[PEN-L:28448] storm watch

["Devine, James" <jdevine@xxxxxxx>]

Title: storm watch

from http://www.financialsense.com/stormwatch/update.htm:

From my perspective, the economic state of our Union looks unhealthy and terminally [!!] ill. All of the excesses of the 90's, which resulted in a mania in financial assets and a debt-induced spending binge on behalf of consumers, have left the economy with a huge hangover. It is hard to conceive that the consumer, who is already burdened by debt, could be expected to go even deeper in debt in order to sustain a lifestyle. Growing job layoffs and collapsing equity markets should be giving consumers reason for pause. If policy makers and strategists see a booming economy and a surging equity market, it would be hard to find the catalyst outside of war. [now there's a statement to make a pen-l heart go pitter-pat! -- JD] Companies are reluctant to spend and expand capital investments. They are in the process of reliquifying their balance sheet. This points to further contractions ahead. Consumers are tapped out. Marginal borrowers are already going into default or delinquency on loans. It is just a matter of time before more households find themselves in greater financial dire straits.

The Fed cites the strong housing market as a key ingredient and big positive for the economy. However, what the Fed has done by keeping rates artificially low is to create another asset bubble. Housing has replaced the technology bubble. The Fed is trying to keep the housing cycle going in order to keep the consumer afloat. Rising housing prices have helped to mitigate some of the damage from hemorrhaging financial markets. Consumers have remained optimistic and have held on to financial assets in the belief that the economy will eventually improve.

What has not been reflected upon by most households is that their own debt spending and housing purchases are one of the few lifelines left holding up this economy. The increase in property wealth has made up for the losses in the stock market. What happens when housing prices no longer continue to rise or when interest rates begin to climb? The housing bubble will crumble. The consumer will no longer be able to extract equity from their homes at little or no cost. Tapping home equity has been a painless way to maintain consumption. Even though mortgage debt went up as consumers extracted more equity out of their homes, payments remained the same or went down because of lower interest rates. It was like getting free money. In other words, mortgage debt went up and equity was extracted from the rise in housing values, yet payments remained the same.

More than anything else, this credit and housing boom explains the mild nature of this recession. It is the reason this recession is different from previous recessions. Unlike past recessions when housing declined and led the recession, this time housing remained strong. With the lowest interest rates in over three decades, consumers have been able to continuously tap the equity of their homes to finance consumption. Since 1998 newly refinanced mortgages have been 6-7 percent greater than the mortgages they replaced.1 According to the Fed, this equity extraction has been averaging about $60-80 billion a year. That is why consumption has accelerated, rather than decline, during an economic downturn. This recession has been a business-led recession. The consumer's spending and borrowing binge and government spending have been the only things holding up this economy.

What happens when the final asset bubble in housing collapses? What's next -- a major war? The bubble in housing will come to an end. When it does, the full impact of the debt and spending binge of the 90's, which continues to this day, will hit the economy and the financial markets with full force. The effects will be devastating on households, businesses, and the financial markets, as well as for the country. It is only then we will have learned that there is no such thing as the alchemist's stone. The endgame is drawing to conclusion for central bankers. They thought it could be postponed. But fiat-based money systems have historically ended tragically. [?? haven't commodity-based money systems also ended tragically?] The end will be brought about by a financial storm. It is now my greatest fear that we are getting closer to my storm scenario -- a storm front in the credit markets, clashing with storm fronts in the stock market, combining with a storm front in the economy to form The Perfect Financial Storm.

The financial jet stream, which is the international monetary system, is moving the storm fronts towards a collision course. Like the Perfect Storm of 1991, the financial markets could erupt with a force so intense it will be unlike anything present-day investors have ever seen. The Perfect Storm was a rare occasion of fate, a freak act of nature. It was the result of a cold Artic cold front joining forces with a warm tropical hurricane that created a pressure gradient most meteorologists will never see in their lifetimes. Let us hope that we never see its equivalent in the financial markets.  ~ JP

(c) 2002 James J. Puplava

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The above is better than the previous week's commentary, but this concern with "fiat-based money systems" ending "tragically" is strange. When they've ended, it involves heavy inflation. But what the world needs now is inflation, sweet inflation.

Jim Devine jdevine@xxxxxxx &  http://bellarmine.lmu.edu/~jdevine