The Fedspan Rule

Former Federal Reserve Chairmen Alan Greenspan, the man credited with creating the housing bubble by maintaining a near zero discount rate after the .com bubble burst, is also the author of a widely respected rule in public finance. Greenspan and Argentinian Pablo Guidotti published a formula in a 1999 academic paper which states that governments should maintain hard currency reserves equal to at least 100% of short term foreign debt maturing within a year to avoid the possibility of default. PIMCO, the respected fund manager, thinks the Greenspan-Guidotti rule is "perhaps the single concept of reserve adequacy that has the most adherents and empirical support". Judged by that rule, the United States is in for some tough times ahead. Within the next twelve months the Treasury will have to refinance $2 trillion in short term debt, 44% of which is held by foreigners or $800 billion. Uncle Sam's pockets are deep, but not that deep. The US holds oil ($58bn), gold ($300bn) and foreign currency ($136bn) in reserve worth around $500 billion. When added to financing requirements for the current deficit spending, the total bill is $3.5 trillion or 30% of GDP in one year! Foreigners are no longer beating a path to buy US securities given what the Greenspan-Guidotti rule says about vulnerability to default. Uncle Sam will have to turn his digital presses even faster to finance the growing mountain of debt. The Federal Reserve has already "monetized" nearly $2 trillion of Treasury and mortgage debt and will have to buy more. These actions weaken the dollar further, causing foreign investors and countries to buy assets like gold and oil. Russia and India are both buying gold. China has told its huge population to buy gold. Brazil, Korea and Chile are the three largest central banks that own the least amount of gold, less than 1% of their total reserves. According to investment advisor Porter Standsberry, they may be among the next countries to abandon the dollar.