Critical Mass Default (Full)

Critical Mass-Definition #1. An amount of material (such as plutonium) that is large enough to allow a nuclear reaction to occur.

Definition #2: The size, number, or amount of something that is needed to cause a particular result.




The mainstream financial press has once again failed to properly inform and educate the public. This time by not properly labeling one of the most important phenomenon in the modern economic environment. The event occurs when there is a default in an over indebted economy that results in a chain reaction of defaults. Once the chain reaction has started is difficult or impossible to stop. I am coining the term critical mass default to describe such an episode.

The media has used the term 'Lehman Event' when discussing the concept.Lehman event is far from descriptive and thus falls short for what will be so vitally important in the years to come. The term systemic is also used, and while this more accurately describes a self perpetuating default it is usually used to describe general risk rather than a single event.

The susceptibility of debt default to create a chain reaction is easy to describe on a micro level.An individual, we'll call him Bob, decides to buy bonds in a fly by night shale oil company, and the shale oil company is forced to default because oil prices drop (I know unbelievable).Without the income from the shale company bonds, Bob can no longer afford his mortgage.John, a retiree who owns the mortgage through mortgage back securities, can no longer afford the student loan payments he co-signed for his granddaughter and so on and so forth.On the other hand if Bob can still make his mortgage payments despite the initial default, the chain reaction is stopped and it can be said that the initial default did not reach 'critical mass'.

Though more complex, the same chain reaction risk exists on a macro level.Lehman was over invested in subprime mortgage backed securities in 2008. Mass mortgages defaults lead to Lehman Brothers not meeting its obligations to other banks, on to insurers like AIG and major corporations like GM.If allowed to continue even governments that can print money are not safe. Why?Well if companies can't make payroll, income taxes drop.If asset values drop, not only can the Federal Government not tax capital gains but individuals can deduct the losses.Deficits in a nation like the Unites States could easily spike to two or three trillion, and borrowing in this kind of environment likely would not be an option. Of course with a few law changes they could print the money, but depending on money velocity, printing 2+ trillion a year in an economy that only has 6-8 trillion within its borders could easily cause a currency crisis.

We have become all too familiar with the phrase 'too big to fail'.This is meant to describe banking institutions that are large enough to cause a critical mass default event.When the term too big to fail bank is mentioned the solution is often to break them up so that they are not large enough to reach critical mass.This misses the point; even if the banks are broken up there are still many places in which a critical mass default event could occur.

A critical mass default could occur in a corporate bond sector such as oil and gas.The critical mass certainly doesn't need to be reached within a single entity. As we all know the critical mass event in 2008 did not originate with Lehman, it was a culmination of defaults in subprime mortgages, and there is similar risk currently in both the student and auto loan sectors.

The elephant in the room that has the most obvious potential for a critical mass default currently resides not with private institutions, or individuals, but with entire nations.The private debt that caused the last crisis did not disappear; if it had the chain reaction would have continued.Instead it was passed along with its risks to government balance sheets.

Greece is the first nation that comes to mind as a potential candidate for such an event, and is likely why the powers that be have not allowed a default despite it being the most logical course of action.If there is fear of a Greek default becoming systemic , Spain and Italy failing to pay creditors would all but assure a critical mass default.

A combination of smaller local governments failing to make good on debt payments could also pose such a risk; a combination of Puerto Rico and Chicago perhaps.States like California could cause a chain reaction of defaults on their own.

Debt based monetary systems become more susceptible to critical mass default events as the debt increases, more specifically when the total debt to total income ratio increases. The total world debt to world GDP, the ability to service that debt, has increased since the last crisis.As this trend continues, which is required in a debt based monetary system, the likelihood of a critical mass default increases, and over time is inevitable.

Keynesian economists were successful in changing the term inflation to mean price increases instead of increases in the money supply.The replaced the more descriptive term panic that would result from credit expansion, booms, and busts, with recession and depression.They change definitions, and use perplexing terms and phrases to confuse the public.When the default sets off a chain reaction that reverberates throughout the economy bringing it to its knees the phrase used to describe it needs to be crystal clear.Critical mass default fits the bill perfectly.

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