Cutting our Monetary ties Part 1

There are several ties holding together the several states. These include:
1) Diplomatic (including common military)
2) Cultural (including religious and historic)
3) Economic
4) Monetary
The legal ties merely codify these more fundamental ties. There may be some more that I have missed, please feel free to point them out. What I am looking at today is monetary ties. These ties are related to economic ties, but are not identical. Example:
Through NAFTA we have some extra economic ties with Canada that we do not have with Singapore. However, those economic ties are not monetary since Canada and the US have different currencies. It is entirely possible to sever many of the monetary ties between (for example) Texas and New York without severing all of the Economic ties.  Why would we want to, and how would it happen?  Here I address why we might want to.

There is a strong push from liberal quarters to endow the Executive branch with an unlimited authority to borrow money on behalf of the people.  The authority to borrow has historically been tied to the authority to spend for quite obvious reasons.  Do you think a house could operate where one member has all spending authority and a different member has all borrowing authority (and an obligation of the second to borrow as much as the first wants to spend)?  That sounds like a recipe for disaster.  Add in a printing press and the ability to catastrophically crash the system is magnified.

Let’s imagine a (not even close to worst case) scenario* where the interest rate doubles to rates last seen in 2000 (not exactly a crisis period) at the same time the SS Trust Fund is attempting to redeem their Bonds for actual money requiring the Treasury to borrow more money on the open market in order to pay back the Bonds (already beginning).  The interest payments on our debt could easily triple from $400B per year to $1.2T per year.  This is without a loss of confidence, if that happened we would be looking at 1980 interest rate levels of 11% and the interest would be $1.5T without even adding any more to the debt (if the debt continued to increase the servicing cost would easily be more than $2T per year).  At some point the ability to borrow wealth from markets (selling bonds at 0% nominal interest rate) and the ability to extract wealth from the economy (raise taxes) will be exceeded and the Federal Government will default either openly or by running printing presses.  The lack of faith in a monetary system would be (to put it mildly) detrimental to our economic system.

At that point it would make sense for the economies in fiscally prudent states not to depend on the reckless Federal Government to provide a sound monetary system.  In other words, Texas might want to have some options other than the “full faith and credit of Ben Bernanke” to continue to attract capital and encourage investment.

Next up – how to add a monetary buffer between your state and the Fed.

* Much closer to worst case (Chicken Little/Henny Penny/Cassandra Scenario) – China (the world’s second largest economy) begins dumping its US bonds on the open market while using its gold reserves to back its own currency in an attempt to replace the dollar as the world’s reserve currency (being the reserve currency affords many substantial economic benefits, including a large impact on the price of oil which China will soon import in greater volume than the US).  China would time this to coincide with a weak US economy and a cash in of the SS Trust fund thereby flooding the bond market.  The global financial system diversifies somewhat away from Treasury Bonds (aka dollars) and into Swiss Francs, Yuan, and Euros reducing the demand for dollars (along with the dollar’s international purchasing power), and the interest rate jumps to ~14% (as happened in 1980, totally within precedent) .  The loss of purchasing power of dollars for foreign goods (lower exchange ratio due to lower international demand) drives inflation in the US, and the weakness of the dollar diverts money away from capital investment (building manufacturing plants) in the US (a factory worth $1B today would only be worth $900M next year, better to invest in Mexico).  The inability of the Treasury to borrow on the open market (due to a flood of existing Treasury Bonds) drives the Fed to monetize the debt (pay off existing bonds with newly printed dollars) in order to prevent outright default and thereby pushing inflation higher.  So, our interest rates spike, inflation skyrockets, and unemployment jumps as manufacturers stay away.  Home prices plummet as the cost of servicing a mortgage (the cost buyers must actually consider since this determines the monthly payment) doubles (due to a tripling of the interest rate) and local revenue from property taxes (based on home values) plummets along with the ability to employ teachers, firefighters, and police.  This happens even as people are unable to sell their houses since their houses drop in nominal value by ~50% (in order to keep a constant monthly payment for new buyers).  Local governments already saddled with large pension deficits and expensive labor contracts face an angry bond market and lower revenue pushing many the way of Detroit (both economic and law enforcement).  Would China be willing to attempt this move (i.e. bankrupt the U.S. in order to improve their international status and economy)?