The below piece is a good analysis of a hypothetical Treasury/Dollar black swan event, courtesy of Eugenio Aleman from, surprisngly, Wells Fargo. Eugenio does the classic Taleb thought experiment: what happens if the unthinkable become not just thinkable, but reality. Agree or disagree, now that we have gotten to a point where 6 sigma events are a daily ocurrence, it might be prudent to consider all the alternatives.

   Thinking the Unthinkable

    Several years ago, economists were saying that a new Great Depression was unthinkable, or even impossible, because we had learned from the 1930s. Today, we are teetering on the edge of a worldwide recession that could very well become a depression, at least according to those self-proclaimed "Doctors of Doom." On this note, I would like to discuss another "taboo" subject related to the U.S. dollar and closely linked to monetary and fiscal policy. And while this topic is a highly unlikely event, one of those events that Nassim Taleb would call a black swan, it suffices to remember how unlikely a collapse in home prices was several years ago. Remember?

    In previous reports, I have touched upon the concerns I have regarding the overstretching of the federal government as well as of monetary policy while the Federal Reserve tries to maintain its independence and its ability, or willingness, to dry the U.S. economy of the current excess liquidity. Furthermore, we heard this week the Fed Chairman's congressional testimony on the perils of excessive fiscal deficits and the effects these deficits are having on interest rates at a time when the Federal Reserve is intervening in the economy to try to keep interest rates low.

    Now, what I call "thinking the unthinkable" is what if, because of all these issues, individuals across the world start dumping U.S. dollar notes, i.e., U.S. dollar bills? We have heard that "rogue" states, like Iran, Venezuela, Nicaragua, Bolivia, as well as not-so-rogue states like China, Brazil, Argentina, Russia, etc., have been discussing a way to go from a dollar pattern for multilateral trade to another country's or a combination of countries' currencies in order to achieve independence from U.S. monetary policy decisions. While these attempts, or at least the noise they produce in the media, have increased during the last year or so, my biggest concern is not with what these countries may do, but what individuals across the world may do if they believe the U.S. dollar is in trouble. Why? Because one of the advantages the U.S. Federal Reserve has over almost all of the rest of the world's central banks is that there seems to be an almost infinite demand for U.S. dollars in the world, which has made the Federal Reserve's job a lot easier than that of other central banks, even those from developed countries. Furthermore, approximately three-fourths of U.S. dollar bills are in foreign hands or foreign safe deposit boxes or mattresses, and an about-face by individuals across the world regarding these holdings of U.S. currency could be a huge blow to the value of the U.S. dollar, U.S. debt and the Federal Reserve's monetary policy. Why? Because all those holdings of U.S. dollar bills are basically a free loan from foreigners to the U.S. government, and if there is a massive run against the U.S. dollar across the world then the Federal Reserve will have to sell U.S. Treasuries to exchange for those U.S. dollars being returned to the country, which means that the U.S. Federal debt and interest payments on that debt will increase further. This means that we will go from paying nothing on our "currency" loans to having to pay interest on those U.S. Treasuries that will be used to sterilize the massive influx of U.S. dollar bills into the U.S. economy, putting further pressure on interest rates.