Saturday, December 31, 2005

HOUSING BUBBLE? Much bigger than housing bubble!

I wrote this paper in December 2005 to try and help others see the "Big Picture". I've been studying the issues for several years now, but only recently did I realize how interconnected the problems really were. The "Big Picture" of our economy (my perspective anyway) is not nearly as rosy as our government officials and the talking heads in the media portray it to be.

Hope you enjoy the read!

The vast majority of American consumers wake up every day completely oblivious to the enormous economic problems at their doorsteps. But why should they care? With two brand new SUV’s in the driveway of their highly appreciating suburban home (located next to a Starbucks where their daily $4 drink can be charged on Visa), and their ability to purchase a cheap, Chinese-made DVD player at Wal-Mart to hook up to their recently financed HDTV Plasma screen, life couldn’t be better. As long as the paychecks can keep up with the minimum monthly payments on their credit cards, autos and interest only mortgage, all is just fine... So is the way of life in America today.

The psychology of average America has changed during the last 15 years. Whereas saving for the future used to be the mantra to live by, it has been replaced by “consume for today”. Living with debt has become the new norm and saving money is out of fashion. Today, consumers rarely even care about an item’s bottom-line price. All they are interested in is a low monthly payment (hey, I can afford that!) and they keep on piling up these payments because they just have to have that brand new widget (which they don’t need). With a big thanks to Alan Greenspan, the lowest interest rates in over 40 years and the capability of using a home as an ATM machine, all of this was made possible. American consumers are graciously spending > 100% of their income today, with no end in sight. Heck… no big deal, they are just following the lead of the US government. With trade deficits running at 6% of GDP, why should anyone worry? Spend, spend, spend… All is well!

Welcome to 2006 & 2007; Interest rates are up, credit card payments have doubled (due to new laws), corporate bankruptcies are on the rise (Delphi, GM, Ford, Delta, US, United and Northwest Airlines, etc), payments have increased on that adjustable rate mortgage, consumer prices are through the roof (food, electricity, gas, consumer goods, etc), Asian Central Banks are losing confidence in the dollar, and the consumer, who was already stretched to the max, can take it no more… How convenient for the US government & corporations to change the bankruptcy laws in November 2005 (a coincidence?) and people will no longer be allowed to completely walk away from debt--and it’s going to hurt them for many, many years!

The events that follow (due to the above mentioned issues)--will lower US consumer spending, increase mortgage defaults, cause auto sales to sag, increase the number of credit card defaults and will lead to falling home prices, layoffs, falling stock market, falling US dollar, etc. Ultimately, after 2 consecutive quarters of negative activity, we will enter a new recessionary period (probably late 2006, early 2007). The recession will start off slow, will gradually fester/get worse and will eventually set off a chain of events that could potentially lead to complete economic calamity (possibly worse than 1929) a couple of years later. Why do I feel this way? Let me explain.

There are numerous underlying fundamental problems with the US economy. From all exterior angles, to the common man, everything does look fine, but you have to look deeper—at the foundation of US economic rot. The problems we have are so huge, there is little we can do now except to try and individually prepare as best as possible (reduce debt and increase savings liquidity) and then brace for the long-term consequences.

I have identified several areas (below) that I feel are relevant to the current economic quagmire and will try, to the best of my ability, to touch on some of the details. My bottom-line analogy that I’d like for you to use during this reading is this: consider each of the issues below as individual dominoes and each depends on the others to either stay in place or to fall. When the first domino does fall (the recessionary catalyst), most of the others will follow suit… a chain reaction that cannot be stopped until all the dominoes are on their sides. Only then (after the calamity) can we begin to start picking up the pieces and reset the dominoes. By that time, however, life will have fundamentally changed and we will be starting from ground zero!

The issues I plan to touch on:

- US Dollar Problems
- Enormous US Debt
- Massive US Trade Deficits
- Rising Inflationary pressures
- Housing Bubble
- Consumer Spending
- Outsourcing of US Jobs/Corporate Bankruptcies

US Dollar Problems: Allow me start with a little history on the US dollar. Throughout the history of the world, there have always been strong currencies, typically held by the superpowers of the day. Theses currencies were/are called Reserve Currencies. The Pound Sterling was the primary reserve currency for much of the world in the 18th and 19th centuries. But perpetual account and fiscal deficits financed by cheap credit and unsustainable monetary and fiscal policies used to finance wars and colonial ambitions eventually led to the pound sinking (sound familiar?).

Post World-War II, the US dollar took over the sterling’s dominant position and became the world’s newest reserve currency. The Bretton Woods Accord established a way to value the various currencies of the world relative to each other and tied only the US dollar (as the reserve currency) to a gold standard (meaning the value of dollars circulating must be backed by gold reserves).

The gold standard caused major problems in the 1960’s when France (under the London Gold Pool) called America’s bluff and demanded gold for payment of debt, rather than US dollars. Due to the rapid loss of US gold reserves, Nixon had no choice but to abolish the Bretton Woods accord in 1972 and he took the US dollar off the gold standard (it was $35 per ounce then; today it is > $500).

Once removed from the gold standard, the US dollar became a fiat currency (tied to nothing tangible and backed only by the word of the US government) and the Fed could print money at will. It remained, however, the world’s dominant reserve and was the baseline upon which all other currencies floated and were traded.

As the world’s reserve currency, the US has been able to, year after year, import goods from the rest of the world (for consumption) and pay for it with dollars. These dollars are then used by foreign central banks to purchase US debt instruments (US treasuries and the like) from the Fed. It’s almost comical, as the treasury securities they purchase are created out of nothing, are backed by nothing and require absolutely no savings by any American consumer. The Federal Reserve just prints them at will and “promises” to repay the debt.

To quote a Robert Blumen comment (from the Ludwig Von Mises Institute—an educational center for the Austrian School of economics): “The current international monetary system, like a bad horror movie, is a sort of return of the living dead Bretton Woods. A vestige of the agreement places the dollar at the center of international finance, and securities denominated in fiat U.S. dollars are the most widely held reserve asset. Dollars that were accumulated under the promise of convertibility are now held in such large quantities by most major central banks that they cannot be sold without destroying the value of the remaining asset.” What he said in layman’s terms: Central Banks (Mostly those of Japan, Korea, China and India) are currently holding > $2.4 Trillion dollars in US securities (helping to finance our US debt). If these Central Banks ever try to cash these securities -- even just the hint of one of the banks thinking about it (the smell of blood in the water if you will), a rush to exit the dollar cashing door will ensue (a first out mentality) and this will cause a dollar crisis--the dollar will collapse and the worldwide economic system will be in complete shambles. Understanding the potential ramifications, all the foreign central banks can do is hold on to these fiat assets (catch-22). Essentially, they are holding on to US checks they are unable to cash.

Central banks (aware of the quagmire they are in) are already starting to become leery with the huge debt levels and increasing trade deficits (~ 6% GDP) of the US, and are starting to diversify their holdings in Euros. Just the lean toward diversification alone is enough to cause the dollar some problems. So, the question is, what can be done about these dollar problems? Answer: Unless the US begins to reel in deficit spending quickly (which I don’t see happening), a dollar crisis is pretty much a foregone conclusion. It’s not a matter of if--it is when. When the dollar eventually does collapse, the world will probably enter into a depressionary period and when over, another currency will have to pick up the reserve, after which the dollar will be relegated to a minor spot in world finance.

Enormous US Debt:
Take a look at the current US Debt Clock. This figure is the Total Public Debt Outstanding as owed by the US government. It is money the government owes to others, financed through treasuries, bonds, mutual funds, foreign banks, etc and is backed by nothing except the word of the US government. The huge $8.1 Trillion dollar debt, in and of itself, is a problem, but the bigger issue is how quickly it is growing. In 2004, the total US debt was less than $7.3T. In 2003, it was less than $6.5T. At current rates of spending, US debt will rapidly overtake the upper congressionally authorized debt ceiling of $8.3T and it (the ceiling) will need to be raised again in early 2006. The new upper limit, when set, will probably be somewhere in ballpark of around $9T, but with no slowdown in sight, the US government will reach that new level in ~ 18 months. It’s pretty scary stuff. How high will we (and the world) allow it to go without consequence? For what it’s worth, my bet is: Not for much longer!

Now, if we look at the TOTAL $40T combined debt of US Households, Business, Government and Financial sectors, the picture gets even scarier. How in the world will we ever get out of this pickle?

Answer: WE WON’T! We’ll just keep increasing the cumulative debt up to the point that a major financial event (depression, dollar crisis, etc) is experienced. This event will naturally solve the problem through defaults, bankruptcies, devalued currency, etc. Don’t believe for a moment that the Federal government has a “master plan” to solve this. They will try to apply band-aids where possible, but it is far too late for a major fix. All they can do is now is pick up the pieces (like the rest of us) when it’s all over.

Massive Trade Deficits: 2005 looks like another record-breaking year! Too bad it’s not good-news. When all is said and done, the US will have exceeded $700B in trade deficits (over $2B each and every day of the year). This new record exceeds the all time trade deficit record of 2004 ($668 Billion)! These massive debt levels equate to roughly 6% of US Gross Domestic Product (GDP). That figure alone should be scary enough, as no country in the history of the world has been able to sustain this level of debt without some sort of financial repercussion (currency crisis, defaults, rampant inflation, etc). The only reason we haven’t felt the pressure yet is because the US Dollar, as we discussed earlier, is the world’s reserve currency. If/when it fails, it’ll most likely be followed by a worldwide depression. In an effort to hold this event at bay for as long as possible (holding off the inevitable), foreign central banks are continuing to finance this debt through the purchase of US securities (with the inability to cash out—as stated earlier). How long will this trend continue? My opinion: NOT FOR MUCH LONGER

So, what has the US government done recently to reign in the spending? Answer: Zilch, Zero, Nada, Nothing. It seems far too difficult a task for Washington to manage. All I can say is: start to prepare yourself now for the bread lines of tomorrow.

Rising Inflationary Pressures: In an effort to stave off a US recession after the stock market collapse in 2000-2002 and the 9/11 terrorist attacks, Fed Chairman Alan Greenspan cut the Federal Funds Rate 13 times (it was 6.5% in Jan 2001) over a period of two years--until the rate reached its lowest point (1% in Jun 03) in over forty years (some argue the Fed kept rates too low for too long). This aggressive Fed action, along with massive printing of money (increasing liquidity) and a lowered tax rate (remember the Bush income tax cuts?) stimulated the US economy and kept the recession very short. With a flood of cheap new money now available in the market, US consumers went on a spending spree. Well, here is where the well-understood law of supply and demand kicked in. Due to high demand of resources (lots of people w/money to buy limited resources), prices rose on nearly everything (homes, commodities, fuel, food, etc). Prices were rising so fast, the Fed had to do something to slow the inflationary pressures… so began the short-term rate increases we’ve seen during the last 18 months. With that said, the Fed was/is also in a pickle. He had to raise rates to: (1) boost foreign investor confidence in the dollar (which had been waning) and (2) slow inflationary pressures, but he couldn’t do it too fast for fear of bursting the housing bubble--created by the extraordinarily low rates (we’ll discuss the housing bubble in detail later).

Now that the Fed is increasing rates, the dollar is beginning to show renewed strength (albeit probably short lived due to our deficit/debt), but the housing market is beginning to slow. If the housing bubble does pop, the US will be in a world of hurt, as consumers have been relying on increased home equity (the wealth effect) for spending, and greater than 25% of US economic growth over the last 3 years has been dependant on the housing market. When this is taken away, an entire industry will collapse and massive ripple effects will be felt across the economy. Do you know any realtors or loan officers? You may want to tell them to start looking for a new line of work.

In addition, we are now nearing an inverted yield curve (where returns on short term investments outperform long-term)—a predictor of numerous past recessions.

What I foresee: The Fed will continue to increase rates for the next 2-3 cycles. This action will cause the US to experience an inverted yield curve and cool the housing market (eliminating the wealth effect). The US will then enter a recession ( probably late 2006/2007) where consumers will pull back on spending (causing further recessionary pressures). The lackluster performance of the US economy and our growing debt will cause foreign investors to lose faith in the US economy and begin further diversification of their holdings. This will, in-turn cause the dollar to lose value against other worldwide currencies and Americans will lose purchasing power… a downward spiral.

Housing Bubble: As we discussed earlier, the low interest rates brought on by the aggressive Fed lowering actions of 2001-2003 allowed the US consumer to borrow money very cheaply. Consumers took advantage of the situation to refinance their home, or they sold their home to upgrade into a larger one that they could now afford (because of these lower rates). Many others took out low rate homeowner equity loans to pay off high interest credit cards, remodel, buy a pool, new furniture, a new car or maybe even purchase a second home. In addition, many folks who previously couldn’t afford to buy a home (renters) could now afford to do so and decided to enter the market. Because so many people were now doing the same thing (buying new homes, refinancing, getting a second home, speculating on and/or flipping homes based upon future appreciation, etc) the costs of homes increased astronomically (again supply/demand situation). This new housing boon created a bubble that has been the main economic engine of the US economy for the last 3 years.

I would like to point out that another factor is also responsible for the run-up in home prices--new strategies in homeowner lending practices (Interest only mortgages, ARM’s, 40 year loans, etc) and significantly relaxed lending standards allowed more people qualify for homes that they could not otherwise afford and lenders took on much riskier loans to qualify people that had no business being in the market anyway. But it really didn’t matter to the lender, as they were not the ones taking the risk. After closing on the notes, they would sell the mortgages to Fannie Mae or Freddy Mac—two massive Government Sponsored Enterprises (GSE’s). These GSE’s would then repackage the notes as Mortgage Backed Securities, Interest bearing accounts, etc and then sell them on the open market, (to be bought up by your retirement plan investments, etc).
Note: Fannie Mae, the larger of the two GSE’s was recently charged with cooking their books (as many had suspected for years) and had to file a $10B loss in 2004. Some feel it is the 1st step towards its ultimate demise and it will go the way of ENRON—only it’ll have wider implications and could ultimately bring down the entire US economy.

Recent evidence suggests that the Fed’s numerous short-term rate increases are finally beginning to have an effect on long-term mortgage rates and in-turn this is beginning to cool the housing market. Many folks, however, still believe that real estate is a “can’t-lose” investment. My gut feeling about the issue: When your taxi cab driver, hairdresser, co-worker and next-door neighbor all talk about how much money can be made in real estate and how you need to increase your real estate holdings, do you really believe that they are on to something? Do you really believe that real estate will continue to make people money indefinitely? Do you honestly believe the peak hasn’t already been reached? I remember the days before the tech stock market bubble—everyone was talking about how you couldn’t lose—buy, buy, buy. Rest assured, the big-money makers in real estate have already left the market and it’s all down hill now. Take a look at why real estate is different this time. When housing prices do plummet, the economy will follow suit.

Consumer Spending: Americans love to consume to excess (food, energy, appliances, autos, electronics, clothes, latest widget, etc) and they can’t seem to get enough. As previously mentioned, Americans used to save for a rainy day (probably due to personal experience in dealing with hardship—war, recession, depression, etc), but today, most Americans live for the here and now. For the first time in American history, consumers are now spending more than they earn and have a negative savings rate. How can they do that? By charging on credit cards, financing equity out of their homes, spending money they had in retirement savings, and the like.

The problem is: this excessive spending (negative savings rate) can’t go on much longer, as most American consumers are in debt up to their eyeballs. With credit card payments doubling next year, rising interest rates and consumer inflation on the rise, consumers will not be able to take on the additional expenses and eventually will have to pull back on their spending. The added impact of the American consumer being stretched so thin is: defaults on credit cards, auto loans and mortgages (remember all those new interest only mortgages and Home Equity Lines of Credit) will increase, causing corporate financial hardships. This in turn could lead to layoffs, bankruptcies and the like… another downward spiral.

The biggest problem is: the world-economy (China, India, Korea and many others) has become very dependent on US spending (a place to sell/export their goods), so when this spending pullback does happen (an absolute must & very soon), the world will probably end up in a recession… possibly the first domino to fall.

Outsourcing of US Jobs/Corporate Bankruptcies: The US was once a manufacturing powerhouse, but due to the high cost of US labor and in an attempt to compete in a global marketplace, jobs/manufacturing were outsourced to cheaper countries. Those home-bound US companies still trying to compete in the Global marketplace are reeling from higher labor costs, pension plans, union benefits, health care costs and the like. Just take a hard look at Delphi and General Motors. Next, looks at Ford--they are not too far behind. In addition, look at the United States airline sector— United Airlines, Delta Airlines, Northwest Airlines, ATA Airlines, US Airlines and most recently Independence Airlines--all are operating under bankruptcy protection .

Whereas the US used to be a manufacturing powerhouse, we are quickly moving towards a service-based, consumer nation and we currently live far beyond our means--on both a personal and government level. How can the US ever compete in the global marketplace when foreign entities pay cents on the dollar for wages and rarely care about health care and/or worker benefits? Answer: WE CAN’T… and the problems, bankruptcies, plant closings, layoffs, etc, will only get worse!

Summary: The US economy has far too many fundamental imbalances (dollar problems, debt problems, deficit problems, rising inflation, housing bubble, excessive consumer spending, corporate bankruptcies/outsourcing) and WILL experience a MAJOR correction in the not too distant future. I haven’t even touched on some of the other areas I feel put the US at risk for a major event (Credit Derivatives, Pension Crisis, Social Security Crisis, Immigration Crisis, Stock Market Bubble, Terrorism, New Fed Chairman, Bird Flu, Peak Oil, Elimination of M3 publication, Iran Oil Burse--trading in Euros, etc). But what I want you to take away from this reading is this: once that first domino does fall (probably due to a recession mid-to-late 2006 or early 2007), the other dominoes will follow suit, and it will take many, many years for the myriad of complex economic problems to work themselves out. The outcome will be extremely difficult, and life as we know it today will never be the same.

What can you do? Try to prepare yourself mentally for the change (as you will be one step further along than most) and then try to eliminate debt, look at the security of your job (change if need be) and then try to increase your saving (buy Gold or Silver) for that rainy day—or years.

Best regards,


november said...

Hi Randy,

Keep going, keep developing your message here. It's interesting.

Adding to what you've said about debt: there should be no upside to taking foolish and extravagant risks. Borrowing money is often necessary, and prudent, when you have a reasonable ability to repay the loan. E.g. mortgage on the family home - the non-financial benefits (socially, emotionally) are huge, not just to the individual, but to society.

However, I don't want to be saddled with the consequences of someone else's foolish borrowing.

Sometimes I look up the hill at all the over-sized, over-priced houses with the SUVs in the driveway, and all I see is a house of cards waiting to tumble down the next time there is an economic downturn.

Who loses? In the first round, it's the creditors - and often they are small tradespeople, independent businesses, and their employees - who have had to extend credit in order to be commercially competitive.

Borrowing when you cannot afford to pay back is a socially irresponsible action.



Tom said...


Great message.

I would like to add with the housing bubble that you left out all the overbuilding by the developers and their massive costs. i.e. Labor and Materials. When the demand for housing drops so will the labor costs to build and the materials. The builders will keep on building and cutting prices in order to make profits. This will make housing even more instable.

On outsourcing. I think in the end, America will be competitive and it will not be as advantageous to outsource as it has been. Things will be harder, but Americans will have to cope more and live within their means.

Good Luck! We're all going to need it.


Out at the peak said...

Thanks Randy. Even though I know all of this and even bet on it, this was an excellent read. (Most of my money is in foreign currency and I sold my house and now shorting RE. I cover these strategies in my blog.)

You have been able to channel all my thoughts into a well written article.

curious girl said...

I posted below at some other blog:

There are lots similaries between fiat money inflation in France (18th century) and our current economy. Could we avoid the coming financial disaters? Or we would face the same outcome as the French did?

Here are some quotes from Fiat Money Inflation in France (www.financialsencesnet):

"To cure a disease temporary in its character, a corrosive poison was administered (Printing Fiat Money), which ate out the vitals of French prosperity."

"New issues of paper were then clamored for as more drams are demanded by a drunkard...The great majority of Frenchmen now became desperate optimists, declaring that inflation is prosperity. Throughout France there came temporary good feeling. The nation was becoming inebriated with paper money. The good feeling was that of a drunkard just after his draught; and it is to be noted as a simple historical fact, corresponding to a physiological fact, that, as draughts of paper money came faster the successive periods of good feeling grew shorter... "

"Prices of the necessities of life increased: merchants were obliged to increase them, not only to cover depreciation of their merchandise, but also to cover their risk of loss from fluctuation; and, while the prices of products thus rose, wages, which had at first gone up, under the general stimulus, lagged behind. Under the universal doubt and discouragement, commerce and manufactures were checked or destroyed."

"Early in the year 1789 the French nation found itself in deep financial embarrassment: there was a heavy debt and a serious deficit."

"Strange as it might seem to those who have not watched the same causes at work at a previous period in France and at various times in other countries, while every issue of paper money really made matters worse, a superstition gained ground among the people at large that, if only paper money were issued and were more cunningly handled the poor would be made rich. Henceforth, all opposition was futile."

"...doubling the quantity of money or substitutes for money in a nation simply increases prices, disturbs values, alarms capital, diminishes legitimate enterprise, and so decreases the demand both for products and for labor."

"Still another troublesome fact began now to appear. Though paper money had increased in amount, prosperity had steadily diminished. In spite of all the paper issues, commercial activity grew more and more spasmodic. Enterprise was chilled and business became more and more stagnant. Whenever a great quantity of paper money is suddenly issued we invariably see a rapid increase of trade.

Jim A said...

I generally agree, but a does a recession mixed with deep declines in the exchange rate (say, the dollar dropping to 50% of its former value over a 1-2 years) imply some kind of economic Ragnarock? Personally, I'm hoping that we'll only experience a period of intermittant recession and serious stagflation for a decade, something like the late '70s-early'80s period. It wasn't the end of the worlk, although somehow it morphed into the irrational exuberance of the '90s. Yes, this will cause the world to drop the dollar as the reserve currency, and yes, doubling the price of everything imported will HURT many, but it would do much cure the trade deficit by lowering the demand for imported goods and lowering the price of exports. Essentially we'd hurting but we'd shaft foreign holders of US debt.

41cadillac said...

Remember the one wild card! The heart of the USA citizens. The feeling during WWII was beyond what the world has ever experienced. Again that feeling of strength will chance the course of 2006, 2007, and 2008.

contrarian2day said...

Appreciate everyone posting your repies.

November-I too see the house of cards waiting to tumble. I believe it'll be very soon.

Tom-agree w/ your comment on labor/materials/costs. When the ball drops, prices will decline on all.
On Outsourcing: Only when the standard of living in America is much closer (lower) to those in China/India will be become competative again. In the long-run, (10+ years) we'll be strong again

Peak- Glad someone out there is on the same wavelength. I too sold my home (renter now), invest in foreign currencies, own I-bonds, use EmigrantDirect, Gold and the like. Took many years of studying the issues before I was able to tie all the pieces together and see the interrelationships. Glad I was able to channel your thoughts

Curious: I believe all fiat currencies are doomed, but the only thing man learns from history is that he doesn't learn from history. The next world reserve will be pegged to something tangible, but will eventually will be converted to fiat.

Jim--You are probably right on many counts, but a 50% reduction in dollar purchasing power would throw the world into a depression

41cadillac-Things were different post WWII. The country banded together for survival and to win.
Today, everyone lives for himself and is not interested in the greater cause. All they care about is the next episode of survivor. Sure we will pull together in the long run, but we must face extreme adversity first.
In the long-haul, the US will be productive and competitive again.

herb said...

American Airlines is not currently in bankruptcy. The parent corporation is AMR and the stock( also AMR ) is the highest its been in several years.

contrarian2day said...

Herb--You are absolutely correct, American is not under bankruptcy protection. I meant to say US Airways (which also owns America West)...see link below.
Ill edit the paper.

Jim A said...

I suspect that we all agree that the current economic path of the U.S. is unsustainable. The questions are: what path IS sustainable, and what do we do to switch to it. I have faith that complete economic collapse is avoidable. I also believe that our current standard of living cannot be supported by our current production.

Part of the problem is that we have so internalized the belief in productivity gains that there is a perception that it will always be easier to pay for something in the future than in the present. This is reflected in the "When I'm making more money I'll pay off my credit cards" and the "If the economy grows at x%, deficits don't matter." memes. Part of the problem with this is that people tend to have a rather selective memory. Individuals tend to discount the chances of major reverses in their life: job losses, divorce, or illness. Politicians also tend to assume no disasters (Very little funding is done for disasters BEFORE they happen) and they tend to look at only best possible windows of the business cycle when calculating future growth.

People often talk about pay differences as if they were the only cause of the trade deficit and offshoring. But corporate CEOs didn't just wake up one day in 1995 and suddenly realize "Gee, those Chinese sure work cheap." Country A's workers can earn twice what country B's workers do and still be competitive if country A's economy is twice as efficient (less bribery, rule of law, better infrastructure, lower taxes, etc.) I beleive that the U.S. is becoming less competetive NOT because of anything that we're doing wrong, but because China and Mexico are increasing their productivity. They are at something akin to a boiling point of efficiency in their economies. It is perfectly possible for their economies to double in productivity in a much shorter period of time than the U.S. economy. The world economy isn't a zero sum game, but their percentage of the pie is growing much faster than the pie is. There is little that the West can do about this short of sabatoge or war. I would argue that in the future, real wages will be much closer between the U.S. and China and Mexico.

The fact that the U.S. Dollar is the world reserve currency puts us in the unique position as a debtor nation of owing our debts in our own currency. As the dollar devalues, past debts become EASIER to pay off, those dollars represent fewer real world assets. Of course current debt becomes HARDER to finance, because lendors will add a "currency risk surcharge" to the rates that they charge. Hopefully this would mean that more debt was financed domesticly. Since dollars borrowed=dollars lent this would imply a greater savings rate, although unfortunately, absent a rise in tax rates on the rich and corporations it would imply an even greater concentration of wealth.

I don't mean to imply that a radical revaluing of the dollar would be painless or without world wide consequences. I just think that it is our least bad option, and one that might avoid total economic collapse.

41cadillac said...

The Blog is great and full of information to evaluate.

General Motors and Ford are not under Bankruptcy protection as of today.

This interest rate policy of the Fed is going to be interesting. Volker kept raising interest rates to kill inflation. I once bought a home to live in at 9% 30 year mortgage.

I am an artist and my job is to interpret society. The "HEART" of man is the cause of all events.

First cause! Individual Men/Women cause events. So..... I see the USA of continual progress in its great mission of the world.

The world dismissed Washington, Franklin, ect. ect. and the new free republic as unimportant and the USA constitution as folly.

The consitution may well be hanging by a thread today; but it is still there.

Now to 2006 and 2007 events:

Yes your Bubble Report is very important. Must be taken into consideration in all investment decisions. Especially timing on purchase of a home to live in.

I see a crash and burn in housing prices. But I do not see a major recession. The 9/11 horrid event, the stock market bubble burst, and last the floods in the Gulf of Mexico did not destroy the economy.

However remember there is always a man/or woman to change events. Kennedy decided we would put a man on the moon first. He pulled the whole congress, citizens, and heart of men to accomplish this goal.

Maybe you, Randy, are that man to change events so the USA will not go into a horrible financial depression. Thank you.

contrarian2day said...

Jim--Excellent points! I will try to reply a little later.

41Cadillac--Thanks for the kind words and your faith in me, but I am just a humble, insignificant man looking for truth. Now that I understand the truth a little better, my only objective was to share this knowledge with others.
I too hope my predictions don't come to fruition, as I have five children and I'd like for their future to be bright.

As for the 9/11 and stock market bust: The Fed had plenty of wiggle room at that time and he was able to rapidly lower rates. (remember we had a surplus then, the dollar was strong and short-term rates were at 6.5%) His cut in rates, in conjunction w/ the Bush tax cuts, kept the recession very short.
If we experience the same today, the new Fed doesn't have too much room to give. Rates need to remain high to support central bank interests/support in the dollar (to continue financing our deficit and standard of living). If the housing market falls, Bernanke may try to lower rates but this action will have tremendous negative consequenses for the dollar.
He is in a pickle and knows it.
Anyway, I need to get to church--running late. I will try to post up some more later in the day.

Happy New Year to all of you!

confused said...

Very interesting article! I am one of the very few who did not buy after selling my house 8 yrs ago in Miami gaining a whopping $6000! after owning it for more than a decade. Condos on Miami Beach were selling under 200.000 in old buildings. I rented and am still renting and for the first time in my life feel utterly panicky about not having bought whene I stil could have! My landlord bought the condo I am currently renting for 214 in Jan of 2005, now condos nextdoor to mine are on the market for 350.000! I can tell you that I am really suffering and have many sleepness nights.
What gets me is that everyone talks about the mortgage but never about the property taxes which are 2.5% in Miami! As prices increase so do taxes on properties.
I for one , hope prices will come down again to a level where I can afford to buy anythng. I have almost 200.000 in the bank and technically could still afford to buy but now more than ever, it makes no sense. I am renting and paying $1,200 p/m on a property of 300.000 I would only pay between maintanance of $4800 and taxes of around $7000 that much.
Thank you for making me feel a bit more at ease during one of my many sleepness nights lately.

contrarian2day said...

You are more than welcome. No one can predict, with certainty, the future. All we can do is try to figure out the issues in-play, and base our decisions on what we think we understand. I personally feel you have made some very wise decisions.

I hope, however, that the significant savings you mentioned are somewhat diversified and not just socked away in a bank somewhere. If the Crap ever hits the fan, FDIC will be absolutely useless.

confused said...

Thanks for your response.. yes I need to diversify,have it in CD's..
To illustrate how volatile real estate has begun..yesterday the Miami Herald reported a cool down in the market and today, 24 hrs later, how new home sales have gone up by 2.9% in Decmeber.
I'm thinking of bailing out and moving to Texas where life still seesm to be more affordable.

Take care..

contrarian2day said...


See my post last night:

Hopefully, It'll shed some light on the conflicting media reports you are seeing.

BTW: I can't provide you with any investment advice, but if it were me, I'd diversify to at least 10% gold/silver assets.
Good luck!

Lee said...

Dear Randy,
Thank you for your work. I must confess that macro economics is not my thing, and though I follow you, I am not really in a position to judge. Aside from the overwhelming 'uh oh' for all of humanity, I cannot help but to revert to: what does this imply for my family? We are about to cash out of our home in Europe and are expecting to draw some substantial savings and move to the States. This sense of financial security feels full of promise, but also fragile and fleeting. I gather from your articles that about 10% of the money should go to gold (or silver) and I also gather, that you- in our shoes- would keep money in Euros and not enter the US (Phoenix) housing market at this time, but rather rent. Beyond that, what should we do? I am really at a loss- not trusting financial planners and subject to so much conflicting information- where do we actually put this money? If this weren't so important, I would balk. But this is my children's future and I hope that we can be smart within this global picture that you paint. Any advice would be appreciated (and taken with a grain of salt).
Best wishes,

contrarian2day said...


I can only speak what I believe, and I only believe what I think I understand... none of this should be taken as gospel, as no one can accurately predict the future… Do not take this as investment advice… these are only my thoughts.

Yes, I feel the fundamentals of the US economy are broken, and I honestly think we are on the precipice of major economic change. With that said, you are correct. I would personally NOT buy a home—yet. Unless you want to be upside down on your home, it will probably be wise to wait 3-5 yrs. By then, the entire market will be different and if you play it smartly, I believe you can come out ahead.

I stated to confused that he should consider “AT LEAST 10% gold & silver”. My current personal approach is ~ 30% gold/silver and I am even considering a greater percentage.

Yes, I believe the Dollar will begin a decline very soon. How bad, no one knows. I feel when all is said and done, several years from now, the dollar’s purchasing power will be around ½ of its current value.

I personally have positions in international markets (faring well so far ~ 14%), I-bonds (yielding 6.75%). Merk Hard Currency Fund is another option you could possibly consider:

If you need to remain liquid with some of your money, Emigrant Directs’ Savings account currently yields an impressive 4% (better than most short-term CD’s).

With those thoughts, I’m going to refer you to OUT AT THE PEAK: He has more suggestions than I do.

Good luck with whatever you do…


confused said...

Hi Randy,

Thanks for the advise.. yes I guess I will wait a while before buying property in Miami.
The increases in rates feel like a flood just hit us! Unbelievable and frustrating to hear those smart enough to have bought a year ago brag in the elevators..
take care, Yvonne

confused said...

Hi Randy,

Thanks for the advise.. yes I guess I will wait a while before buying property in Miami.
The increases in rates feel like a flood just hit us! Unbelievable and frustrating to hear those smart enough to have bought a year ago brag in the elevators..
take care, Yvonne

Gary Anderson said...

I was thinking about the same thing that Jim A was stating here. The recession would cause a rebalancing of trade deficit. The problem would partially correct. However, I was reading where Goldman Sachs was saying that the purchasing will be taken up by the emerging middle classes in other countries, and that our businesses would remain strong. That would keep us away from a recession, creating a soft landing for housing. But if that scenario plays out wouldn't that contribute to continued balance of payment deficits and a possible freefall of the dollar? Just wondering. No one really knows. I personally see higher interest rates, and a slowing domestic economy, but strong overseas sales and a weaker dollar. If that plays out we should have inflation before deflation. Randy set me straight!

Lem said...

I felt the same way. I had vacant land in California near Redding that I had oened for 15 years and unloaded summer of 2004.
Check out the bottom video embedded on my blog about this current crisis. We all need some humor in this blame game with all the crying going on:

HegdeS said...

A great job done. Your views are excellent and now I can easily relate them to the events which actually took place during 2006 to early 2009. Keep going, keep blogging your message here. It's interesting to read and understand the macroeconomics of USA written by you...Good Luck!

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pierce79 said...

As with all types of economic bubbles, whether real estate bubbles can be identified or prevented is contentious. Bubbles are generally not contentious in hindsight, after a peak and crash.

Within mainstream economics, some argue that real estate bubbles cannot be identified as they occur and cannot or should not be prevented, with government and central bank policy rather cleaning up after the bubble bursts.

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pierce79 said...

Others within mainstream economics and in heterodox economics, such as American economist Robert Shiller and British magazine The Economist, argue that housing market indicators can be used to identify real estate bubbles. Some argue further that governments and central banks can and should take action to prevent bubbles from forming, or to deflate existing bubbles.

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