Thus, investors will not simply fund the U.S. Treasury blindly. They’re already demanding the Fed step up QE by buying more Treasuries as the bond markets push long-dated interest rates above the levels where they were when QE started about one month ago. This clash of wills between the Fed and the bond markets is potentially very destructive for the Treasury – like quicksand. As the WSJ article notes, stresses and strains are not, in fact, easing, but have massively been transferred to U.S. bonds. Something’s liable to break down here, and soon, with potentially very serious repercussions. As the Fed is obliged to belly up to the bar to buy more and more Treasuries and other assets to try to keep yields / interest rates low, investors see more and more risk in buying and holding sovereign debt, and less and less profit opportunities in doing so, at least for anything but the very short term. Past the short term I can easily see the Treasury as having no choice but to do some selective defaults on some flavors of sovereign debt. QE is a slippery slope to proverbial financial/monetary hell because the bond markets are going to hold the Fed’s feet to the fire. The Fed and Treasury have gotten themselves into a QE meat grinder they can’t very well free themselves from anytime soon.

So- the problem isn’t treasuries- the US government will have no problem funding itself.

In fact, I think we are going to see some serious “crowding out”. With the securitization market dead and the bank loan market anemic, private companies are not going to be able to get enough new loans nor rollover enough maturing debt. Credit spreads will stay high as the US government absorbs investment dollars that should have funded private enterprise. I hope a bunch of overpriced windmills, underfunded handouts, UAW jobs banks and undeserved payouts to subordinated bank creditors are worth it to the American taxpayers, because they will suffer the consequences of anemic economic growth for years to come.

China will also suffer. A huge percentage of their GDP growth was fixed investment- much of it as speculative and inappropriate as a new condo tower in Vegas. Well, that investment bubble has dried up, too, and won’t be coming back for years. Meanwhile, the Chinese government (like the US government) will try to make up some of the difference, but, like Obama, they will be doling money out to their friends, supporters and favored industries rather than on the basis of economic rationality.

Governments will learn that they have neither the resources nor the expertise to take the place of private industry in the economy, just as their tax hikes and massive financing needs crush the private economy even further, requiring more government intervention and ultimately default and inflation.

Will that circle be broken or will we be facing another decade like the 1970s?

No, defaults are more like children; they can be big or small. GB defaulted in the 1930s by unilaterally cutting coupons on one type of bond (the perpetual bond). It didn’t cut the coupons on other bonds, and it didn’t renege on the nominal. So it was a very small default.

A sovereign default by the United States would be something close to the end of the world. There would be basically nothing left of value in financial assets.

a: There are gradations in the US defaulting (reneging on Social Security obligations, cutting coupons paid out, wholesale repudiation of nominal). Their consequences are very different.

Default is like pregnancy, either it happens or it doesn’t. Reneging on social security obligations or medicare obligations wouldn’t be a default, since Congress has not said those magic words “full faith and credit of the United States.” Not paying out Treasury coupons or FDIC obligations would be a default.

The whole point of the system is arranging things so that there isn’t a graduation possible. Once Congress says “full faith and credit” then that’s it.

This is to conflate all bad scenarios as the End of the World. It is a serious and dangerous error IMHO.

There are gradations in the US defaulting (reneging on Social Security obligations, cutting coupons paid out, wholesale repudiation of nominal). Their consequences are very different.

And there are gradations and differences in how bad scenarios can play out: Ireland in the 1840s is very different from Russia in the late 1910s and 1920s. Owning farmland was useful in Ireland; it didn’t help in Russia.

concretely, russia dipped into its reserves to meet a surge in demand for dollars from russian banks and firms that needed to repay their external debt, and likely will dip into its reserves further to make up for a shortfall in export revenue. the saudis have also dipped into their reserves to make up for the fall in oil export revenue, and thus have financed a smallish current account deficit by selling foreign assets rather than running up foreign debt.

china doesn’t have a lot of external debt, and it is running a trade surplus not a trade deficit as imports have collapsed more than exports, so it doesn’t have the kind of (external) financing need that can be financed by selling off foreign assets.

a domestic deficit like china has will be financed domestically unless the deficit generates enough demand for imports that the country starts to run a trade surplus. in china’s chase, a bigger fiscal deficit would likely bring the trade surplus down, not get rid of it — so it wouldn’t necessarily lead to any net sales of reserves, only less accumulation.

the key point is reserves are foreign assets and can only meet a need for foreign funds, whether capital flight, the repayment of external debts or covering imports.