Tags: World | bankers | US | Default

World Braces for Unthinkable Disaster: US Default

Friday, 29 Jul 2011 07:33 AM

By Michael Kling

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Central bankers around the world must now prepare to face a once unthinkable concept: the default of the U.S. government.

Central banks around the world must prepare to cut interest rates and engage in quantitative easing in an attempt to avoid a global recession if the government defaults, Carl Weinberg, the chief economist at High Frequency Economics, wrote in a research note Friday.

Central banks, Weinberg stated according to CNBC, could also change regulations so that banks don’t have to immediately write down the value of Treasurys they own. Banks, he noted, would take "a big and immediate" hit to their balance sheets.

The once-unthinkable default of the U.S. government, which could happen as soon as next week, and loss of its AAA rating will have disastrous consequences. The world's banking system would fail, and world trade and exports would collapse, he said.

The Treasury Department is working on contingency plans to pay bond holders, but those efforts will become increasingly difficult if the crisis isn’t resolved, Weinberg wrote.

The government pays interest to bond holders on the 15th and last day of each month. That means the world's financial system would face the equivalent of a Lehman's failure twice a month until the crisis is resolved.

The government could print more money or sell assets, Jack M. Balkin, a law professor at Yale Law School, suggested in an opinion piece for CNN.

The law limits how much money the Treasury Department can print, but it can issue coins in any denomination. So how about depositing a couple trillion dollar coins? The government could also sell the Federal Reserve an option to purchase government property, and the Fed could credit the proceeds to the government's checking account.

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