Effective treatment for this crisis will come with “The Master Settlement of 2009”

Summary:  This is part three in a series discussing what needs to be done to prevent a crash of the US economy.  This post considers in detail one aspect of the treatment for our financial crisis described in “A solution to our financial crisis“.  This is a revised version of my 1 October post America has changed. Why do so many foreigners see this, but so few Americans? This is as far beyond most American’s imagination as were my forecasts a year ago.  That does not make them right, of course.

A solution to the crisis resulting from the end of the post-WWII debt supercycle

Broadly speaking, a solution must accomplish the following three things.

1. Stabilize the financial system (there are several ways to do so; it just takes money)
2. Stabilize the economy (there are many ways to use fiscal and monetary policy to do so; it just takes money)
3. Arrange long-term financing for steps #1 and #2 with our foreign creditors (to provide the money)

The solution must also not substantially raise US interest rates or destabilize the US dollar.  These two conditions greatly narrow the range of options.

In my opinion it is not possible to do these things without negotiating with our foreign creditors.  The US government seeks to avoid this, for good reason.  Probably to no avail, as we will have to do so when the current ad hoc financial and regulatory mechanisms break down.  That might be soon, judging from recent events.

We are likely to get the money we need.  The debate will be on what terms we get the money.  We can only speculate how this might work.  Here is my guess.

The Master Settlement of 2009

I. The US receives $1.5 trillion in new lending in 2009 and 2010, with smaller loans in the following five years.  New lending under this agreement ends in 2015.  After that we must run both trade and current account surpluses, so we can pay our debts.

II. Existing US government and agency bonds held by foreign central banks are rescheduled.  Principal or interest payments will begin in 2016, amortized over the following 30 years at low fixed interest rates.

III. The bonds are denominated in an index of currencies, weighted by the debt held by each nation.  We lose the ability to inflate the debt away by printing money.

IV. The US dollar is immediately devalued by some fixed amount (perhaps 20%).  The lower dollar will reduce our imports, as they become more expensive.  Our exports again become competitive on world markets, so we can earn the money to pay our debts.

V. Our creditors will demand (and receive) political concessions.  We can only guess what those might be.  China will certainly ask for a sphere of influence that includes Taiwan.

The very fact that we must conduct these negotiations, a common thing for emerging nations, will mark an inflection point in history.  On that day the post-WWII geopolitical order will end.  We can only guess what will follow.

Consequences

Needless to say, this will end our pretensions to global leadership.

As one of the minor consequences, we will have to watch our budget.  Like everyone else, we will need to carefully ration foreign spending so that we have the foreign exchange needed to pay our debts.  Like the post-WWII UK, foreign bases — and foreign wars — will become expensive luxuries.

The hidden assumption of COIN theorists is that we can afford all these foreign interventions.  As we learned in Iraq — and are discovering for the second time in Afghanistan — waging COIN is expensive.

This abrupt change might prove difficult for Americans to accept, as our leaders themselves show no signs of understanding the precarious financial foundations of our “empire.”  How well we adapt to this new world might be a large factor in how well America does in the 21st century.

What should we do to prepare for this harsh new world?

The world is changed, I can feel it in the water, I can feel it in the earth, I can smell it in the air.
Said by Treebeard, leader of the Ents, from The Two Towers– part II of Tolkien’s The Lord of the Rings trilogy.

We speculate about these things in order to better understand how the world is changing — what futures open before us.  Keeping that in mind, I take the guesses presented in this post and give simple (or simplistic) answer in A solution to our financial crisis.

Afterword

If you are new to this site, please glance at the archives below.  You may find answers to your questions in these, such as the causes of the present crisis.  I have been writing about these events for several years; since November 2007 on this site.  As you will see explained in these posts, the magnitude of the events now happening is beyond what most Americans have — or can — imagine.

Please share your comments by posting below.  Please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

Some FM posts about the current crisis

1. Treasury Secretary Paulson leads us across the Rubicon, 9 September 2008
2. High priority report: a geopolitical sitrep on the financial crisis, 15 September 2008
3. Say good-bye to the old America. Welcome to our new socialist paradise!, 17 September 2008
4. Another voice warning about the nationalization of AIG, 18 September 2008
5. A vital but widely misunderstood aspect of our financial crisis, 18 September 2008
6. A new sitrep, as we move into phase 3 of the financial crisis, 19 September 2008
7. Another step away from our Constitutional system, with applause, 19 September 2008
8. What do we know about the financial crisis? What are the key questions?, 20 September 2008
9. Slowly a few voices are raised about the pending theft of taxpayer money, 21 September 2008
10. America appoints a Magister Populito deal with the financial crisis, 21 September 2008
11. Legal experts discuss if the Paulson Plan is legal, 21 September 2008
12. Essential steps to surviving the current crisis, 23 September 2008
13. How should we respond to the crisis?, 24 September 2008
14. A solution to our financial crisis, 25 September 2008
15. Is the US economy in good shape, or in terrible shape?, 27 September 2008
16. A quick guide to the “Emergency Economic Stabilization Act of 2008″, 29 September 2008
17. The last opportunity for effective action before disaster strikes, 3 October 2008

For a full listing see the FM reference page about the Financial crisis – what’s happening? how will this end?.

A few of the most important posts warning about this crisis

This crisis has long been forecast by many, including in articles on this site.  Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results.  To see the all posts on this subject, go to the FM reference page about The End of the Post-WWII Geopolitical Regime.  Here are some of those posts.

1. A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
2. The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
3. We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
4. Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
5. Geopolitical implications of the current economic downturn, 24 January 2008, – How will this recession end?  With re-balancing of the global economy, so that the US goods and services are again competitive.  No more trade deficit, and we can pay out debts.
6. A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
7. What will America look like after this recession?, 18 March 208  — The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
8. The most important story in this week’s newspapers , 22 May 2008 — How solvent is the US government? They report the facts to us every year.
9. Prof Nouriel Roubini describes “The Decline of the American Empire” ,18 August 2008
10. The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.
11. “The changing balance of global financial power”, by Brad Setser, 22 August 2008
12. “The Coming US Consumption Bust”, by Nouriel Roubini, 6 September 2008