Financial Armageddon

We live in interesting times.

The United States is only a few weeks away from what potentially could be one of the largest defaults in world history. Given how the Republicans do not want to increase taxes and that the Democrats do not want to decrease spending, the only machinery that can prevent this default is currently seized up. Obama was so upset the other day during negotiations that he just up and left.

Moodys once again threatened to lower the outlook on US treasuries. Given that the US is on the verge of a default, they are a little late to the game, but even so it’s also a rather historic negative outlook on the United States.

Interest rates are near an all time low, which means any movement in the upward direction will hurt bond prices. That means that other than short term bonds, most bonds are extremely risky right now, especially since the yields are so small.

Inflation is high, more so in China (likely due to the US exporting their inflation there), but here in North America as well. That means any money people have in the bank is eroding in purchasing power.

The traditional hedge against inflation, gold, hit an all-time high this last week, and is close to $1,600/oz.

Despite saying that another round of Quantitative Easing wasn’t likely after QE2, the Ben Bernanke alluded to QE3 in a recently talk, which is part of the reason why gold spiked. Despite the failure of the Federal Reserve to stimulate the economy with QE1 and QE2, Ben Bernanke still seems to think that another round of QE may help put people back to work. I guess when all you have is a hammer, every problem looks like a nail.

So basically right now there are three scenarios.

First, the United States could miraculously come to an agreement about the debt that involves reducing spending. This would put the US on the long and painful road of reduced benefits and debt repayments. This is what needs to happen, but I don’t believe it will.

Second, the United States could default on their debt payments. This would crash the US dollar, the bond market, and most stock markets in the world. It would be pretty bad. Other than the US, China would bear the brunt of the losses, which would probably make the panda angry. You won’t like the panda when he’s angry. China would probably start dumping their US treasuries which would further decimate the bond market.

And finally, the US could kick the can further down the road by raising the debt ceiling. That’s what will probably happen. It means further QE, additional monetization of debts, higher inflation and further erosion of the US dollar. This would be a good thing for precious metals and commodities.

What will happen is anyways guess at this point. We’ll know in a few weeks.