John Williams: Debt Limit Debate Sign of Deeper Dysfunction
Interview

The Gold Report: Unless Congress approves and President Obama signs an increase in the $14.29 trillion debt ceiling, the U.S. Treasury is set to begin defaulting on payments starting August 2. That threat launched months of competing big deals to cut spending and/or raise taxes. To add to the pressure, in mid-July the credit rating agencies Moody's and Standard & Poor's threatened to downgrade the U.S. credit rating from its historic AAA status if the debt limit isn't raised in time to avoid defaulting on interest and bond payments. That could raise interest rates for the government and trickle down to consumer mortgage loan and credit card payments. John, what kind of deal would be good enough to satisfy bond rating agencies and avoid a double-dip recession?

John Williams: First of all, the chances are nil that the government actually will default. There is some talk that if the debt ceiling were not raised by the August 2 deadline, the government could avoid default for a while by playing games with its payments—pay interest and debt first instead of paying other obligations. That could trigger a rating downgrade, if one had not occurred otherwise. Also, I don't think global investors would view non-payment of general obligations as a plus and could engage in dumping the dollar. I think Congress will agree, however, to something by the deadline. I have no expectation, though, that the deal will be of any substance; nothing that has been proposed would improve U.S. fiscal conditions meaningfully.

A country's credit rating is a measure of the risk of debt default. The U.S. dollar, as the world's reserve currency, is considered the benchmark instrument for an AAA rating. That generally is considered the riskless category. It would be very unusual for rating agencies to downgrade a benchmark. Yet the credit rating agencies now are seeing risk of a U.S. default and are talking a possible downgrade of U.S. Treasuries. A downgrade would have about as much negative impact as an actual default. You don't want to see a downgrade. You don't want to see a default. Those actions would have all sorts of implications, very negative implications for the financial markets, particularly for the U.S. dollar. You would see heavy U.S. dollar selling and dumping of U.S. dollar-denominated assets such as Treasury bonds. You would see a spike in dollar-denominated commodity prices such as oil. Gold prices would rally sharply, as would silver, as traditional hedges against inflation.

TGR: Is printing more money really what the government is going to do to pay its debt?

JW: That is what countries that spend beyond their means usually do if they can't raise adequate tax revenues. I can tell you that the current government cannot raise enough taxes to bring the actual deficit under control. It could tax 100% of income, take 100% of income and corporate profits, and it would still be in deficit. In terms of generally-accepted accounting principles (GAAP) that include annual increases in the unfunded liabilities on a net present value basis, the U.S. is long-term bankrupt. A true balanced budget approach would require excessive overhaul—I'm talking massive cuts in the social programs because cutting every penny of government spending except for Social Security and Medicare would still leave the country in deficit. We are spending well beyond the bounds of reason in a number of areas. The country just does not have the ability to pay for all the services it provides.

TGR: In a July 14 commentary, you said that, "In the event of an actual default or downgrade, the United States position as the elephant in the bathtub of sovereign risk likely would cause the dollar to plummet against all major currencies irrespective of any ongoing concerns related to Euro-area debt." What would this mean for the U.S. dollar and the price of gold going forward?

JW: Already stocks are down because the markets are frustrated with the lack of a deal. The U.S. is such a large player in the world markets that if the dollar is downgraded, the impact will be felt globally. The dollar should sink against most major currencies, including the euro, and gold prices would experience a big bump up. It should be very positive for gold long term. It doesn't mean that Central Banks aren't going to intervene and that the Treasury or IMF are not going to try to keep gold prices down. But, over the long haul, you'll see much higher gold prices.

TGR: What would default or downgrading mean for the dollar?

JW: If the U.S. defaults or gets downgraded, that likely will end the U.S. dollar as the global reserve currency. That's not a viable option for the United States. People involved with getting the country to that point should be removed from office. If you are the most financially powerful country on earth, you don't fool around with your creditworthiness.

TGR: So, if the dollar isn't the benchmark, would it be the euro? Would it be the yen? Would it go back to a gold standard? What would happen?

JW: It would probably revert to some kind of a basket of currencies, probably including gold. The dollar would tend to suffer against the new benchmark and gold would tend to increase relative to the dollar in such a circumstance. But I can't tell you exactly what would happen.

TGR: The new European Union plan for reducing the debt burden for Greece, Ireland and Portugal offers longer-term and low-interest loans and allows some bonds to go into temporary default. Does that set a precedent? Will it contain Europe's debt crisis?

JW: The euro never should have been put in place. Anyone who ever thought that the Germans and the Italians could coordinate fiscal policy didn't know the Germans and the Italians very well. The euro would have been disbanded or at least realigned by now if we weren't in the middle of a systemic solvency crisis. The European Union will do anything to keep Greece afloat, as long as it is viewed as a threat to systemic solvency. Once the system stabilizes, I'd expect to see a breakup of the euro.

TGR: In our conversation with you last January, you talked about the difference between the true deficit and the cash-based deficit published by the government. What is the true deficit and what can be done to deal with that?

JW: The GAAP-based deficit is running around $5 trillion a year right now. That includes the numbers popularly looked at in the press and the year-to-year change in the unfunded liabilities for Social Security and Medicare adjusted for the present value of money.

To bring the true deficit into balance, there is nothing that can be done short of slashing Social Security and Medicare programs, and I see that as a political impossibility. Again, I mention the entitlement programs here, because you could eliminate every penny of government spending except for Social Security and Medicare, and the government still would be in deficit.

TGR: One of the other things that we've discussed with you before is quantitative easing (QE). Federal Reserve Board Chairman Ben Bernanke said there will be no more quantitative easing. In your July 8 commentary, you said the Fed will likely find the markets and banking system pressuring it into some form of QE3. What form might that take? And, how might that impact the dollar and precious metals?

JW: Well, Mr. Bernanke hemmed and hawed about the status of QE3 at his Congressional testimony earlier this month. The economy is weak enough; he will use that as an excuse. I can't tell you exactly what the Fed is going to do. I imagine it will go back to buying Treasuries, once the debt ceiling is raised. That will cause weakness in the dollar and strength in gold. Generally, anything the Fed does to debase the dollar, which it continues to do on an ongoing and very deliberate basis, means higher gold.

TGR: So, what is your prediction for the final solution?

JW: In terms of the debt ceiling, the solution is going to be to continue raising the debt ceiling. Either that or eliminate the debt ceiling. I don’t know what can be done politically on either side there. But, the government is committed to certain obligations. It doesn't make sense that it wouldn't follow through and borrow the funds to pay what it has already committed to spend. As to bringing the U.S. fiscal circumstance under control at present, there simply is no political will by the president or by the aggregate sitting Congress to do so.

TGR: Isn't it strange that instead of having this debate when they were voting about the budget and whether to spend the money, they are talking about it when it is time to pay the bill for the spending decisions already approved?

JW: No, we're just dealing with a group of individuals in Washington who are politicians first, second and last. Most of them have very little real interest in the nation's fiscal condition. They are looking at getting reelected and serving their special interests wherever they can. That has been evident to anyone who has watched the system in recent decades. There are some new, good people in Congress, but not enough to change things, yet. As Congress stands right now, there is no chance whatsoever of putting the U.S. fiscal house in order.

TGR: You look at a lot of numbers. We have really only talked about the debt limit. Anything else that you would like to leave us with that could impact the price of gold?

JW: Well, I think you have covered them. You are going to see ongoing weakness in the economy. The government is going to respond with more stimulus before the 2012 election, despite the so-called efforts at reducing the deficit. The Fed is going to ease liquidity more. All those actions to address the economic problems will tend to be inflationary, and that is generally positive for gold.

TGR: Thank you John.

Walter J. "John" Williams was born in 1949. He received an AB in economics, cum laude, from Dartmouth College in 1971, and was awarded a MBA from Dartmouth's Amos Tuck School of Business Administration in 1972, where he was named an Edward Tuck Scholar. During his career as a consulting economist, John has worked with individuals as well as Fortune 500 companies. For 30 years he has been a private consulting economist and a specialist in government economic reporting. His analysis and commentary have been featured widely in the popular media both in the U.S. and globally. Mr. Williams provides insight and analysis on his website, www.shadowstats.com.

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