Karl Denninger: "The Problem, Graphically Illustrated"

"This is the "economic collapse" scenario, because further government spending in such a situation requires the dilution of all existing money in the system by the same amount spent. This is a circle jerk - you're not actually able to spend that money and get the goods and services you want as a government, since you are creating and consuming at the same time. As such the operations cancel each other in effect and the government finds it cannot fund its internal operations with Treasury issuance any more, being forced back onto whatever tax base it has left (which won't be much at that point!) Here is the problem, graphically illustrated:

Note the breakdown. We are anticipating at least a $1 trillion shortfall this year, and frankly, that's unreasonably "good"; the real shortfall is likely closer to $2 trillion. So what happens if half of that $2 trillion is no longer "money" from foreigners - it is a circle-jerk from The Fed and Treasury? You can basically remove it, that's what. Now look at that chart - you can't remove the "net interest" (about $250 billion), because that has to be paid. "Other spending", that is, other than defense, interest, and social programs, is about $700 billion. Defense is also about $700 billion.

If we find ourselves unable to sell debt to actual investors with actual money, and are circle-jerking ourselves; to balance this budget we would need to contact spending to roughly $1.0-1.5 trillion in total. Since the interest payments are inviolate, that leaves us $1.25 trillion for everything else. Assume we can cut half of the defense budget, and we've got $800 billion left. Cutting "other spending" (that is, all other programs) by 50% would leave us with about $500 billion net-net for social programs - forcing a reduction of about sixty percent in Social Security, Medicare and Medicaid - all at once. In short this would wind up costing us roughly a 50% across-the-board cut in every program within government on an immediate basis. That in turn would force further reductions in GDP, which would further shrink tax revenues. You can see where this leads, I'm sure, and it's not pretty.

Ben Bernanke may think he can extricate The Fed from this outcome before it happens. But I must ask - exactly why would anyone believe that? He hasn't been able to extricate himself from anything he's tried thus far. The danger here is that this really is "the last bullet in the gun." If it fails, our currency and political system would appear to many who read this to go down the toilet in a hyperinflationary detonation.

Not so fast grasshopper. See, if he fails, it won't be simply a United States phenomena. Quite to the contrary. That failure will in fact be global - Bernanke has guaranteed it by tying The Fed to every other major central bank in the world via his "unlimited swap lines." We may be a cheap $5 hooker in the bar, but of the hookers, we've got crabs and everyone else has AIDS! The error in the hyperinflationist scenario is that without being able to couple price increases back into wages they are unsustainable - price increases instead collapse demand. If gasoline goes to $20/gallon you will buy less of it - a lot less - not because you want to, but because you simply don't have the money. This in turn destroys the gasoline retailer and oil company's operating cash flow, which in turn causes them to lay off more people. In a debt-laden economy the debt percentage (of GDP) continues to rise even as spending drops and a mad dash to try to redeem what debt can be repaid soaks up all available money.

The nightmare scenario that is staring us in the face, right here, right now isn't hyperinflation. It is in fact a collapse of monetary systems driving demand for dollars through the roof in a crescendo of attempted redemptions into collapsed ("no bid") asset prices - a demand that Ben will not be able to meet, as the collateral backing those dollars will have all been exchanged for toilet paper. Whether Bernanke holds all this trash on his balance sheet or manages to scam Treasury into exchanging it for T-bills, the result is the same - there is no collateral behind Bucky and as employment collapses no production to replace it with either. The mad scramble will be on, and as it happens trade will be choked off by not a collapsing dollar but other currencies collapsing around the world. Paradoxically, the DX, or dollar index, will skyrocket - not go through the floor - as this plays out.

Unfortunately this shuts down virtually all exports - at a time when we desperately need them, as we cannot borrow to consume any more. he economy collapses, along with government funding and our currency - but not through hyperinflation. The mad dash to redeem and sell anything and everything instead collapses pricing (that is, it becomes out-of-control deflation in an exponentially-increasing fashion) irrespective of Ben's attempt to halt it. The "death spiral" ends in the destruction of our monetary base - not due to hyperinflation but due to the inability to borrow any more funds, the reduction of the currency's base to a giant circle jerk, asset fire sales in a mad liquidation dash and ultimately, the collapse of both the monetary and political systems in the United States as tax revenues collapse to very close to zero.

This is a national security emergency that quite literally can take down our government and way of life within months or even days, and I'm willing to bet that not one person in Congress understands the seriousness of the matter. By refusing to confront the bankrupt nature of institutions under Bernanke's supervision and by choosing instead to continue to bail them out and take their trash onto his (our) balance sheet, Bernanke is risking something much worse than a Depression. He is literally risking the end of America as a political and economic power. Watch for a bond market dislocation very carefully. I will be, and hopefully I will detect it in time to warn people if Ben's "last bullet" gambit ends up blowing up in his face.

In the meantime, for however long this rally in the market lasts (and it might be a while if the sheeple misdiagnose what's coming - if the newsletters I've seen thus far this evening are any clue, most people have) use it to raise cash and be prepared for some really tough times. I have been singing this song - raise cash now - for quite some time. Let me be succinct - it has been my considered belief that you need enough in liquid cash - not credit access in the form of credit card available balances or anything similar - for at least six to twelve months. I'm upping that here and now to twelve to twenty-four months - that's right - one to two full years of "minimum necessary to make it" expenses. Figure out right here and now what your minimum "monthly nut" is, and raise 12-24 months of that much in safe, liquid funds.

That's a minimum; if you can in fact have enough available to be able to execute a "bug out" plan where you are able to become effectively self-sufficient on short notice (a couple of months maximum) if necessary, that's even better. Yes, we're talking chickens, goats, enough arable land to grow what you need to survive (bartering for what you don't have with what you do) and the means to defend it. If you live in a big city consider carefully what you intend to do if unemployment goes north of 20% and the city effectively goes feral - if you're interested in "how bad can it get" go drive through major parts of Detroit - bring an armored vehicle for your tour and/or at least semi-automatic weapons. There's an ill-wind blowing and while this storm has not yet reached the shore, I'm putting up the plywood."

- Karl Denninger, http://market-ticker.denninger.net/archives/879-Bernanke-Inserts-Gun-In-Mouth.html