What we need and what we actually get may be vastly different

This is in response to a question raised by Thomas Franklin:

Hi Colin,

….. My question is not just about the bond market although it is part of it but a reflection of the bigger picture globally with what is unfolding. With many governments facing rising debt levels and the Feds policy of financial stimulus, surely this is just delaying the inevitable of “Global Financial Meltdown” The USA and the dollar is a sinking ship, with the Fed losing the battle of bailing the ship out. So what do you think will replace the system we currently have?

Hi Thomas,
What we need and what we actually get may be vastly different.
Firstly, what we need:

• A consensus Swiss-style democracy instead of the winner-takes-all system we have at present, where incumbent politicians run up fiscal debt in order to boost their chances of re-election.
• Restrict the Fed to a single mandate, to protect the currency, rather than targeting inflation to help the politicians.
• Restrict capital flows between countries, like China/Japan’s purchase of >$2 trillion of US Treasurys, used to manipulate exchange rates and create a massive advantage for their export industries.
• Austerity to cut unnecessary spending and public works programs to improve national infrastructure and create employment — but the programs must deliver real returns on investment so they can later be sold off to repay debt.
• Europe needs a eurobond system, with central borrowing and restrictions on individual member deficits.

What we will probably get is:

• More of the same: government controlled by special interests and dominated by fear of the next election.
• The Fed going nuclear and buying more Treasurys — creating inflation to bail out the banks and save Treasury from default.
• Inflation as a soft form of default to give bondholders (read China/Japan) a haircut and deter them from buying more Treasurys.
• More profligate spending and ill-chosen, bridge-to-nowhere infrastructure projects.
• A breakup of the Euro?

Hope that doesn’t sound to optimistic 🙂

Regards, Colin