation rises because our currency will be so weak. This will then pummel the consumer.

Look at Japan's currency after taking the "hide the sausage" approach to their banking sytem and its failures. The Yen(Japan's currency) is the joke of the world. You may see the US dollar right beside it if we use Japan's gameplan to get out of our economic mess.

So what do you guys think? Is America too big to fail? I am starting to think this risk is a serious one that I may see in my lifetime if the bailouts don't stop.