The focus of the European Sovereign Debt Crisis has shifted to Italy from Greece. This story continues primarily because of Credit Default Swaps and other economic weaponry. In fact, Jim Cramer this morning commented on CNBC that the same mechanisms used to attack Lehman Brothers in 2008 are at work today. This fits the 3-phase hypothesis outlined in the 2009 report we prepared for the Pentagon titled Economic Warfare: Risks and Responses.
The basic hypothesis was that the first phase was represented by a speculative ramp in oil prices that filled the coffers of Sovereign Wealth Funds in oil-producing nations. That took place from early 2007 until mid 2008. It repeated on a smaller scale just recently when oil prices exceeded $100 per barrel.
The second phase was a "bear raid" on the stock market to trigger a market crash and a global financial crisis. The bear raid was targeted at Lehman Brothers, Fannie Mae and Freddie Mac, and other financial institutions. The result was a collapse so severe that it nearly triggered a second global depression. As we predicted in the report, major Western governments responded with additional sovereign debt and massive stimulus packages.
We then predicted that a third phase, directed at sovereign debt and currencies in general (and the US Treasury and the US dollar in specific) would occur. We believe that we are in Phase Three now. While the dollar looks fairly strong against the Euro short term, this is only masking underlying weakness. As can be seen in the chart from the Congressional Budget Office, any US strength in transitory. The baseline scenario assumes that all tax cuts expire and the Alternative Minimum Tax stays in place, neither of which is politically reasonable. In addition, the CBO uses static models meaning they assume that 100% tax rates would bring in $14 trillion in revenue. The reality is that 100% tax rates would bring in ZERO revenue as all economic activity would cease. The reality is that our long-term domestic budget outlook is very much in line with Greece and Italy and that is not good news.
The point of this is that without some dramatic changes, it is only a matter of time until the United States is in the crosshairs. We need to dramatically lower our debt and deficits (without harming the economy in the process) and thus reduce our vulnerability. In addition, we need to recognize that there are certain elements willing to use economic weapons against us and properly respond to the threat. Otherwise, the international community (IMF, Sovereign Wealth Funds, and China) will soon be handing down terms to us as they have been doing in Europe.
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