I haven't written much in the past year here on Lowbar but the recent shutting off of this domain has caused me to reflect on how fun it is to spout off here. So I thought I'd give you all a dose of the kind of thing I spend my day thinking about. You are free to consider me a freak, doomsayer, economic genius or libertarian regurgitate, it don't matter to me. Feel free to post your own thoughts.
So here's what I think about the current world economy:
- Countries that are manufacturing cheaply produced goods are selling to the Americans
- Because these countries are selling to us and are not buying what we produce there is a trade deficit.
- This money that the producing countries are making is going back into our economy in the form of bonds.
- Because of the demand for bonds by these foreign countries (Japan and China mostly) the yield on the 10 year bond is very low (a 4% yield is attractive to these countries because their yields are much lower).
- Mortgages and long term bank loans are tied to the 10 year bond yield. Because this is low, this is fueling the housing boom and also the home equity loan boom (credit)
- Because there is lots of "easy money" available, Americans are spending and not saving
- The US trade deficit is running at $55+ billion a month
- We make up for that deficit and for our unbalanced budgets by borrowing money (selling bonds)
- Our national debt, what we owe on the money we've borrowed, is at an all time high of $8+ trillion dollars
So what's that all mean?
It means that in much the same way that many Americans are using easy money to purchase homes that they otherwise wouldn't be able to afford, the US government is using the easy money that countries like China and Japan are giving us to buy things it can't afford (such as footing the Bush tax cut and funding an expensive war in Iraq). This system works as long as the bank (either literally a bank or in the global sense another country) stays solvent and trusts the debtor. Debtor countries get into trouble with their debt when they are viewed as unlikely to pay it off, just like a person. If a country is perceived to be in trouble, the creditor countries will pull their money out and the currency of the debtor country will drop. Argentina had this happen to it when it's debt was 4% of GDP, ours is now over 6% and rising.
In the mid 1920's, Charles Ponzi, inventor of an ingenious scheme involving purported international stamp arbitrage that promised a 50% return on any sized investment, would take in more money than he paid out (a classic "rob Peter to pay Paul" scheme). Mr. Ponzi was able to keep the image of propriety because his scheme sounded plausible and people were making money. He was also very dapper and drove the finest car available, so he looked the part. He even began buying up shares of banks to add to his stable appearance. Eventually he was discovered, he went to jail and lots of people lost their money, plus a couple of banks failed.
The same thing is going on with the US economy and we are playing the role of Charles Ponzi. Countries are giving us money so that we will in turn buy their goods and also pay them interest (yield). We are using that money just like Ponzi did, to buy things that we really can't afford and to keep up appearances and we are not investing it or saving it.
All it is going to take for this house of cards to fall is for someone to say "the emperor has no clothes." There are a couple of reasons why this hasn't happened yet:
- The US has a solid reputation for repaying its debts
- The dollar is the defacto currency for trading in oil (thanks to Henry Kissenger) and thus it has clout as a currency
- The competition hasn't gotten its act together (yen and euro)
- The creditor countries are not in dire straights economically (yet) and therefore they are not pulling their loans and they are continuing to invest in the US debt
- We are buying their goods so it is in their best interest to keep us in a buying mood
Some possible scenarios on how this may play out
- The US will continue to increase its debt (why wouldn't we?). The recession that started in Japan and now is taking hold in Europe will worsen and expand and foreign countries will begin scaling back their investment in US bonds
- Our debt to GDP ratio will start to look ridiculous to our creditor countries and they'll stop investing in our bonds. After all, with all those baby boomers retiring, who is going to pay the interest on the debt?
- An unforeseen fluctuation of markets will cause highly leveraged hedge funds to loose record investment monies. Since banks are hedge fund players, many of these institutions will fail. This will cause a tightening of easy money lending and possibly a massive government bailout which will add to the debt
We'll still need to fund our spending however so as the dollar becomes less attractive and starts to drop the Fed will be forced to raise short term interest rates. This will not be the quarter point rate hikes that we've seen from the Fed of late but will be much sharper and quicker rates of increase. These increases will spill over to the banks and they will tighten the easy money. The housing boom will go bust overnight in that those home buyers that are using creative loans will no longer be able to do so and their mortgage rates will go up, so they won't buy. In addition, people who have existing adjustable rate mortgages are going to get shafted. The really bad news here is that for most Americans their home is their savings (and also their debt through home equity loans). If that investment dries up, Americans will not be in the mood to spend. If Americans are no longer spending then the rest of the world is in a load of trouble since we are the #1 consumer in the world. Countries like China, whose entire economy has become dependent on US consumption, will crash.
I think this worldwide crash is inevitable since we continue to get into debt. Sooner or later that rate of debt will catch up to us. This is further exacerbated by our increasing dependence on foreign labor, increasing demand for oil and its rising price and of course our expensive war.
How you can profit by the coming crash
Learn how to short stocks, commodities and currencies (dollar). Any stock will do. Those dependent on housing are good choices. Index stocks are a good pick. Gold will likely go up as well.
If you are looking for a cheap house learn how to buy preforclosures. I don't recommend buying these as investments but soley as your primary residence (since the costs of homes is likely to go down for many years). Here's good information on how to buy preforeclosures.
Refinance your existing ARM to a 30 year fixed if you can afford it, pay off your credit cards and save cash. Better yet, sell your inflated house now while you can.
More to come (lucky you)....
I got a sweet Double Dribble arcade game at a foreclosure - Leaf Grosch-Jackson.
