The Next Shoe

By Kevin Freeman
July 28, 2011Jul 28, 2011

Amidst all the current wrangling over the debt ceiling one thing is certain. We are vulnerable to financial attack. This blog has documented the risks in detail. We have shown enemies of this country with motive means, and opportunity. We have demonstrated how such attacks can take place but appear to be normal economic activity. We have identified the weapons used. We have demonstrated the impacts and future threats.

What has happened to Greece can happen here. We are vulnerable even if we don't want to admit it. The Federal debt is over $14 trillion and we now have a Credit Default Swap problem emerging here as reported by CNBC today:

The cost of buying insurance against a default by the U.S. rose to a record on Wednesday, in a sign of growing unease that gridlock in Washington over raising the federal debt ceiling may result in the Treasury failing to pay interest to bondholders.

The market for buying and selling insurance on the creditworthiness of the U.S. is thinly traded, denominated in euros and dominated by European and UK banks in London. But trading in so-called credit default swaps has picked up as the threat of a default has grown.

In a CDS, a buyer of protection is compensated by the seller should there be a default or missed payment, known as a "credit event".

"The U.S. CDS market is much less liquid than other sovereign markets as up until recently no one thought the chance of a U.S. credit event was very high," said Ira Jersey, strategist at Credit Suisse. "The market is getting nervous over the risk of a default."

Premiums for one-year U.S. sovereign CDS rose sharply this week and traded at about 90 basis points in London on Wednesday, overtaking the previous high set in March 2009.

In a sign of greater concern of a near-term default, U.S. one-year CDS was trading higher than premiums for the more liquid five-year sector, at about 65bp, for the first time.

Otis Casey, director of credit research at Markit, said: "Typically you see an inversion of the short end in [issuers] that are fairly well distressed."

…Later on Wednesday, the International Swaps and Derivatives Association released guidance on common questions about a possible U.S. default. On Monday, ISDA posted an updated Q&A for Greek sovereign debt on its website.

In the case of the U.S., a credit event would occur if the Treasury failed to make a payment on government bonds. In that situation, a committee under the auspices of the ISDA would rule that a default event had occurred only if the payment had not been made after a three-day grace period. At that point, U.S. CDS trades would be triggered and then settled."

All of this was unimaginable just a couple of years ago. Now, it feels almost inevitable. Of course, there will likely be a debt deal of some kind. But, just as in Europe the real action takes place AFTER the bailout deal is announced. That's when the market players step in and start their attacks. As the Democrats and Republicans wrangle over budget cuts and the debt ceiling, never forget what the Chinese said in their official publication the Qiushi Journal as reported in India Times:

China on its part, it said, can consider the idea of launching economic warfare through strategies to contain the US dollar and making effective use of forums like the IMF and initiating a space war by developing strong space weapons… It also said the China should also launch a public opinion war by making an effective use of the free media in the US and other democracies.

"Of course, to fight the US, we have to come up with key weapons. What is the most powerful weapon China has today? It is our economic power, especially our foreign exchange reserves (USD 2.8 trillion). The key is to use it well. If we use it well, it is a weapon; otherwise it may become a burden," it said.

China, it said, should ensure that that fewer countries should keep their forex reserves in US dollars. "China, Japan, the UK, India, and Saudi Arabia are all countries with high foreign exchange reserves," it said analysing each country's ability to align with China against the US.

So in view of this China should "pick up courage" and go for aggressive buying of other currencies, including the Indian Rupee hence taking the lead in affecting the market for US dollars.

This approach, it said, is market-driven and it will not be able to easily blame China.

"Of course, the most important condition is still that China must have enough courage to challenge the US currency. China can act in one of two ways. One is to sell US dollar reserves, and the second is not to buy US dollars for a certain period of time," which will weaken the currency and cause deep economic crisis for Washington.

Given the fact that China is the biggest buyer of US debt, its actions will have a demonstrable effect on the market.

"If China stops buying, other countries will pay close attention and are very likely to follow. Once the printed excess dollars cannot be sold, the depreciation of the dollar will accelerate and the impact on Americans wealth will be enormous.

"The US will not be able to withstand this pressure and will curtail the printing of US currency," it said.

All of this describes PHASE THREE from the original 2009 report prepared for DoD, Economic Warfare:  Risks and Responses.

All posts Copyright (c) 2011 Kevin Freeman, All Rights Reserved