Bernanke says foreign demand for US securities remains strong but that demand could be hurt if the US does not tackle its debt problem long-term.
That is the market’s greatest fear, though so far it has been unrealized: at some point the kindness of strangers may come to an end and the US would be left to fend for itself. If that eventually every comes, the end-game is hyper-inflation as the Fed would have no alternative but to monetize the debt by printing money to buy bonds, thus dooming the dollar.
That cycle has happened time and again in emerging markets and the US is desperate to avoid that same fate, though it has the ultimate built-in advantage. It remains the world’s unchallenged reserve currency, for now. Inter-European problems have made the euro an even less attractive reserve currency than it was ahead of the crisis.
While the US’s debt load remain a huge economic challenge, if the level of massive government spending is limited to a year or two and the economy resumes growth, the challenge is manageable. If it drags on beyond 2010, the year Bernanke referred to as a recovery year in his testimony today, then Houston, we’d have a problem.
