What would happen if another Dubai incident (only much larger) were to shock the world on Monday?

There would be a scramble for American dollars, if for no other reason than the reality that a certain amount of liquidity in the world will vaporize with any major default. And any major default would likely trigger another. In my view, the threat of deflation is very real and just barely below the surface. I don’t think it would take much for that monster to pop its ugly head up at any moment, and go on a rampage the likes of which the world has never seen before. That would represent the unwinding of literally decades and decades of credit expansion in the past. Eventually the deflation creature would die. But before it died, the damage would be catastrophic.

Admittedly, this is where I get lost. I need some help from Moon or Michael to get the logic straight. What would happen with another major default… one that actually defaults instead of being temporarily bailed out by daddy… one that portends that more defaults are almost assuredly just around the corner? What would happen if the deflationary scenario unfolds in a serious and ugly fashion?

American dollars would surge in value. So American paper should also surge in value, would it not? That should equate to a sharp drop in interest rates on the longer end… a flattening of the yield curve, would it not? If that’s the case, then the banks who are currently buying the treasuries would do very well with the surging value of that paper. So would all others who have loaned money to the gov’t by purchasing bonds and treasuries, would they not? That would include the biggest big daddy of them all, China.

In such a deflationary scenario, as long as the banks are holding all the cash (like they are now, because they are not lending to the economy) but instead are turning their dollars into dollar equivalents (treasuries), the banks would be about the only entities who would benefit from a deflationary nightmare. All others who owe money would get slaughtered because they’d have to sell their depreciating assets (before they depreciate away to zero) and pay back their loans with ever increasingly valuable American dollars.

Now here’s where I really get lost. In such a scenario, since it’s borrowers who will get slaughtered, that would mean the US government (the biggest borrower in the solar system) should get slaughtered the worst. How is this possible? How could the American debt ever be re-paid in a scenario of deflation where the value of the paper they’ve promised to buy back in the future goes through the roof? Would they be forced to tax the American people to death in an effort to come up with sufficient income? I see no other option. I see disaster.

Am I missing something? In a deflationary scenario, I see those who are owed money as doing very well and those who owe money getting crucified. Those who are owed money are the banks. Those who are holding money (or cash equivalents) again are the banks. Those who owe money are the American people and corporations. And the granddaddy of all borrowers is again government…. the people.

If I have this correctly in my mind, I can’t see a single reason why Bernanke or his owners would fight the deflationary scenario… as long as they have all their ducks in a row. If they had any intentions of fighting the “inflationary” scenario, they would have been lending out the recently printed trillions like madmen, in an effort to have it multiply its own volume 100x via the machinery of the fractional reserve banking system. They are doing no such thing.

The more I think about this, the more I’m starting to believe that the stage is being set for a massive surge in the value of the dollar as the deflationary scenario unfolds for a year or two. I’m starting to think that so many people my age have experienced nothing but “inflation” for so many decades now, that they don’t believe there is any other possibility. Some people have no concept of the word “down”. I do!

I think the bankers are setting the table real nice for themselves. In decades past, banks were all too eager to loan money on properties that they were confident would increase in value. Banks would consider it insanity to loan money for the purchase of a property that they thought was going to decrease in value. A borrower might default in such a case. That’s what we’re seeing today… a refusal to lend. What are the bankers envisioning? I has to be deflation!

Two or three years from now, when the value of everything in the world is a fraction of what it is today, who will be left holding bankloads of money and money equivalents? Money that they’ll use to swoop in and buy beautiful American properties for pennies on the dollar. I don’t even need to answer that question, you all know the answer. As I said in my first sentence… I honestly see this as one of the biggest traps of all time being skillfully set.

I admit, I’m not certain that I have it all figured out. I’m serious about wanting some input from others. Clue me in further… please.

Merry Christmas All

- Northern Dancer

Related Posts:

• Today the treasury is selling $124 billion of short term debt including one longer term 2 year note of $44 billion.
• We are having deflation at the same time as inflation.
• The proverbial “this time it’s different” is dead give away that it’s not different.
• Janet Yellen is a Keynesian shrill. Keynesian’s believe they can prop up bankrupt entities and grow an economy with debt-financed consumption.
• I think only increasing inflation of prices can lead to higher interest rates.

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