The declining exchange value of the US dollar
There is no danger of the US defaulting on its bonds. The bonds are denominated in US dollars, and dollars can be created without limit.
If equities continue to fall, if flight continues from the euro, if bank fees drive people out of cash, it is possible, for awhile, that the inflows into Treasuries can finance the large annual deficit, removing the need for the Federal Reserve to monetize the deficit via Quantitative Easing. On the other hand, the weakening economy, given traditional policy views, will likely lead to a renewal of debt monetization or QE in an effort to stimulate the economy.
Continued debt monetization threatens the dollar. Investors will move out of Treasuries and all dollar-denominated assets not because they fear default, but because they fear a fall in the dollar’s exchange value and, thus, a fall in the value of their dollar holdings.
Debt monetization can cause domestic inflation (and imported inflation for those countries that peg to the dollar) as, and if, the new money finds its way into the economy. This has not happened to any extent so far in the US, because the banks are not lending and consumers are too indebted to borrow.
But the fall in the dollar’s exchange value results in higher prices of many imports. So far the inflation that the US is experiencing is coming from the declining exchange value of the dollar. However, there is little doubt that asset prices, such as those of Treasuries and stocks, have been inflated by the Fed’s monetization of debt.
To flee from the dollar, there must be someplace to go. There are presently no alternative currencies large enough to absorb the dollars, especially with China pegged to the dollar and the euro experiencing troubles of its own because of the sovereign debt crisis in Greece, Spain, Ireland, Portugal, and Italy.
[Excerpt of article by Paul Craig Roberts, former Assistant Secretary of the Treasury in the Reagan administration and associate editor and columnist at the Wall Street Journal.]