It’s the elephant in the room. The United States is utterly bankrupt and has been living off of borrowed money since 1971, when it defaulted on its loans — though of course, it wasn’t worded like that. Not even an income tax of 100% is enough to cover the expenses, and the US is about to go the way of the Soviet Union.
A while back before the dollar’s dead cat bounce, I wrote a story in Swedish explaining the issue to an eight-year-old. I think it’s time to repeat it in English.
So imagine we we’re a bunch of eight-year-olds. There’s Anna, Wei, Jesús, Felipe, Maria, Sven, Jean-Pierre and Sergei.
Oh, and there’s Wedgie.
His real name is Eddie, but everybody calls him Wedgie because he’s such a mean bully. Nobody really wants to play with him, but if we don’t, he’s mean to us. So we do anyway.
We collect nice shiny things. We build other things out of them sometimes. And then we sell the things we find and make to one another. And playing with Wedgie was okay after all, because he was buying a lot from all of us. Candy, jewelry from smooth stones, shiny seashells. Everybody was happy. Or at least nobody wanted to protest, because as fun as it was that Wedgie was buying, he could get very threatening when people would doubt him.
The thing was, Wedgie had been buying more than he had been selling for quite some time now. He was always in the red, living “above his means”, like they say. Wedgie had stopped paying in money altogether, because he never had any. He would pay with little pieces of paper instad, where it said how much he owed us, and he promised to pay for real later. He was writing those small pieces of paper in his room at night, and paid the rest of us with them, promising to replace them with real money later. He never said when that “later” would actually be.
Nobody else could pull this off. Only Wedgie. Because if somebody were to stand up to him… Wedgie was rather large and could look mean. Could be very mean, too. And besides, everybody wanted their money back the day Wedgie would have real money to pay us back, so everybody kept accepting the small pieces of paper that Wedgie was making in his room. “Five Wedgiemoneys”, they would say.
We even started trading directly in Wedgiemoney. Everybody had collected so much, it was just simpler that way. Some of us had almost as much Wedgiemoney as we had real money, or more.
Wedgie also made sure, in his threatening way, that some things could only be bought with Wedgiemoney. This forced us to change our real money for Wedgiemoney first, between each other, before we could buy what we wanted. Or we could Wedgiemoney directly from Wedgie, of course. In exchange for real money.
But it was fun too, in a way. Everybody had more money. Well, the price of everything went up too, of course, because we couldn’t find or make more things, we only had more money. But several of us had gotten much richer thanks to all the Wedgiemoney we had. We were very glad over that.
Then… something happened. We started thinking about the fact that Wedgie almost never sold anything. First, we were just looking at each other, as if we knew what we were thinking. Gradually, when Wedgie was not around, we started to look worried among each other.
Then somebody, I don’t recall who it was, said out loud what everybody was thinking:
What happens if Wedgie never pays back?
Suddenly, like a strong flashlight being turned on in the night, everybody realized that the Wedgiemoney could be completely worthless. Everybody was just pretending that they were worth as much as real money. If Wedgie didn’t pay back, everybody was sitting with a pile of stupid paper that wasn’t worth anything. But since nobody wanted to say out loud that “my money isn’t worth anything”, and suddenly be very poor compared to everybody else, we kept on pretending that Wedgiemoney was worth as much as real money.
Felipe was the one to carefully try to get rid of all his Wedgiemoney. He offered all of us to buy his Wedgiemoney for less than they were worth. Or less than the worth Wedgie claimed, anyway. Felipe wanted four real moneys for every paper that said “Five Wedgiemoneys”, the Wedgie-fivers.
Then, Anna asked for three real moneys for every Wedgie-fiver. Anna and Felipe soon only had real money, for the rest of us had bought their Wedgiemoneys. For Wedgie would pay back soon, wouldn’t he? It would have been a good deal.
But it wasn’t. All of a sudden, everybody was trading the Wedgie-fivers for two and fifty. Nobody really wanted Wedgiemoney any more. We agreed that they were only worth half of what they said. Nobody said it out loud, we all knew it anyway.
This didn’t worry Wedgie at all. He just started writing Wedgie-tenners instead, so he would continue buying things that cost five real moneys. When somebody asked when he was going to pay back, he just looked mean like Wedgie could do, and that everybody knew that Wedgie could do.
Then, that day came.
The day when we realized that Wedgie never had had any intention of paying back in the first place, and we realized he had been playing us for fools. We had paper, and he had all the nice things. He had been writing pieces of paper for us that we had accepted as real money, and didn’t want to lose.
But it was too late. We had realized he was never going to pay a single money back, even though the Wedgiemoney said he would.
So we put all our Wedgiemoney in a large pile, that we knew were garbage. And we didn’t accept any more from him. They weren’t good for anything, he was never going to pay back. He became really angry, and really mean, but it didn’t help him this time. We knew that we had been played for fools, and were going to keep our nice things to ourselves instead.
But only then came the real shock.
None of us had any money to buy things from each other any more. We had gotten so used to things costing both twenty and thirty moneys, even though they had only costed one or two before Wedgie had started writing his stupid pieces of paper. We thought we all had a lot of money, but we didn’t. We had gotten used to paying for a thirty-money item with five real moneys and 25 Wedgiemoneys.
Suddenly, nobody could afford the thirty-money items at all. Nobody had any money. Nobody could buy things as the prices remained where they were, and nobody could lower their prices, as everybody needed the money for what they wanted to sell.
We realized, even though we didn’t really want to, that it wasn’t only Wedgie’s fault that we had become poor. It was just as much our own. We had been dumb enough to believe him, even though we knew he was lying. It was always too expensive for us to say out loud that he had been lying the whole time, and therefore, we were in a much worse situation now.
We entered a very poor and rough time where nobody could afford anything. Everything was very, very expensive, all because of Wedgie’s stupid pretend money. They had made everything expensive, when nobody really had any money in reality. We had to get used to buying things for maybe one money instead of the things that we had bought before for ten. We weren’t used to living like that, day by day, and it was really rough. But nobody had any money and everything was still expensive.
Let’s end the story here and jump to today:
The United States has had a negative trade balance since 1976. The United States has lived above its means every year, year by year, after 1975 — and at a rapidly accelerating rate. Five years prior, the United States had unilaterally terminated the Bretton-Woods agreement that tied the dollar to gold, following a rapid decline in gold coverage during the Vietnam War. Charles de Gaulle of France demanded that the United States made good on its loan contract, and demanded gold for France’s dollars. The unsolvable situation caused President Richard Nixon to default on the US debts and say they weren’t going to pay any back. This event has been called The Nixon Shock and happened on August 15, 1971.
Of course, it wasn’t called a bankruptcy; it was spun as a reform of the international monetary system. Had anyone else done it, it would probably have been called a bankruptcy. In any case, after that point, all the United States had to do was to fire up the dollar printing presses. And boy, did they.
The last few years, the United States has had a trade deficit of over 500 billion US dollars, peaking at over 800 billion. That is eight times more than the country in second place and is growing rapidly. The United States is simply buying vastly more than it is selling, and has done so for thirty-five years. It compensates for this by selling IOUs, and at the same time pointing at its huge military powers for an implied threat in the case of nonacceptance of the IOUs — a military force which is unsustainably funded by these same IOUs.
Today, there are over three trillion dollars in currency reserves outside the United States. More specifically, there are 3,144,256,000,000 US dollars. That’s one portion of those IOUs. They have roughly halved in value in the past ten years.
In 2008, people were talking about a “financial crisis”. As if the bottom was reached, as if it was a temporary glitch, as if things were under control.
We have only reached the point in the story where people look at each other and ask “what if Wedgie doesn’t pay back?”.
There’s only a seed of doubt necessary to let loose the snowball in the avalanche slope. In 2008, the seed came from financial institutions that went belly-up. Unwisely, the US absorbed their huge losses into the government and so created an even worse situation for today, even though it created a dead cat bounce.
Some of the most prestigious financial analysts — Standard & Poor and Moody’s — have warned the US that they may downgrade the United States’ credit rating. The European ratings firm Feri Euroratings went ahead and actually downgraded the United States on June 8, right after Republican Paul Ryan said right out that the United States should default. That is quite extraordinary.
Many brokers have as a stability rule that they may only trade in triple-A bonds, the highest creditworthiness. With the US Treasury Bonds now downgraded, these brokers need to sell these bonds, accelerating the process. This was unthinkable — the US Treasury bonds have been the norm for credit grading, axiomatically being the triple-A rating.
The world has been buying IOUs without coverage to maintain the value of the previous IOUs, with no other creditworthiness than an assumption that the US will pay back some day. That day is not going to come, and we’re all going to be poor for a while.
The situation will stabilize, but not without Wedgie ceasing to buy things for pretend money. On the other side of that fence is another world economy, that I know very little of.