Choose your poison

So here's a bit of math that doesn't look too good.

The US Treasury would like to borrow $138 billion next week. That is, they want to print some IOU's and take people's money and promise to return it with interest.

Recently, the Federal Reserve has been providing almost half of these loans to the US government, using brand new money, invented out of thin air. It's not that the Fed really wants the IOU's, it's that nobody else wants them.

This arrangement with the Fed is known as "quantitative easing" or QE. (A leading Scottish money manager recently said: "Quantitative easing is a phrase which bears the same relationship to ‘printing money’ as ‘terminological inexactitude’ does to ‘lie’.")

Trouble is, QE was not an infinite program. The Fed says it's being wrapped up now and is coming to an end. Only $7 billion more can be spent buying Treasuries this way. And -- not to belabor the obvious -- but $7 billion is a far cry from half of $138 billion.

So what if we can't sell our IOU's for some fast cash? What happens if people look over the Treasuries and say "No thanks," and there's no Fed to ride in and save us?

Well, they wouldn't exactly say "No," they'd say "You look like a shady character, so I'll give you the money, but only if you pay me a heck of a lot of interest to make it worth the risk." So instead of borrowing money at some measly amount like 2%, we get the loan all right, but we have to pay 4%. Or 6%. Or 10%. Who knows, once confidence is lost?

This is Poison #1: Rising Interest Rates. The housing market was just starting to pop its head out of the bunker to see if the smoke had cleared, and here come high interest rates to discourage home sales, make refinancing even less feasible, and crush adjustable-rate mortgage holders. Not good. And the federal budget deficit would balloon even more quickly than it has been.

Alternatively, we could simply revert back to QE again and let the Fed step in and buy debts within a new, emergency round of money-printing. This is Poison #2, and it would be very risky. Words like "Armageddon" are being used (video) to describe what happens if we piss off China and Japan enough that they start refusing to buy our bonds. And they would certainly be pissed. Nobody wants to be paid back in Weimar-like currency, which is to say, kindling. Run the printing press enough, and you're on the path to currency collapse.

Poison #3 has political and economic ramifications, but is the least unpredictable and least chaotic of the options. And it would cause a dollar rally, smash the gold price temporarily, and please our foreign creditors. It's the simplest thing, really-- you just push the stock market off a cliff. Have Goldman hurry it along so it can be out of the way by Oct 7 or 8 when we have to sell some longer-duration IOU's that nobody would otherwise buy. Make stocks plummet (which was inevitable anyway, just a matter of timing), and investors and fund managers panic and race into Treasuries as a "safe haven." Problem solved, for the time being.

Of course, political approval ratings and consumer confidence are heavily dependent on stock markets. Pension funds, 401k's, university endowment funds, and some municipal funds will all suffer. It's not good political policy to enrage the middle class, as it's the middle classes who engender revolutions. But the first two options risk chaos on the international scene. Nobody likes the dollar, but as it is the world's reserve currency and foreigners are in possession of around 2/3 of all dollars in existence, everyone would prefer that it die an orderly death.

So that's how I see the dangers in the next 10 days. (There may be a less awful scenario that I haven't thought of, like working out a back-room deal with EU nations, but I can't envision how that would work.) We could see rising interest rates, or money-printing and a plunging dollar, or a crash in stocks bad enough to cause panic. If you've been reading the blog, you know how I feel about stocks.

[Addendum: Immediately after posting I went to Zero Hedge and saw that Goldman just revised its estimate of job losses from 200,000 jobs gone to 250,000 jobs gone. A bad jobs number, coming on top of today's bad day in stocks and other bad econ data this week, could set off the downturn in equities.]