With the economy increasingly looking like it will slow down materially in the last half of the year, there is a drum beat for the Federal Reserve to cut rates. But how likely is a rate cut this year? We take a very different look at inflation to see if there is any room for the Fed to give a boost to the economy. We look over our shoulder at Japan and the yen carry trade and ask a heretical question: does the Fed cutting rates make any difference?
When 2008 rolls around and the U.S. economy is sinking with frightening momentum into a bottomless quagmire, you’ll be glad you read this entry. Why? Because you anticipated every step of the implosion and warned your friends who were still floating complacently down that river in Egypt (de-nial).
In keeping with our theme of context, let’s begin by noting that the proper context for the housing bubble is the all-encompassing global credit bubble which has inflated every asset class. With this fundamental firmly in mind, let’s follow Deep Throat’s advice from the classic film All the President’s Men and "Follow the money."
Let’s first dispense with "the real estate market". Yes, supply and demand and housing starts and zillow.com and neighborhood sales and all the other market stuff play a part in the coming implosion, but all that noise is more a sideshow than the Main Event. Why? Follow the money. The main event is the credit market, because if you can’t borrow money, or can only borrow it at a premium and under tight conditions, then how many houses are for sale in your neighborhood or the median price paid, etc. shrink to near-meaningless. Real estate sales and valuations depend solely on credit. Everything else is secondary.
Next, let’s dispense with the notion that the implosion of housing-based lending can be "quarantined" and won’t affect the economy. The reason is that mortgage-backed securities, and the CDOs and other derivatives which have been piled in untold trillions onto them, are one leg of an increasingly wobbly three-leg stool. The second leg is so-called "junk bonds" and other commercial paper (which has ballooned to astounding levels–see chart), and the third is government bonds in all their flavors. Once the MBS leg snaps, the entire debt stool collapses.
Even now, the ads on television, radio and the internet continue: "Is your credit bad? Don’t worry, we’ll provide the loan for the home of your dreams …" What those commercials should, but do not, add is: go through the small print with a toothcomb. Or else you, too, could be swept up in America’s subprime mortgage crisis.
Just as in Britain, homeownership is a traditional goal of American society. But as interest rates have climbed and the housing market has slumped, the number of what are politely called "delinquent" loans has soared. And as home repossessions grow, civil rights groups and presidential contenders alike are stepping into the row over the high risk, or subprime, mortgage market.
In the most sweeping call yet, a coalition of civil rights organisations have demanded a six-month moratorium on foreclosures. They want lenders - whose reckless and sometimes predatory policies are largely blamed for the crisis - to help victims refinance their mortgages, or face law suits.
"We know that there are safe and affordable loans that meet the needs of our communities," said Janet Murguia, the president of the National Council of La Raza, the biggest Hispanic civil rights group in the US, noting that minority groups were especially hard hit by the crisis. Lenders should "match families to the sustainable loans that they should have had in the first place", she added.
The subprime crisis has erupted over the past few months as borrowing rates have turned upwards while house prices have fallen steeply in many parts of the country. All sectors of the mortgage market have been affected but none more so than subprime loans, extended to borrowers with shaky credit histories.
Dark clouds are converging over America’s economy. Here are three scenarios on how they could develop into a serious storm that could hit you.
Fishermen and sailors must be constantly on the lookout and prepared for changing weather. Smooth sailing can quickly turn into a fight to keep one’s head above water. Likewise, today’s breadwinners must be prepared for abrupt changes in the economy. Good times can quickly turn into recession; high-flying stock markets can crash; and as history clearly shows, all bubbles eventually pop. Often, fat years are followed by lean years.
As economist James J. Puplava has said, “Economic and financial conditions never remain constant. They are as seasonal as the weather. Forecasts change depending on the patterns that emerge” (Financial Sense Online, March 15, 2001).
Financial meteorologists and prognosticators identify two looming, yet self-induced storm fronts threatening America’s economy: deflation and inflation. However, like climatologists trying to predict the weather, many disagree as to which poses the most immediate danger. Further, some identify a third and even more powerful economic storm brewing.
Although the outcomes of these coming storms are predicted to be very different, their origins are similar.
Mounting Debt Levels
Like a downdraft of dense freezing air, virtually all levels of American society have become weighted down and pressured with debt. Personal, corporate, state and federal debt levels are all at or near record highs.
U.S. consumer credit debt hit an all-time high of $2.4 trillion last September, soaring 80 percent since 2000. Similarly, the amount of household and mortgage debt as a percentage of disposable income is at its worst level in over a quarter century. For the past two years, Americans on average spent everything they made and then some. During 2006, people spent 1 percent more than they earned. The only other time in history America’s savings rate was in negative territory for a full year was during the Great Depression.
In corporate America, debt has become so endemic that there are now more companies with “junk” credit ratings than with investment-grade ratings, says credit rating agency Standard and Poor’s.
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