The debt piled up at the rate of nine billion a day, or fifteen thousand a second. The official national debt was over six trillion dollars. The unofficial debt, which included “out year” unfunded obligations such as entitlements, long-term bonds, and military pensions, topped fifty-three trillion dollars.
Even the official national debt had ballooned to 120 percent of the gross domestic product and was compounding at the rate of 18 percent per year.
The Federal government was borrowing 193 percent of revenue for the year.
The president was nearing the end of his term in office. The stagnant economy, rising interest rates, and creeping inflation troubled the president.
Publicly, he beamed about having “beat the deficit.” Privately, he admitted that the low deficit figures came from moving increasingly large portions of Federal funding “off budget.” Behind the accounting smoke and mirrors game, the real deficit was growing. Government spending at all levels equated to 45 percent of the Gross Domestic Product. In July, the recently appointed chairman of the Federal Reserve Board had a private meeting with the president. The chairman pointed out the fact that even if Congress could balance the budget, the national debt would still grow inexorably, due to compounding interest.
The president didn’t let trifles like ledger sheets and statistics get in his way.
The economy was on a roll. The stock market was at an all-time high. It was business as usual for his administration. Instead of reducing the growth in government spending, he launched an immoderate bank lending stimulus package, corporate bailouts, mortgage-backed securities bailouts, and another extravagant round of his pet “infrastructure building” programs in inner city areas as well as in Iraq and Afghanistan.
In Europe, international bankers began to vocally express their doubts that the U.S. government could continue to make its interest payments on the burgeoning debt. In mid-August, the chairman of the Deutsche Bundesbank made some “off the record” comments to a reporter from The Economist magazine. Within hours, his words flashed around the world via the Internet: “A full-scale default on U.S. Treasuries appears imminent.” He had spoken the dreaded “D” word. His choice of the word imminent in conjunction with the word default caused the value of the dollar to plummet on the international currency exchanges the next day. T-bill sales crashed simultaneously. Starting with the Japanese, foreign central banks and international monetary authorities began to dump their trillions of dollars in U.S. Treasuries. None of them wanted the now risky T-Bills or U.S. bonds. Within days, long-term U.S. Treasury paper was selling at twenty cents on the dollar.
In short order, foreign investors at all levels began liquidating their U.S. paper assets—stocks, bonds, T-bills—virtually anything denominated in U.S. dollars. After some halfhearted attempts at propping up the dollar, most of the European Union nations and Japan announced that they would no longer employ the U.S. dollar as a reserve currency.
To help finance the ever-growing debt, the Federal Reserve decided to make a tactical move. It began monetizing larger and larger portions of the debt. The Fed already owned $682 billion in Treasury debt, which was considered an “asset” for the purposes of expanding the money supply. In just a few days, Federal Reserve holdings in Treasury debt more than doubled. The printing presses were running around the clock printing currency. The official domestic inflation rate jumped to 16 percent in the third week of August. To the dismay of the Fed, the economy refused to bounce back. The balance of trade figures grew steadily worse. Leading economic indicators declined to a standstill.
In reaction to the crisis, the lawmakers in Washington, D.C. belatedly wanted to slash Federal spending, but were frustrated that they couldn’t touch most of it.
The majority of the budget consisted of interest payments and various entitlement programs. Previous legislation had locked in these payments. Many of these spending programs even had automatic inflation escalators. So the Federal budget continued to expand, primarily because of the interest burden on the Federal debt. The interest payments grew tremendously as interest rates started to soar. It took 85 percent interest rates to lure investors to six-month T-bills.
The Treasury Department stopped auctioning longer-term paper entirely in late August. With inflation roaring, nobody wanted to lend Uncle Sam money for the long term. Jittery American investors increasingly distrusted the government, the stock market, and even the dollar itself. In September, new factory orders and new housing starts dropped off to levels that could not be properly measured. Corporations, large and small, started massive layoffs. The unemployment rate jumped from 12 percent to 20 percent in less than a month.
The catalyst for the real panic, however, was the stock market crash that started in early October. The bull stock market had gone on years longer than expected, defying the traditional business cycle. Nearly everyone thought that they were riding an unstoppable bull. From fifteen to twenty billion in new mutual fund money had been pouring into the stock market every month.
The mutuals had become so popular that there were more mutual funds listed than individual stocks. By 2009, there were 240,000 stockbrokers in the country. It was the 1920s, in déjà vu. Just before the Crunch, the Dow Jones Industrial Average was selling at a phenomenal sixty-five times dividends—right back where it had been just before the 2000 dot-com bubble explosion. The market climbed to unrealistic heights, driven by unmitigated greed.
Soon after the dollar’s collapse, however, the stock market was driven by fear. Unlike the previous crashes, this time the U.S. markets slumped gradually.
This was due to circuit breaker regulations on program trading, implemented after the 1987 Wall Street slump. Instead of dropping precipitously in the course of one day as it had in ’87, this time it took nineteen days to drop 7,550 points. This made the dot-com “bubble burst” in 2000 look insignificant. Nobody could believe it. None of the “market experts” thought that the market could go down that far, but it did. Only a few contrarian analysts predicted it.
Finally, the government suspended all trading, since there was almost no one buying any of the issues that came up for sale.
Because all of the world’s equities markets were tied inextricably together, they crashed simultaneously. The London and Tokyo markets were hit worse than the U.S. stock exchanges. The London market closed five days after the slump started. The Tokyo market, which was even more volatile, closed after only three days of record declines. Late in the second week of the stock market collapse, the domestic runs on U.S. banks began. The quiet international run on U.S. banks and the dollar had begun a month earlier. It took the GDP—the “generally dumb public”—in America that long to realize that the party was over.
The only investors that made profits in the Crunch were those that had invested in precious metals. Gold soared to $5,100 an ounce, with the other precious metals rising correspondingly. Even for these investors, their gains were only illusory paper profits. Anyone who was foolish enough to cash out of gold and into dollars after the run up in prices would have soon lost everything. This was because the domestic value of the dollar collapsed completely just a few weeks later.