The Wall Street Journal yesterday highlighted how the greed of mortgage lenders had, in effect, conned people into mortgage refinance and financing commitments that were beyond their means.
Many of our readers will remember being bombarded with seemingly fantastically attractive refinance and mortgage advertisements, only to find that they were "fool's gold" and were, upon closer examination, far less attractive, particularly if interest rates rise.
[Editor's Note: Expert: Residential Real Estate Will Fall 20% to 40% -- Go Here Now]
We, and our sister publication Financial Intelligence Report, have long warned of the unraveling of the vast and speculative residential property boom and its likely "spillover" into the real economy and into stock prices.
Despite our warnings, some investors have preferred to listen to the calming voices of Fed Chairman Ben Bernanke, Wall Street, and the popular media, who, until very recently, were seeking to reassure speculative property and stock markets that all was under control and the problem was most likely restricted to the subprime market.
Bloomberg posted some alarming, but realistic, items.
Story Continues Below
One article exposed the "ripple effect" caused by the sub-prime lending meltdown. It reported, "As many as 1.5 million more Americans may lose their homes, another 100,000 people in housing-related industries could be fired and an estimated 100 additional subprime mortgage companies…could go under. It added that, "Financial stocks also could extend their declines over mortgage default worries."
Mark Zandi, chief economist for Moody's Economy.com, told Bloomberg, "The correction will last another year." We feel this is an understatement.
We believe that the busting of the wildly inflated property boom will be like that of the collapse of the dot.com boom. Like the dot.com collapse, we feel the real estate bust will spread into the general economy and other assets including the stock market.
The Chinese market is experiencing a major stock price correction. The United States looks like it will experience a major housing correction.
Meanwhile, the Bloomberg reported last week the stagflationary (recession plus inflation) news that U.S. productivity for 2006 rose by only 1.6 percent (the lowest since 1997) and that labor costs jumped by 6.6 percent.
This news comes at a very bad time for the Fed.
A meltdown in residential real estate that spreads into the economy would normally encourage the Fed to lower rates. Indeed, some argue that the Fed is already too late in lowering rates if it wished to avoid a spread in the real estate collapse.
The problem is that the Fed faces two other vitally important economic problems that both require higher rates. These are inflation and the historic and chronic weakness of the U.S. dollar.
It is known that the Fed is already concerned about inflation. This concern is compounded by the fact that the Fed's concern is based upon figures that we and others, including Lou Dobbs of CNN believe are "cooked" to the downside.
[Editor's Note: Lou Dobbs Agrees With Us: Inflation Numbers Lie!]
As we have also pointed out for many months, the U.S. dollar is under heavy scrutiny and potential selling pressure.
Sadly, competing international interest rates have been rising. This puts further upward rate pressure on the Fed as it moves to defend the dollar.
The European Central Bank (ECB) just last week raised its key interest rate by a quarter percent to 3.75 percent, with expectation of a further increase to 4 percent in June.
Last week, New Zealand raised its rate to 7.5 percent. Great Britain held its rate at 5.25 percent, but expectations are for an increase by May.
Meanwhile the yen continues to appreciate against the dollar, threatening further unwinding of the massive "Yen Carry Trade" (where Yen are borrowed at a quarter to a half percent, converted mainly into U.S. dollars and invested in U.S markets at a handsome "carry" return and the option to repay in a depreciated currency.)
This series of events and observations combine to put upward pressure on U.S. interest rates.
We have long warned of the two issues of stealth inflation and the growing obligation to defend the dollar. But the Fed has apparently remained nervous and has shied away from both.
We believe the Fed was too timid in raising rates in the face of mounting evidence of what we term stealth inflation and the falling credibility of the dollar in 2006.
Now, the Fed is faced by a U.S. economy indicating recession, even severe recession, caused by a residential real estate meltdown.
If the Fed lowers rates, it risks unleashing inflation and a run on the dollar.
To us, it appears that stagflation now threatens.
With a timid Fed having to balance recession against both inflation and a new need to defend the dollar, it is likely we are facing a period of indecision and of interest rate volatility.
History shows that interest rate volatility soon leads to economic volatility and then to stock market volatility.
Volatility is bad for both the U.S. economy and financial markets.
We continue to recommend that our readers think in terms of capital preservation by concentrating upon cash, short-term, high quality CDs, and bonds and gold.
[Editor's Note: Four Gold Picks Set to Skyrocket in 2007 - Get Them Now]
Cash already holds the position of a king in the residential property market. We feel its status will soon rise to that of an emperor and extend its "rule" to yet more markets.
In such conditions, we feel it unwise to continue with the popular view that gold is a hedge against inflation, or incremental (salami slice) default — it is that, only over the long term!
As gold trades in a market heavily distorted by governments, it cannot be a free market measure. Indeed, if the gold price were to be adjusted for the average inflation rates (3.9 percent), it would now have to stand at $2,076 to equal its January 2000 high of $850 per troy ounce.
Our readers should view gold, over the short to medium term, not as a hedge against inflation but as a hedge against major default — a scenario we now see threatening as we look ahead.
Editor's note:
Four Gold Picks Set to Skyrocket in 2007 - Get Them Now
Lou Dobbs Agrees With Us: Inflation Numbers Lie!
Expert: Residential Real Estate Will Fall 20% to 40% -- Go Here Now
The Nine Best Energy and Precious Metals Stocks
