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No one will deny that last week
was one of the most tumultuous in history. The streets red with blood... the
bodies of the dead and dying strewn about where they fell.
You already know the names:
Lehman, Merrill, AIG. Fannie and Freddie.
But none of this happened by
accident.
The warning signs have been all
around us for years.
Bud Conrad, chief economist at
Casey Research, wrote about the beginnings of our current problems back in
March of 2007... before most people were even aware
of the storms brewing just over the horizon.
"Faced with historic levels
of debt, falling housing prices, and weaker economy, the pressure on housing
would gain momentum as desperate homeowners either hand their keys back to
the banks, or simply hit the bid on the best (low) offer they can get. A
vicious cycle would set in, threatening to shove the economy into uncharted
and unpredictable waters.
"The impending calamity -
mass housing foreclosures, failing banks, Fannie Mae and Freddie Mac in
ashes, millions of personal bankruptcies - is so dire, most people can't even
conceive of it. And indeed, it may not hit us this year, or next, but the
market always corrects itself, and this time will be no exception - sooner or
later... That's why the coming crisis is so predictable: there's no way to
avoid it."
I actually wish that his
analysis had been flawed.
I also wish that the government
officials had been right who have consistently claimed since then that the
subprime crisis was contained and the markets would rebound in the second
half of the year.
Unfortunately, this is not the
case.
The Fed's recent attempts at
quick fixes have not worked, and current events are reinforcing what Bud
Conrad prognosticated almost two years ago: that this is much more than a
normal cyclical correction. This is a disaster of biblical proportions.
As the Fed and the Treasury
continue to intervene in the market, they continue to lose ground and
credibility, caught between a sharp recession and strong inflationary
pressures. In an effort to bail out the financial sector, they have no choice
but to start injecting hundreds of billions in liquidity into a contracting
market place.
This will contribute to the
creation of a stagflation period that will make the '70s look like a tea
party.
The Fed's never-ending injection
of liquidity into the market has, and will continue to, devalue the
dollar.
Ordinarily, a country threatened
with currency collapse would lean toward tight money, perhaps contracting its
domestic money supply. That would push interest rates upward and compensate
foreigners for holding on to the currency despite the depreciation risk. And
it would soften that risk.
But this time, things aren't
ordinary... there is a difference that has turned what might otherwise be a
disturbance into a disaster: the U.S. economy's inability to
endure high interest rates.
Because of the corrections
taking place now in the grossly distorted U.S. housing, commercial real
estate, and personal credit markets, raising interest rates to protect the
dollar would prove as calamitous as not raising interest rates.
The housing bubble fueled a blockbuster business in first mortgages, and
then home equity loans. Homeowners drew down their equity to splurge on
consumer goods, including shiploads of imports.
The relative attractiveness of U.S.
financial instruments kept the game going into overtime. The foreigners who received
all those U.S. dollars put them back into U.S. Treasury bills and other
dollar-denominated instruments, thereby underwriting low interest rates for
all U.S.
borrowers.
The net result? Foreigners
funded our housing boom. The amount of mortgage growth annually matched the
amount of trade deficit, which foreigners dutifully invested back into the U.S.
And subprime lending was no mere
sideshow. It was big business. In 2005, it accounted for 25% of all new
mortgages - about $600 billion of high-risk paper, most of it with adjustable
interest rates.
The collapse of the subprime
market soon spread into other mortgage sectors... and the derivatives created
on top of all those subprime mortgages made everything much worse. Given that
the annual GDP of the U.S.
economy is just $13 trillion, the $250 trillion in derivatives should have
been seen as an accident waiting to happen.
Foreign reinvestment is part of
the system of U.S.
debt, and we are already seeing a significant impact, as depicted in the
chart below.
As foreign investors watched the
collapse of the U.S.
housing markets, and the relative values of their debts began to sink, they
quickly moved out of U.S.
debt, particularly Fannie/Freddie obligations.
This massive exodus of foreign
cash out of the debt of Fannie/Freddie prompted the biggest stock market fall
since the days just after 9/11. On September 15, 2008, Treasury Secretary
Paulson injected the biggest amount of daily liquidity since 2001, a whopping $70
billion in just one day.
And now the government is
proposing an additional infusion of approximately $1 trillion. More than the
total cost of the Iraq War.
To put this amount into
perspective: if you had spent $1,000,000 a day, from the birth of Christ
until today, you would have only spent about 732 billion
dollars.
It's going to be interesting to
see what happens to our markets if that proposal goes through.
***
If you had known all this was
happening, what would you have done differently?
If you had seen this coming, you
could have moved to protect yourself and your portfolio. You could have
shorted financials and bond insurers, like MBIA. You could have played more
in the gold fields.
But how could you know all this was going to happen?
We at Casey Research have long
foreseen what is unfolding right now... and those investors who followed our
recommendations made three- and four-digit returns. We believe in making the
trend your friend... otherwise it can be a fearsome enemy.
Which is what The Casey Report is all about - giving you the pertinent and well-researched
information on big economic trends unfolding at this moment, and how best to
invest to make them work for you, instead of against you. Find out
more about the power of the trends, and about The Casey Report, by clicking this link now.
Olivier
Garret
Caseyresearch.com
Olivier Garret is CEO of
Casey Research, LLC., one of the nation’s oldest and most respected organizations
dedicated to providing independent investors with unbiased research on
opportunities to earn extraordinary profits by being just ahead of the crowd.
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