QBAMCO's Take On The US Downgrade

Tyler Durden's picture

It is still not too late to submit one's thoughts of what the US downgrade means for various asset classes and for the economy, and world, in general. Here is one of the few worth reading, courtesy of QBAMCO's Paul Brodsky and Lee Quaintance. Their conclusion: "the downgrade is effectively a currency downgrade, which seems very reasonable, overdue and, in real terms, insufficient. We would argue that in real terms, US Treasury obligations are non investment-grade. We think Treasury obligations today and always will be money-good, but principal and interest will be repaid with bad money."

Full note:

Takeaway: We believe the downgrade of US Treasury obligations is legitimate and, in one very relevant way, insufficient.

First, the nominal creditworthiness of Treasury obligations is solely a function of controlling the printing press. Congress ultimately retains the legal right to print the nation’s money. It may even decide unilaterally to maintain the US dollar as the nation’s currency or change it. Thus, in light of the prolonged Congressional impasse on raising the debt ceiling, S&P’s downgrade based on Congress’ willingness rather than Treasury’s creditworthiness seems reasonable.
AA+ remains a long way from non investment-grade. US Treasury obligations would become non investment-grade if, for example, Congress were to either maintain the debt ceiling as-is for a long period, which would force Treasury to divert available revenues away from other government services towards principal and interest payments, or if Congress were to completely abandon the US dollar as the nation’s currency, which would force outright default of Treasury obligations.

US Treasury obligations are denominated in US dollars. The current US monetary base, (M0 or currency in circulation plus dollar-denominated bank reserves held at the Fed), is only about 19% of Treasury obligations. So, there is currently insufficient money to repay Treasury debt. Thus, a divided Congress or government may theoretically block further money creation, which would either increase pressure on Treasury to divert available funds towards meeting principal and interest obligations or eventually lead to outright default. We believe S&P’s downgrade is legitimate in light of growing public sentiment, reflected increasingly in the House, not to raise the debt ceiling.

Second, we believe the downgrade is substantially insufficient when viewed in real terms. (Importantly, rating agencies and Treasury are not mandated to address or provide positive real rates or returns.)

The stark difference separating nominal return of principal and interest from the return of inflation-adjusted principal and interest for holders of US Treasury obligations is the critical issue. The necessity to manufacture more money to service and repay existing Treasury debt suggests substantial diminution of the purchasing power of existing US dollars in which Treasury interest and principal have to be repaid. We believe unlevered holders of Treasury obligations are locking-in negatve real interest rates and levered holders of longer duration Treasury obligations are at great risk of capital loss in real terms.

We believe Treasury is already in the process of defaulting in real terms and that such default will be magnified and recognized by more sponsors of Treasury obligations over time.

Non-inflationary solutions to Treasury’s debt and deficit problem, (as well as other public and private sector dollar denominated debtors), are limited to: 1) politically-sponsored austerity (via the the allowance of credit deterioration); 2) a change in tax policy, or; 3) some combination of both. (Base money printing is inflation, per se, and would not reduce debt and deficits, merely lessen the burden of repayment for all current debtors while raising that burden for future revenue producers.)

Although S&P is careful to point out that a downgrade of government obligations does not imply risk among all commerical entities within that domain, we believe this sovereign credit downgrade does imply increasing risk for all US dollar-denominated financial assets. Implicit in S&P’s downgrade is the growing likelihood that the Fed will have to manufacture sufficient base money with which systemic debt can be repaid. (Currently the ratio of dollar-denominated claims to base money is 26:1.)

Thus, the downgrade is effectively a currency downgrade, which seems very reasonable, overdue and, in real terms, insufficient. We would argue that in real terms, US Treasury obligations are non investment-grade. We think Treasury obligations today and always will be money-good, but principal and interest will be repaid with bad money.

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Hugh G Rection's picture

Somebody forget to payoff the S&P?

zorba THE GREEK's picture

Monetizing the debt is still default.

MoneyWise's picture

DOW will finish Green or flat tomorrow on ECB bond buying program aka EZ QE1, read statement Though some freaks will be jumping out, creating buying opportunityin the Morning

Read ECB statement: http://www.reuters.com/article/2011/08/07/us-ecb-italy-idUSTRE7762RD2011...

Snidley Whipsnae's picture

Wow, you're a fountain of information... 

The only way Dow finishes green tomorrow is to bring in lots of extra help for the plunge protection team...

Nice try troll

Newsboy's picture

I'll take what they are givin', cause I'm workin' for a livin'.

But, I'll accumulate gold and silver as possible, because the debasement of currency is an unstoppable death spiral.

darkstar7646's picture

I've said it before and I will say it again:

Especially in a currency debasement, you have to watch out for a confiscation event, rendering your PM purchases worthless.

That is basically the only reason I'm not a goldbug, on this or any other discussion.

Newsboy's picture

"That is basically the only reason I'm not a goldbug, on this or any other discussion."

I read you and copy that. I share that concern. The silver can be used, I think.

The gold might have to be held quietly for an important moment in one's life.


Cheesy Bastard's picture

"The gold might have to be held quietly for an important moment in one's life.""

Such as bribing a border guard?

nmewn's picture

Or a mayor in a small town far far away ;-)

darkstar7646's picture

Like in another country? (Which see the border guard comment...)

gwar5's picture


But they're already confiscating your money in the banks through deficit spending and debasement, have been for decades. I think last year they took 13% from everybody holding USD.  Now, the USA is in soft default by paying back loans in even more inflated money.

As long as the Chinese and Saudis think gold and PMs are money, there will always be a market for it. Make them come and get it. Why feed the bear and make it easy for these criminals by leaving it in the bank?

"Keep it secret, keep it safe" -- Gandalf


StormShadow's picture

Let 'em come try to take it.  That's what the other precious metals are for (Steel, Brass, Copper, Lead--for diversification purposes ;)

vast-dom's picture

Absolutely insufficient downgrade. In utter agreement. 


Hey Ty there's something funny going on with the ZH IP bias ;) Careful now or u may end up in the ring and liking a little taste of ur own blood ;p

darkstar7646's picture

The fact is that the game is over.

The only real question, at the end of the day, is whether the actual end (when the benefits stop, in all realistic discussion, is the end of the game -- the riots follow and most I've read said that's when the cities go feral) comes in weeks, months, or maybe a year or two.

But this is absolutely correct:  It's a currency downgrade, and wholly insufficient to cover the present situation.  Western Finance has failed -- and. as one I've read on the subject today said, we had a three-year grace period.

It all blew up when Fannie and Freddie got nationalized.

oogs66's picture

it all blew up when the fed wouldn't let bear fail

darkstar7646's picture

I disagree for one reason. If Bear failed, it would've forced the hand on Fannie/Freddie several months sooner.

The facts are that the whole system has to have a "ground" -- and that "ground" was a $1Q notational derivatives system which went thermonuke the moment Fannie/Freddie got nationalized. At that point, the "house-as-ATM" and liar loans which were really the only basis of real consumption in this country _ended_.

DormRoom's picture

If Aliens came to Earth, and you told them the world's reserve currency was AA+, while other currencies were rated AAA, they'd leave our solar system, and think we're all mad.

nmewn's picture

Munch munch munch.

"We think Treasury obligations today and always will be money-good, but principal and interest will be repaid with bad money."

So, I'm not insane. Thats reassuring.

StormShadow's picture

Greenspan said it himself.  I rest my case.

infolode's picture

...put it in your pantry with your cupcakes.

maxmad's picture

Dow finishes -600 tomorrow... TPTB pulled the plug

AUD's picture

That's a corruption of the term 'money good'.

Quixotic_Not's picture

5 minutes ago on CNBC:

Jim Rogers:  Why did the S&P wait so long to downgrade the US, and why only to AA since the US is the largest debtor nation in the history of mankind and will never be able to repay its debt?

S&P David Beers:  Surprised look, followed by blank face (pretends he can't hear Jim)

CNBC host checks the link and asked Jim to try again...

Jim Rogers restates the question, another shocked look followed by silence!

OMG...too fuckin' hilarious!!!

<img src="http://thetruthisnow.com/wp-content/uploads/2011/05/EVIL1.jpg">

slaughterer's picture

Jim Rogers exaggerates for effect, and those who follow his investment moves lose.  

Doña K's picture

Sorry, I bought a Porsche from Jim's tips 

Quixotic_Not's picture

I took the proceeds from my house sold in 2001 and my biz profits and bought Ag  :-)

Don't think you could do much better than that over the last 10 years...

P.S.  Who is that asian cocksucker dood on CNBC right now?

Talk about a koolaid swillin' liar-for hire!  LOL

gwar5's picture


But please tell me you got that sweet gold-plated Bang Dai HoMobile Porsche pictured on ZH last week and you wear a Zero Hedge T-shirt with the top down.

Spastica Rex's picture

Have you noticed that you're kind of playing by yourself?

JohnG's picture

WTF!?!?!  Are you serious or just trolling?

He called commodities over two years ago.  I've made a killing.

You might try some research on JR.

TwelfthVulture's picture

Rogers has been bullish on commodities much longer than 2 years. Few can boast of his trading record.

Sambo's picture

You dont think Beers would want to end up as a corpse, do you?

automato's picture

Thank GOD, these guys get it! The only question is where do we go from here? Precious metals? A basket of commodities? Most things can't be trusted anymore because of all the accounting tricks and obscene leverage! Look at China, most equities, and sadly commercial and residential real estate.

slewie the pi-rat's picture

if the FED keeps printing new currency and increasing the amount of "money" yes, we will debase the currency of the IOUs below investment grade, already have, to S&P.

which is why the FED should stop printing money and expanding its balance sheet, now. 

however, if deflation goes too fast, benzelbub might hit those afterburners, again. 

gold = $1685 and not too shabby, world-wide against all other paper, too!  trade any fiat you want, anywhere on the planet tomorrow, as always, for PMs, or the banksters will also gladly buy your PMs for green stamps or red or whatever.  really.  play your own hand with PMs. 

so, currencies aren't doing well, eh?

Henry Chinaski's picture

Exactly.  As long as the FED keeps buying treasuries, downgrade is no biggie.  'Cept for the inflation thingy.  The world turns...

Mr Lennon Hendrix's picture

Gold/silver/dollar are tracing their last move 1:1:1.

A fascinating move is under way.  Where it leads is likely a hyperinflationary event, but not before Bernanke throws gold under the bus so he can afford QE 3.  Don't worry, any loans Bernanke makes only make gold worth more in the long run, but the initial impact will be a rise in supply (albeit in paper only), and a quell of demand, similar to the SPR release.

darkstar7646's picture

If, but ONLY if, you can't get it repossessed in a hurry at the business end of a gun.

Irelevant's picture

At $60 mil per ton the chinese will empty Fort Knox faster than the DHL crue on Heatrow.

MoneyWise's picture

Well they can repay and will repay in Zimbabwe dollars :)))

Re-Discovery's picture

Silver trading exactly like a currency tonight . . . moving in direct relationship with gold . . . so far.

Itsalie's picture

If it is a "currency downgrade", why is oil CAD AUD NZD all tanking? Give the investment committees a week to convene, then you assess the damage to treasuries, practically every member of every european fund is on the beach or under the sun. The economic and financial impact cannot be judged by stoopid algos and computers working night shift, time for ZHers to make the distinction.

darkstar7646's picture

Because they were bubbled too, on the demand of a lot of the players in the game.  The whole mess may be beginning to come down.

I expect something desperate to come down the pipe in very short order.

StormShadow's picture

Netanyahu, Israel, Iran...anyone?

darkstar7646's picture

But can you pull that off without further squeezing the poor and middle classes here into riot?

Long-John-Silver's picture

This will be posted at all financial institutions soon.

US Dollars are not redeemable for other Currencies, Gold, or Silver.

darkstar7646's picture

Which ends all American financial institutions, the instant that happens.  One of the reasons that many inflationistas believe the final nail in the coffin will come when OPEC effectively reprices oil in one of:  RMB, Euros, or Gold.

Long-John-Silver's picture

Gold became the worlds reserve currency Friday evening. Few will understand or accept it for a while but they will point to 5-AUG-2011 as the day the US Dollar lost it's reserve status.

politicskills's picture

Oh Stop Iiiiiiiitttttttttt!  You're hurting our self-esteem!!!! Boo Whoooooooooooooooo.


"What I think the S&P thing did was to hit a nerve that there's something basically bad going on, and it's hit the self-esteem of the United States, the psyche" said Greenspan

Andrea needs to drive him to the hospital for evaluation. 

darkstar7646's picture

Reiterating: At that point, every US financial institution falls.