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Old 11-28-2010, 11:20 AM   #41
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Sometimes intelligent people can get caught up in an issue and lose perspective.
On the other hand, maybe he correctly perceived overvaluation and risk, but could not predict just what unprecedented money and credit injection and Fed balance sheet expansion might be able to do to spin out the game?

Similar warnings quoted on this board in summer 2007 were also ridiculed.

Ha
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Old 11-28-2010, 11:51 AM   #42
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In response to your main point, I think it is unclear that if given the stark choice, the US would prefer to stiff small domestic owners of FDIC insured accounts, about whom the case could be made that it was not exactly unknown that the FDIC was woefully underfunded; or default on money full faith and credit owed to our bankers the Japanese, the Chinese, and the oil exporting nations.
I think my main point was that whether a Treasury default or an FDIC default is more likely depends entirely on what the nature of the crisis is. An FDIC default doesn't 'solve' the same problems that a Treasury default would.

My secondary point was that a U.S. default is an entirely political act, right now, considering that we have a monopoly on the unit of exchange in which 100% of our debts are denominated. Stiffing voters to benefit foreigners doesn't seem like a smart political move. But your point is well taken, that defaulting on our external obligations is not costless. But neither is it costless for the FDIC to default, considering that the vast majority of financing for our banking system is insured, overnight deposits, that will vanish in days or weeks once a single dollar is lost. It's not clear to me that a complete banking collapse is a better alternative than being shut off from external financing. And it's also not clear to me that external financing would be forthcoming in the face of a complete banking collapse precipitated by a failure of the U.S. government to honor an implied guarantee.

Of course a Treasury default could just as easily precipitate a bank run, so maybe it is not possible to silo the two. But given a choice to place a bet, I'll bet politicians take care of voters before they take care of the Chinese, but that is just one opinion.
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Old 11-28-2010, 11:56 AM   #43
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Somewhere between the doom/gloom/tinfoil hats and the "S&P500 will return %12 for the next 3 decades" is the most likely path of reality. Be diversified and ready to roll with the punches...like always.

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Old 11-28-2010, 01:31 PM   #44
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Here's one research paper that seems to confirm my intuition . . .

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Creditor identity can trump both governing law and currency of denomination in determining government approaches to debt management. Governments want to know who their creditors are partly to predict how they would behave and to have a sense at least of the initial allocation of losses in the event of a debt crisis. . . .Governments’ decisions to default or restructure are influenced by the politics of who wins and who loses. Where local residents vote or otherwise influence the government and resident institutions have a direct claim on the country’s fiscal resources, the residence of the holder may reflect these concerns.

Recent restructuring experience confirms this intuition. For example, Argentine banks and pension funds continued to buy government debt under government pressure long after non-resident institutions had stopped. In crisis, they accepted local-law instruments rejected by foreigners.74 This allowed the Argentine government to separate domestic and foreign creditors into different instruments, so that default on foreign-currency, foreignlaw bonds was in the first instance a default on the foreigners.75 Other governments have variously refrained from defaulting on debt held by local banks and have compensated local residents after default while leaving foreigners in the lurch.
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Old 11-28-2010, 03:05 PM   #45
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Somewhere between the doom/gloom/tinfoil hats and the "S&P500 will return %12 for the next 3 decades" is the most likely path of reality. Be diversified and ready to roll with the punches...like always.

DD
I don't see this as necessarily a "doom/gloom/tinfoil hat" conversation. The question seems to be, "should I invest in ST Treasuries yielding a couple of basis points, or should I put the same money in FDIC insured deposits earning 1%-3%". That's a lot of spread. If we were talking about corporate bonds that spread is easily the difference between investment grade credit and junk. Is that extra yield appropriate compensation for significantly more risk in FDIC insured deposits, or is it a free lunch? I think free lunch.
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