The television news anchors had recently started calling the intensifying economic crisis “the Crunch.” The term soon stuck with the general public, becoming part of the general lexicon. Government spending was out of control. The credit market was in continuous turmoil. Meanwhile, bank runs and huge federal bailouts had become commonplace.
The debt and budget deficit had spiraled to stratospheric numbers. A Congressional Budget Office report stated that to pay just the interest on the national debt for the year, it would take 100 percent of the year’s individual income tax revenue, 100 percent of corporate and excise taxes, and 41 percent of Social Security payroll taxes. As the Crunch began, interest on the national debt was consuming 96 percent of government revenue.
The official national debt was over $6 trillion. The unofficial debt-which included “out-year” unfunded obligations such as entitlements, long-term bonds, and military pensions-topped $53 trillion. The debt accumulated at the rate of $9 billion a day, or $15,000 per second. 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 him. 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.
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.” His choice of the word “imminent” in the same sentence 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.
Foreign investors began liquidating their U.S. paper assets: stocks, bonds, T-bills-virtually anything denominated in U.S. dollars. After some weak attempts to prop 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.
The Federal Reserve 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 presses were running around the clock printing currency. Soon after, the 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.
Legislators 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. Even worse, by law, many of these spending programs 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 rates started to soar.
It soon 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, began massive layoffs. The unemployment rate jumped from 12 percent to 20 percent in less than a month.
Then came the stock market crash 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 wave. 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 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 in 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 and the 2008 stock market meltdown both look insignificant.
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 citizenry in America that long to realize that the party was over.
The only investors who made profits in the Crunch were those who 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.
The dollar collapsed because of the long-standing promises of the FDIC. “All deposits insured to $100,000,” they had pledged. When the domestic bank runs began, the government had to make good on its word. The only way that it could do this was to print money-lots and lots of it. Since 1964, the currency had no backing with precious metals. Rumors suggested, and then news stories confirmed, that the government mints were converting some of their intaglio printing presses. Presses that had originally been designed to print one-dollar bills were converted to print fifty-and one-hundred-dollar bills. This made the public suspicious.
With overseas dollars being redeemed in large numbers and with the printing presses running day and night turning out fiat currency, hyperinflation was inevitable. Inflation jumped from 16 percent to 35 percent in three days. From there on, it climbed in spurts during the next few days: 62 percent, 110 percent, 315 percent, and then to an incredible 2,100 percent. The currency collapse was reminiscent of what had happened in Zimbabwe.
The value of the dollar began to be pegged hourly. It was the main topic of conversation. As the dollar withered in the blistering heat of hyperinflation, people rushed out to put their money into cars, furniture, appliances, tools, rare coins-anything tangible. This superheated the economy, creating a situation not unlike that in Germany’s Weimar Republic in the 1920s. More and more paper was chasing less and less product.