American Strategic Default

Some things are a long time coming. You see them approaching slowly. Sometimes you are ready,sometimes you are not. Sometimes you want to believe, sometimes you don't. Regardless of your individual ideas and interpretations...they happen anyway.

Yesterday's S&P downgrade of the U.S. debt outlook is precisely such an event. It shouldn't have surprised anyone. In fact, it is pretty easy to argue that this news is simply an official admittance of our daily reality of the past three years. The dollar is weakening, multiple states are functionally bankrupt, a tank of gas is becoming a luxury purchase and our national debt is swallowing up everything in sight, with no suppression of its ravenous appetite anywhere on the horizon.

Whenever things start getting fishy it is wise to look around and think about who stands to benefit from the chaos. But when the whole room, house and neighborhood reek of foulness you can no longer simply ignore daily occurrences. You have to face facts or at least...consider some alternative possibilities.

I see a positive side to all of this. Yes... you did just read that. Growing up around Jurassic Wall Street, strategic default was that little red button they all joked about pressing. Back in those days it was a perverted in house joke, today it may become reality for us all.

Strategic Default: The U.S.A's Ace in the Hole



There is an old saying in the industry which most of us have heard or used in some way, shape or form:

When you owe the bank $100,000...the bank owns you. When you owe the bank $100,000,000... you own the bank.

Nowhere can I see this principle better applied than in the silent chess game playing out in global finance over the past couple of years. The world's biggest borrower has turned the tables on everyone, by becoming the biggest debtor on the planet.

That's right boys and girls... America is strategically defaulting on its debt. I am starting to believe that has been the plan all along. It is certainly the only logic I can accept at this point. In spite of my own fondness for throwing rocks at the throne, the people in power didn't get there by being dumb. Like so many of our own welfare mommas, eternal un-employees, illegal insurance usurpers, union commies, corporate fascists, etc...our government is playing the World Bank, the IMF, the Paris Club, China, OPEC and anyone else dumb enough to have loaned us a dime in the first place...in the same exact way.

We are simply playing dumb while grinning in private glee. Borrowing money we do not intend to pay back and exporting inflation that we cannot hope to curtail at home.

Think about it honestly, without econ and corp fin class rhetoric clouding your judgment. We are too deep in the hole to pay our way out. Cutting off entitlements is not compatible with politician needs to bask in the comfort of incumbency. The leaders of Unions and Corporations alike, are not leaving their dens of wealth and power without a fight.

The new battle becomes America vs. Her Creditors. Except this time, in the stead of our attempts to export capitalism, democracy and our values...it will be "the world" trying to get the U.S. to honor our debts.

What will they do when they arrive at our doors in New York, D.C, Chicago, L.A and find the lights on... but the doorbell ignored?

I am changing my tune. I am becoming a Keynesian. I am breaking out my credit card. I am going shopping. I am going to borrow. I like debt.

Please sirs, may I have some more?

Comments (41)

Apr 19, 2011

Well if the US defaults and refuses to pay people back, what are they going to do? They're not going to go to war with us. Sure, our purchasing power would collapse for a couple years, but after that they'll basically be forced to lend to us again, because we're such a huge export market.

Still, wouldn't it be a lot better to grow the proper way rather than risk potential chaos?

Apr 19, 2011

One thing that never seems to crop us in these debates is the simple fact that a hell of a lot of U.S. debt is held by entities within the U.S., particularly U.S. banks.

So if the U.S. defaults, you can be sure that the vast majority of America's 8000 or so banks will fail. Then what happens... it's not like you can bail them out all of a sudden because no one's going to lend to someone who's just defaulted. So I suppose you then have the option of printing money like never before and hyperinflation, or allowing joe public et al. to lose their life savings.

I don't intend for the above to be a proper serious argument, but my point is that if I were considering strategic default, problems associated with foreign countries being pissed off would be far far down my list of concerns...

Apr 19, 2011

Midas, this is what I've been trying to say all along.

Everyone has talked about economic self-sufficiency but nobody is talking about environmental carrying capacity. Aside from Australia, Canada, and New Zealand, the US is one of the few countries that lives under its long-term carrying capacity- and can turn a huge profit exporting a fraction of its surplus to the rest of the world.

We have 1/3 of the world's arable land- all owned by a bunch of largely middle-class (soon to be filthy rich) midwestern farmers due to corporate/nonresident farm ownership restrictions. The anti-American expatriation fans- for all of their so-called brilliance- are such idiots. They will be- and deserve to be locked out of the country when the food crisis hits.

This is the time to start picking up stock in boring rural midwestern retailers. Like Kohls, JCPenney, and Sears/K-Mart.

Apr 19, 2011
IlliniProgrammer:

Midas, this is what I've been trying to say all along.

I know, but you ignore some crucial factors...

Everyone has talked about economic self-sufficiency but nobody is talking about environmental carrying capacity. Aside from Australia, Canada, and New Zealand, the US is one of the few countries that lives under its long-term carrying capacity- and can turn a huge profit exporting a fraction of its surplus to the rest of the world.

This part I agree with, however....

We have 1/3 of the world's arable land- all owned by a bunch of largely middle-class (soon to be filthy rich) midwestern farmers due to corporate/nonresident farm ownership restrictions.

If this was who made up the majority of American decision makers or hungry, needy mouths there would be no worries. The power in America, however, is in coastal cities packed with pseudo intellectuals who don't know much about getting their hands dirty. Once the shit storm starts, those newly minted Midwestern billionaires will have a whole lot of enemies/dependents telling them what to do and how to do it. I don't see that as a positive scenario.

The anti-American expatriation fans- for all of their so-called brilliance- are such idiots. They will be- and deserve to be locked out of the country when the food crisis hits.

Pretty funny that you call ex-pats un-American. Re-read what I just wrote. Are the expats going to be the ones saying that corn and wheat should feed the whole country...it belongs to all of us. Are the people who love the ideals America was built around the guilty for leaving it? I would argue the bread liners should be locked out, but that's why people like me have no heart. We'll see the real value of human capital soon enough, I suppose.

This is the time to start picking up stock in boring rural midwestern retailers. Like Kohls, JCPenney, and Sears/K-Mart.

I don't disagree. Though I can definitely see some of these to push for going private in anticipation of such market reaction. In a funny way, Midwestern retailers might be the private security companies of the future...catch my drift?

Apr 19, 2011
Midas Mulligan Magoo:

Pretty funny that you call ex-pats un-American. Re-read what I just wrote. Are the expats going to be the ones saying that corn and wheat should feed the whole country...it belongs to all of us. Are the people who love the ideals America was built around the guilty for leaving it? I would argue the bread liners should be locked out, but that's why people like me have no heart. We'll see the real value of human capital soon enough, I suppose.

Hardly. In the interest of pragmatism, however, it is very beneficial to ensure that people near the areas where the food is grown get to eat first. Otherwise you get lots of violence. The country is going to become a little more socialist over the next 30 years and many of the American values a lot of people in the pre-Reagan era grew up on- both independence but also making sure your neighbors can eat rather than waiting for them to steal from you at gunpoint- are going to come back.

When the famine comes, the global grain market is going to quite literally shut down and food will become unavailable at any price outside the food-producing countries.

I don't disagree. Though I can definitely see some of these to push for going private in anticipation of such market reaction. In a funny way, Midwestern retailers might be the private security companies of the future...catch my drift?

Nobody has ever bet on the Midwest, and a lot of supposedly very smart people did LBOs before the mortgage meltdown. I'm not sure the elite are going to see this coming- even if they do, I doubt they'll be able to do much to prepare. Regardless, I think there's a distinct possibility you'll be able to walk into a rural Sam's Club in thirty years, plunk down $50 Billion, and buy a relatively small Lockheed. Plunk down another $150 Billion and they'll come out to your farm and build you a space-efficient but fairly safe runway.

Apr 19, 2011
IlliniProgrammer:

Midas, this is what I've been trying to say all along.

Everyone has talked about economic self-sufficiency but nobody is talking about environmental carrying capacity. Aside from Australia, Canada, and New Zealand, the US is one of the few countries that lives under its long-term carrying capacity- and can turn a huge profit exporting a fraction of its surplus to the rest of the world.

We have 1/3 of the world's arable land- all owned by a bunch of largely middle-class (soon to be filthy rich) midwestern farmers due to corporate/nonresident farm ownership restrictions. The anti-American expatriation fans- for all of their so-called brilliance- are such idiots. They will be- and deserve to be locked out of the country when the food crisis hits.

This is the time to start picking up stock in boring rural midwestern retailers. Like Kohls, JCPenney, and Sears/K-Mart.

You do realize that a lot of this "arable" land is dependent on the ogallala acquifer, which is not going to last forever? Also dependent on a wide host of fossil fuel inputs, that's why oil prices and food prices are very strongly correlated.

Still better than what will probably happen in Southeast Asia, when the glaciers in the Himalayas are gone, so will the runoff, ergo the rivers run dry, and no more rice paddies.

The fundamentals for food in the long-term look pretty horrendous. All the projections say 9 billion people (40% more than today). How in the hell is the world going to feed that many people if key water sources are projected to be under enormous strain, and fossil fuel availability will be about 1/4 of what they are now?

People have this view of the world 30 years from now as this utopia where we're all traveling around in jet packs and computers like those in minority report. The reality could be drastically different; worldwide famine, resource wars, etc. I'm not saying that's my base case, but we do have to make some drastic changes to avoid that outcome.

Apr 19, 2011
alexpasch:

You do realize that a lot of this "arable" land is dependent on the ogallala acquifer, which is not going to last forever? Also dependent on a wide host of fossil fuel inputs, that's why oil prices and food prices are very strongly correlated.

Ehhh, we've been farming in states like Kansas and Nebraska long before we could do mass irrigation. Yes, some of our water does come from the Ogallala- most of it comes from rainfall if you're east of the Missouri river- but we also didn't have drought resistant corn twenty years ago.

The fundamentals for food in the long-term look pretty horrendous. All the projections say 9 billion people (40% more than today). How in the hell is the world going to feed that many people if key water sources are projected to be under enormous strain, and fossil fuel availability will be about 1/4 of what they are now?

http://en.wikipedia.org/wiki/Great_Recycling_and_N...

People have this view of the world 30 years from now as this utopia where we're all traveling around in jet packs and computers like those in minority report. The reality could be drastically different; worldwide famine, resource wars, etc. I'm not saying that's my base case, but we do have to make some drastic changes to avoid that outcome.

I saw it as a cool new future ten years ago. Five years ago I saw WWIII and a return to feudalism. Today, I look past the food crisis- knowing Russia and China have a lot of land to fight over- and see a return to an economic growth situation for the US that looks very similar to the 1950s in 20-30 years.

All the US has to do is sit and wait and stay out of it.

Apr 19, 2011
alexpasch:
IlliniProgrammer:

Midas, this is what I've been trying to say all along.

Everyone has talked about economic self-sufficiency but nobody is talking about environmental carrying capacity. Aside from Australia, Canada, and New Zealand, the US is one of the few countries that lives under its long-term carrying capacity- and can turn a huge profit exporting a fraction of its surplus to the rest of the world.

We have 1/3 of the world's arable land- all owned by a bunch of largely middle-class (soon to be filthy rich) midwestern farmers due to corporate/nonresident farm ownership restrictions. The anti-American expatriation fans- for all of their so-called brilliance- are such idiots. They will be- and deserve to be locked out of the country when the food crisis hits.

This is the time to start picking up stock in boring rural midwestern retailers. Like Kohls, JCPenney, and Sears/K-Mart.

You do realize that a lot of this "arable" land is dependent on the ogallala acquifer, which is not going to last forever? Also dependent on a wide host of fossil fuel inputs, that's why oil prices and food prices are very strongly correlated.

Still better than what will probably happen in Southeast Asia, when the glaciers in the Himalayas are gone, so will the runoff, ergo the rivers run dry, and no more rice paddies.

The fundamentals for food in the long-term look pretty horrendous. All the projections say 9 billion people (40% more than today). How in the hell is the world going to feed that many people if key water sources are projected to be under enormous strain, and fossil fuel availability will be about 1/4 of what they are now?

People have this view of the world 30 years from now as this utopia where we're all traveling around in jet packs and computers like those in minority report. The reality could be drastically different; worldwide famine, resource wars, etc. I'm not saying that's my base case, but we do have to make some drastic changes to avoid that outcome.

These are the sort of debates we should be having. +1 for both of you guys.

Apr 19, 2011

This is obviously not even remotely feasible.

US would become an isolated country. What would happen to international corporations? Would every McDonalds outside of the US be forced to close? We would basically become high tech hunters and gatherers. And for the love of god HOW would we support the people who choose not to work?

At this rate, I'm convinced the only thing we're banking on is the world ending at some point. We will continue to overspend until that day.

twitter: @CorpFin_Guy

Apr 19, 2011
accountingbyday:

This is obviously not even remotely feasible.

US would become an isolated country. What would happen to international corporations? Would every McDonalds outside of the US be forced to close? We would basically become high tech hunters and gatherers. And for the love of god HOW would we support the people who choose not to work?

We control 35% of the world's arable land. Make us an isolated country and China goes to war with Russia, India devolves into chaos, and the world quite literally shuts down.

At this rate, I'm convinced the only thing we're banking on is the world ending at some point. We will continue to overspend until that day.

Or a food crisis. The planet has 6.8 Billion people. All of them want meat. Not all of them will be able to afford it. We'll sell our corn to the highest bidder.

Apr 19, 2011

Great topic.

Three years ago, I went to visit the Federal Reserve Bank of NY. Well below street level, American soldiers and security technology guard the fortunes of the nation's of Earth. They transfer payments - in gold- between these countries. And we "guard" it all.

The U.S. has a vast supply of natural resources, including energy, agriculture, and raw materials. Plus we have the strongest army in the world, with bases on multiple continents. We can land a missile on a dime anywhere in the world. Agree with IP, our ability to control a significant portion of food suppy/arable land really puts us in a great position.

The rest of the world mooches off of us anyway. Europe basically has free security. Hell, we are spending billions in Libya to protect illegal immigration into Europe but we won't even do this in our own country. The Chinese would be better off exporting all the coal they mine, but instead they inefficiently subsidize their own manufacturing interests at the expense of world GDP. Throw in IMF subsidies, World Bank subsidies, Foreign Aid, and we can see that we support a significant number of countries worldwide.

Apr 19, 2011

I strongly believe that 20-30 years from now there will be massive suffering around the globe, including here in the U.S. Yes, I am actually a pessimist.....but I also like to think I am a realist.

"One should recognize reality even when one doesn't like it, indeed, especially when one doesn't like it." - Charlie Munger

Apr 19, 2011
cplpayne:

I strongly believe that 20-30 years from now there will be massive suffering around the globe, including here in the U.S. Yes, I am actually a pessimist,,,,,,,,but I also like to think I am a realist.

Regardless, short of a nuclear winter or an asteroid strike, it will be very difficult for there to be widespread hunger in the US. Perhaps there will be suffering on some level here- I don't know. What I do know is that the US is positioned perfectly for geopolitical stability.

Apr 19, 2011

A little off topic, but not really.......I am not actually expecting an accurate answer. What would be the cost if say a massive earthquake (think magnitude 9) like in Japan recently struck near San Fran or anywhere in Cali?

"One should recognize reality even when one doesn't like it, indeed, especially when one doesn't like it." - Charlie Munger

Apr 19, 2011
cplpayne:

A little off topic, but not really.......I am not actually expecting an accurate answer. What would be the cost if say a massive earthquake (think magnitude 9) like in Japan recently struck near San Fran or anywhere in Cali?

I think there is a fault in LA that they discovered that is very different than all the other faults there in that it can cause a really, really powerful quake. (there was a documentary on it, maybe one of the mega disasters series ones?) I think they said like 10K fatalities or something like that would be expected (similar # to Japan)

Apr 19, 2011

While sovereign defaults have been around as long as money has been lent, in response to your piece I have to say, C'MON, are you serious?

Going from a downgrade on the short-term outlook of the US debt from 'AAA' to 'A-1+' (and we still maintain a 'AAA' on the long-term outlook) to strategic default?

Unless there is some catastrophic event (nuclear war) this is unfathomable. I put the odds of the US "strategically defaulting on its debt" on par with the world ending in 2012. For starters, if this occurred there would be an utter loss of confidence in paper currency, corporations would go out of business, trade would break down, beginning with oil, and there would be mass unemployment that we couldn't even fathom. If you honestly think that this is even remotely possible versus the US curbing entitlements and raising taxes then I really have to question your intelligence as a human being.

Apr 19, 2011

This election cycle won't change anything, and that's fine. The deficit didn't get this big overnight, and it won't go away overnight. It's time to start thinking about 2016 and beyond.

Chicago85:

I put the odds of the US "strategically defaulting on its debt" on par with the world ending in 2012.

Agree.

Most of the current hysteria is the same paraniod fear of anything government we saw from the left in the early part of last decade, just coming from right wing views as opposed to left. Most of it is driven by people who are genuinely political for the first time in their lives and simply don't understand how the gov't works or see these extreme views as the last hope of getting to have a say.....given the utter failure of the last administration [which by the way, does not imply that I support this one at all]. All fine and well. Someone DOES need to make the national debt an issue.

If there's an issue with our currency, the US will do business the same way it always has since WWII: pull an aircraft carrier off the coast and sign a deal in the morning over handshakes and photo ops. The dollar is still OVERWHELMINLY the reserve currency of the world for this reason: it's predictable. If a bank tries to call in a debt, Uncle Sam will park a tank in front of the building, either openly or behind closed doors. This extortion, and that's what it is, extends to nations that piss us off. In the big picture, countries like India get a whole hell of a lot more out of trading with us than we do with them. WE get cheap fuzzy dice. THEY get the rudimentary beginnings of a modern civilization. Long before the day of reconing, however, we will elect someone who makes good fiscal policy a priority. So no, I just don't buy into the fear.

At all.

I do completely agree with you that the current debt to GDP ratio is TOTALLY UNSUSTAINABLE, and I do think that the current craze over the deficit will push the debate towards Uncle Sam balancing his checkbooks.I think it's just a matter of time before we see a Chris Cristie type ascend to the federal level and clean house.....but to promote such certainty that the American public isn't smart enough to elect such a person shows nothing less than a lack of faith in the American system....which is fine. Actually, I think everyone should question their blind optimism in America at one point in their life just to see it for what it is: a system that works, more or less, century after century.

To quote Churchill, "Americans can always be counted on to do the right thing...after they have exhausted all other possibilities."

Apr 19, 2011
Chicago85:

While sovereign defaults have been around as long as money has been lent, in response to your piece I have to say, C'MON, are you serious?

Going from a downgrade on the short-term outlook of the US debt from 'AAA' to 'A-1+' (and we still maintain a 'AAA' on the long-term outlook) to strategic default?

Unless there is some catastrophic event (nuclear war) this is unfathomable. I put the odds of the US "strategically defaulting on its debt" on par with the world ending in 2012. For starters, if this occurred there would be an utter loss of confidence in paper currency, corporations would go out of business, trade would break down, beginning with oil, and there would be mass unemployment that we couldn't even fathom. If you honestly think that this is even remotely possible versus the US curbing entitlements and raising taxes then I really have to question your intelligence as a human being.

Thank you. Seriously, strategic default? Posts like these are getting out of hand. There is a loud minority here trying so hard to be the next Michael Burry. I can't tell if it's an attempt to appear contrarian and cynical or if it's a way of garnering attention through fear mongering, a la Fox News. It's the same few guys every time, but it makes this website look a bit ridiculous. It is kind of disappointing to see this kind of extremism constnatly blasted on the front page of WSO.

Apr 19, 2011

A magnitude 9 earthquake simply isn't possible in California. The San Andreas fault isn't long enough. Perhaps a magnitude 8 is a possibility. That would be pretty devastating. I think San Onofre and Diablo Canyon are specifically designed with magnitude 7.4-7.6 earthquakes in mind- in particular, I just discovered a few weeks ago that Diablo Canyon's ECCS is gravity fed and really just relies on someone flipping a switch and running for cover- never to come back for several weeks- to protect the plant. San Onofre also has a huge seawall- much bigger than Fukushima's- in the event of a tsunami. It's impossible to rule out an earthquake resulting in a severe release of radioactive material, but such a situation would be tough to imagine.

A magnitude 9 is possible in the Pacific Northwest. Expect something on the order of three hundred billion in damage, an increase in the current account deficit, and an increase in GDP. More specifically, it would be bullish for non Pacific Northwest timber, other building materials, and oil. The Pacific Northwest has no operating reactors within hundreds of miles of the faults, so that probably would not be a concern.

The earthquakes would kill a lot of people and cost a lot of money, but I don't think we'd see any permanent environmental damage like the experts seem worried about at Fukushima.

Apr 19, 2011

The Fed owns more US debt than any foreign country

Apr 19, 2011

Great discussion, very freshing to see macro economic topics being debated instead of the prestige of various universities by 20 year olds

Here is an interesting article I read last month in the CFA magazine which is relevant here:

http://pvgassetmanagement.wordpress.com/2011/03/16...
I tend to be on the contrarian side of the argument by thinking the US will fare well over the next 50 years and will once again see strong growth/boom periods

Apr 19, 2011

I'm pretty impressed with the knowledge being dropped in here. Seriously, how do you guys know so much stuff?

Please continue...

Apr 19, 2011
Barcadia:

I'm pretty impressed with the knowledge being dropped in here. Seriously, how do you guys know so much stuff?

Please continue...

I worked for the GOP, Democrats, Libertarians, Communists, several European political cults and also bartended for almost a decade at the types of places that attract local power brokers......politics is my primary interest and I give this finance thing a decade or so before I'm OUT and go back into the cultural / political scene.....albeit with more resources + real world experience. For what it's worth, I tend to change my argument sometimes in an effort to get someone to explain their viewpoint more thoroughly....I'm still in the learning phase.

I'm curious about a lot of these guys as well.....it's always cool to see debates with information I've never even seen before.

+1 SB to MMM for initiating a really good debate thread....

Apr 19, 2011

UFO......sometimes your posts lighten my pessimism on these topics

"One should recognize reality even when one doesn't like it, indeed, especially when one doesn't like it." - Charlie Munger

Apr 19, 2011
cplpayne:

UFO......sometimes your posts lighten my pessimism on these topics

Glad to help. MMM's doomsday scenario is entirely possible, but unlikely. It's fun mental excercise for me.......

Apr 19, 2011

"The government today announced that it is changing its emblem from an eagle to a condom because it more accurately reflects the government's political stance. A condom stands up to inflation, halts production, destroys the next generation, protects a bunch of pricks, and gives you a sense of security while you're actually being screwed."

" A recession is when other people lose their job, a depression is when you lose your job. "

Apr 19, 2011

Look the down grade just pointed out the obvious: that the U.S. has a debt problem. And no matter what people in the media tell you nothing really happened in the markets.

This is because if Wall Street really paid attention to the downgrade the dollar would have fell and treasury yields would have went up but instead the dollar strengthened and yields plummeted. Also investors and traders would have left the dollar and went in to other assets like stocks and commodities but that didn't happen obviously because almost all stocks dropped and nearly every commodity slid (except for gold and silver) because of a STRONGER dollar. The real reason stocks dropped was because of continued fear about the Euro debt crisis in Greece. Let me repeat that the EURO debt crisis.

If the S&P really wanted to get our attention they would have relinquished the AAA rating from American debt but I don't think they had the balls or the real want to do that. Also the U.S is still by far the most powerful country (both economically and militarily) on this planet and has a long drop to go before it loses that status.

Apr 19, 2011

Only a certain portion of the total debt is owned outside of the US. If the government defaults, Americans are f**ed just like everyone else in the world. The people/govt's that lend money to the US are not dumb either, maybe they see that America will screw itself if the gov't defaults, especially when most of the debt is floating inside the US economy itself. It's like a down payment on a house, except in this case it's in trilions

Apr 19, 2011
Midas Mulligan Magoo:

The dollar is weakening, multiple states are functionally bankrupt, a tank of gas is becoming a luxury purchase and our national debt is swallowing up everything in sight, with no suppression of its ravenous appetite anywhere on the horizon.

I vaguely recall seeing the same scenario at the beginning of the Atlas Shrugged movie....

Apr 19, 2011
brooksbrotha:
Midas Mulligan Magoo:

The dollar is weakening, multiple states are functionally bankrupt, a tank of gas is becoming a luxury purchase and our national debt is swallowing up everything in sight, with no suppression of its ravenous appetite anywhere on the horizon.

I vaguely recall seeing the same scenario at the beginning of the Atlas Shrugged movie....

...it did wonders for the general morale in finance

Apr 20, 2011

The audience at the end gave a standing ovation during the credits.....who does that?

Apr 20, 2011

Star Wars and LOTR fans.

Apr 20, 2011
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Apr 20, 2011

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