The risk you talk about does not seem to exist in the real markets. If the US were viewed as unstable like you suggest, it would be priced into US bonds, which are trading near all time highs. If there is a risk in there, it's nearly negligible.
Internet stocks were trading at all-time highs in 1999. Housing was doing great in 2006. Any asset being at all-time highs doesn't mean there are negligible risks only that the majority of the market currently thinks there is (they might be right and they might be wrong).
Perhaps, but isn't it also true that the US government itself now constitutes a very large part of the bond market? Rarely do I ever hear the term bond vigilantes any more, maybe because there no longer is such a thing, except perhaps under extreme circumstances.
I'm not 100% sure how to answer the first question. Yes, in a way, but those aren't tradable instruments any more - they're part of the Fed balance sheet. And technically, the Fed isn't government.
Yeah, I know....
This is the point - no more bond vigilantes as in days of yore. Bonds are smooth sailing on calm seas. This signals that everybody's on board with the low rates.
So this signals a lack of concern without deficits/debt.
If you look at what the bond markets did in the period preceding World War I, you see that they did not predict it. Thinking that markets value risk correctly leads to disaster.
You would see a collapse in the prices. People with USD would stop buying them as well and would start buying gold/silver/other currencies. You are confusing currency with bonds.
What I think would be more likely is a collapse in demand for US bonds, which would cause a collapse in USD because less people have to transfer their local currency to USD to buy US bonds, therefore decreasing demand of USD, thus lowering it's price.
US government bonds would need higher interest rates to convince people to hold their wealth in dollars. Higher interest rates means the price of bonds would go down.
US bonds are priced in percent growth, just like all bonds. If the markets expect that the US is going print money to pay off bonds then the interest rates on US bonds would go up, since the future exchange rate is expected to go down.
At least US bonds being priced in USD does reflect the risk and demand associated with them.
What I wonder is, how is inflation being calculated in terms of the CPI, which is essentially prices in dollars? After all, what exactly is being measured by this? If dollars the very currency which is being printed, how does measuring prices account for how much M0 money there is?
