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Default on Social Security Bonds
Eric Von Baranov

(Editor's Note:

"Enter, Social Security Reform. Now politicians are suggesting that federal withholding revenues be redirected into the stock market. Wow! What an idea. That should keep the markets inflated for a little while longer. It could certainly give the Fed a new a new source of wealth to siphon off. But wait. One of the biggest myths about Social Security is that there is any money in the Social Security trust fund. The fund has been systematically tapped and squandered by every administration since its inception. It was an unconstitutional sleight of hand to begin with. It is, and has always been a Ponzi scheme, which depends on new workers to pay the old workers. Maybe that is why the present administration is doing everything in its power to tear down the borders and accommodate as many illegal aliens as possible. Maybe that's why they're attempting to raise the age of retirement. The privatization of Social Security is simply one more scheme to siphon off the wealth of the middle class through commissions and fees, and keep the stock and bond markets inflated for a little while longer. Do you see a pattern emerging here?"

excerpt from my 2005 essay: Paradise Lost. - JSB)

How low can interest rates go, and how long will they stay that way? A year ago, I projected that 10-year T-bond yields would fall from 5.35% to 3.35% - a 200-basis point drop. Rates fell steadily to the 3.5% level, stalled for a while, then plunged.

The drive up in demand for T-bonds certainly looks like a blow-off move; all logic -- and the long wave -- suggests a long trend reversal. Some buying a 10-year bond today for 2% will see much of their capital consumed by inflation, even if it returns to relatively modest levels (5%). 5% inflation should put T-bond yields in the 7% range, which would consume most of the capital of a 10-year T-bond purchase over the full term.

Such an investment makes no sense, unless current conditions are responding to different parameters. Therefore all logic suggests T-bonds are overpriced, and must fall off precipitously.

However, the conditions driving yields lower are merely side effects of forced liquidation - which I’m not convinced is over. Stock-market momentum is still negative. While T-bonds are extremely overbought, momentum hasn’t declined, not even on a short-term basis.

I do think the economy will rebound very strongly by the end of 2009. The factors driving liquidity are unprecedented. But at the same time, Obama must keep interest rates low.

His administration will be walking a knife’s edge. Just as Rubin pushed Clinton to pass NAFTA and made government financing short-term, to save on interest costs, Obama (employing some of the same players) will now want to transfer as much debt as possible to as far off as possible - and at as low an interest rate as possible. Locking in low rates on the massive US debt will be critical to continued policy renewal going forward.

If the US government remains short-term-oriented, the volatility in budget management and the rise in carrying costs will kill any new government spending - and will eventually consume most tax revenues.

15-20% T-bill rates (as seen during the Reagan era) could mean disaster for the new administration. If rates are forced too low, the dollar will get slammed, which could push more T-bills onto the market (as investors flee the currency), which would push short-term rates up. In flooding the marketplace with new paper to fund the new trillion-dollar debt, Obama will have to create a market for T-bonds.

There’s only one way I can see for him to do this: Default on Social Security bonds. $4 trillion of the $10 trillion national debt is held by the Social Security Administration, which can maintain its current surplus for at least a few more years. Congress has already spent that $4 trillion - and Social Security payouts will exceed income.

Being a Democrat, Obama may be able to do what Bush could not: Trading the Social Security Trust Fund obligation for the ability of the Social Security Administration to invest in state revenue bonds would instantly reduce US federal debt by almost 40%, remove the future tax burden from general fund taxes, give states needed revenue for infrastructure rebuilding, create more jobs, and make the US government appear fiscally stronger.

Such a move takes a pending unfunded liability off the books and increases the rating and value of US bonds - especially long-term bonds. It also gives Obama an opportunity to move debt into long term paper while not killing the value of the dollar.

Is the Obama administration smart enough to make such a dramatic move? He does have Rubin, and the country is desperate enough to allow major changes to occur. There could, for example, still be a push to further suppress rates in order to fund the new debt long-term. If the stability of China and Europe remain in question, money will continue to flow into the US and drive rates even lower.

However, there will come a day of reckoning, when money flows rapidly out of T-bonds and into US stocks. We saw an example of this just this past week. When the momentum gets going the move up in stocks and the move down in bonds will be nothing short of spectacular. There’s an unexploded liquidity bomb lying in wait under this market: As fast as people were liquidating stocks to cover illiquid investments, they will someday be liquidating stores of value to buy underpriced stocks.

The real fun is yet to come.

Eric Von Baranov writes and speaks extensively about economic, geopolitical, technological and social trends.

www.minyanville.com


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