Dollar devaluation or default: Which will the U.S. government choose?

Adjustable mortgage rates got a lot of homeowners in trouble as we saw with the collapse of the housing market.  Now the U.S. government will start using floating rate securities to issue its debt:

The U.S. Treasury Department said it plans to sell a floating-rate security as early as the fourth quarter this year and signaled it may decide to “gradually” reduce the supply of notes and bonds at auction.

In its quarterly refunding statement today, the Treasury said a final rule on the floating-rate note auction is planned for coming months, with a first sale estimated to occur either in the fourth quarter this year or the first quarter of 2014. The department said it will use the weekly high rate of 13-week Treasury bill auctions as the index for the notes.

With a budget deficit of more than $1 trillion last year, the Treasury needs to expand its base of investors. So-called floaters may appeal to those who are seeking to protect themselves from a possible increase in interest rates or faster inflation stemming from the Federal Reserve’s unprecedented monetary stimulus.

So U.S. bond holders will get some protection should rates rise from increasing inflation.  But what does that mean for the federal government and the rest of us?  John Rubino of writes:

Rising rates would send the interest the government owes to non-Fed bondholders through the roof, increasing the deficit and either crowding out productive spending – which would tend to slow economic growth – or creating an even bigger mountain of debt that will require low interest rates to pay off. A 6% average borrowing cost applied to the $20 trillion that Washington will owe in another few years yields an interest expense of $1.2 trillion – every year forever, much of it going to China, Japan, and Saudi Arabia.

To sum up, floating-rate government bonds are just one more reason that interest rates can never be allowed to rise (and QE can never stop), even if it means sacrificing the value of the dollar, yen and euro. Devaluation is the only way out – for everyone.

There is a limit to the devaluation that can be allowed to take place.  The Fed would surely be blamed for anything approaching hyperinflation.  The most likely scenario is that of mass inflation (20 – 30 percent per year) and eventual default on some debt obligations.  Bondholders won’t be protected and neither will anyone else relying on the federal government for their income, including Social Security recipients.

There will be a Great Default, as Gary North says.  It’s not a question of if but when.  You’ll want to be prepared for this eventuality.

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