Tuesday, January 31, 2006

Does the Fed Know What Is About to Happen?

Yes, this article is written by someone who invests in precious metals. But the article is an informative read nonetheless. It explains the current, highly leveraged situation that the US financial system finds itself in vis-à-vis the housing/credit bubbles and the possible dire consequences if the system is tipped too far off balance. I'd be interested to hear what our local experts here on this blog have to say.

I almost feel sorry for Bernanke as Greenspan steps down today (here's a fitting send-off).

Here are some quotes to whet your appetite (they don't do the article justice, you'll just have to read it):
Thus, what started out as a simple home mortgage, has been transmogrified in to something one would expect to find at a Las Vegas gambling casino. Yet the housing bubble now depends on precisely these instruments as sources of funds.

If too great a portion of FF [Fannie and Freddie] mortgages were to go into default and cease to pay interest or principal, FF would not have sufficient cash to pay the holders of its bonds. If the situation were to become too great FF would default on its bonds. So, whereas before one had one economic catastrophe - the default of some mortgages – because of the way the housing market is structured, this produces a second catastrophe – the default of FF’s bonds which are at least 10 times greater than that of any corporation in the U.S. Such a default would put an end to the U.S. financial system, right then and there.

As such, a total in excess of $12 trillion is laden on to the homes and attached to to the incomes of America's homeowners. And then there is credit card debt, car lease debt, cell phone contract debt, bank loan debts, margin debt, etc! Nothing, absolutely nothing, must stand in the way of consumers fulfilling their financial obligations - and they absolutely must not default on their mortgages. Cheap money must prevail. Not dirt cheap like before but still very cheap by historical standards. Cheap money is necessary to keep the real estate bubble in force because consumer spending increases 0.62% for every 10% gain in the housing market (more than twice that of a 10% gain in the stock market).

Regretfully, though, this FF house of cards is on the verge of collapse. Bond prices have fallen and interest rates are approaching 5%. The ramifications are dire.

The Fed is between the proverbial 'rock and a hard place'. They engineered low interest rates in the first place, both to keep the financial markets going, and in large measure to keep the housing bubble afloat. They are now in the final stages of raising interest rates to prop up the collapsing US dollar and to forestall rampant inflation. Were they to initiate one quarter percent increase too many it would destroy the interest rate environment that is essential to keeping the housing bubble alive; to keeping consumers spending at a high level thereby keeping the economy growing; to keeping corporate sales and profits high thereby keeping the stock market healthy. Have they gone too far already? The bubble seems to be loosing air slowly at this point but what will the impact be of the next increase? The impact of one too many rate increases on such a chronically debt-ridden and maladjusted economy must not be over estimated.

But rest assured the Fed will do absolutely everything in its power to prevent the puncturing of the housing bubble!... Indeed, the Fed are so concerned about this happening they are flooding the economy with almost limitless liquidity. There must be a crisis of historic proportions coming, and the Federal Reserve Bank of the United States is making sure that there is enough liquidity in place to protect our nation's fragile financial system. The amazing thing is that the Fed's actions mean they know what is about to happen.

12 Comments:

Blogger fredtobik said...

Got Fear?

I already bought into metals so I can make more money so I can buy that 2 million $ Tuscan Villa in Mill Valley.

Jan 31, 2006, 2:01:00 PM  
Blogger sf jack said...

Hey - do you think anyone in Tuscany sitting around with his family and friends says, "hey, I'm going to sell my ristorante here... so I can buy a house in Marin (perhaps a teardown POS)"?

Didn't think so.

Jan 31, 2006, 5:54:00 PM  
Blogger Tako John said...

1. Precious metals provide a terrible return over the long term. Always have. Go to Goggle. Punch in "compound interest calculator". Click on the Moneychimp link then type $20 into the window. Enter a 75 year period. This would take you back to when gold was $35 per ounce rather than $500 per ounce. At a 5% return you'd have $776 after 75 years. At 7% you'd have $3,197. With a 10% return you'd have an astounding $25,437!

2. The author is selling contradictory arguments (catastrophic deflation and runaway inflation). In all liklihood the outcome will be in the middle, and (over time) the value of houses and gold will revert to their long term averages. Yes, it will take $1,000 dollars to buy an ounce of gold someday, but as shown above, it would make MUCH greater sense to invest where there's growth potential.

This guy is SELLING metals and wants to SCARE people away from all other investments. That's the fatal flaw of goldbugs and always has been. They are either extremely overcautious or covert momentum investors. The metals sellers have owned metals and want to dump it off on a greater fool, or like real estate agents, they want to drive transaction volume and collect fees.

Jan 31, 2006, 7:07:00 PM  
Anonymous Anonymous said...

But if there was ever a run on the US dollar and the central bank needed to stabilize the currency wouldn't it revert back to the gold standard even if only temporarily?

And if you divide all the US dollars out there by the ounces of gold I'm sure it's greater than 550$!

Jan 31, 2006, 7:20:00 PM  
Blogger Tako John said...

Gold was the first fiat money (several thousand years ago it was a pretty metal used for decoration--it had no industrial value).

Gold retains it inherent value and will never deflate to zero. Exactly what you can barter for it depends on the severity of the present economic situation. If a man has 1,000 ounces of gold and no food he may well trade 1 ounce for a meal. In such a severe economic situation a gun, knife, or bow would be far more valuable than gold...

Society has moved beyond the barter system and the use of gold as the ONLY fiat money. Society sets the value of gold, just as society sets the value of stocks, real estate, and all other items.

Gold is a dead assest that tracks inflation whereas higher-risk investments in technology and growth (i.e. stocks) have vastly greater potential.

A reversion to the gold standard...not sure...

Jan 31, 2006, 8:21:00 PM  
Blogger fredtobik said...

"Hey - do you think anyone in Tuscany sitting around with his family and friends says, "hey, I'm going to sell my ristorante here... so I can buy a house in Marin (perhaps a teardown POS)"?"

That was sarcasm.

Jan 31, 2006, 8:56:00 PM  
Blogger fredtobik said...

I meant my first post was sarcasm.

Jan 31, 2006, 9:11:00 PM  
Anonymous by_palladium said...

Right on. Nasdaq has far out performed gold and gold mining stocks over the last 5 years. FALSE. For most tech investors, 5 years is long term.

There have been many periods over the past 100 years , to say nothing of the past 500 years, where gold has outperformed paper assets. Many and often by wide margin as stocks go to zero, companies bankrupt and currencies inflate away.

Too many have been bamboozled by stock market wealth, just like the real estate wealth.

Gold is a fine means of storing wealth.

Actually, any asset class can store wealth depending on the circumstance. To be so dismissive of gold is exactly what I like to hear. It comfirms that there isn't a gold bubble (yet).

Also, a little more than 75 years ago, gold was revalued by an authoritarian "democratic" government from $20 to $35. Put those real numbers in your monkey chimp and you get approx 4.5% return to todays price. That is not that bad. Given the security and liquidity and the wars in the last 75 years...IT IS A BETTER DEAL THAN PAPER ASSETS

And please, Google will need your help tomorrow. Put some of your down payment money in its shares for preservation if you think tech stocks are so great.

Jan 31, 2006, 9:12:00 PM  
Anonymous rejunkie said...

sf jack-

No, they are sitting around with family and friends because they are unemployed ;-)

Jan 31, 2006, 9:22:00 PM  
Blogger Tako John said...

To be so dismissive of gold is exactly what I like to hear. It comfirms that there isn't a gold bubble (yet).

One person disagrees so a bubble doesn't exist! Wow!!!! What a conclusion! There's plenty of disagreement at any time, every time a stock is sold there's a disagreement about its value.

It's your money.

Jan 31, 2006, 10:26:00 PM  
Blogger Rob Dawg said...

Gold is a mighty useful industrial metal and shiny all pretty as jewelry. Somebody figures out a cheaper replacement in electronics and the the stuff will only be worth what the shiny wedding band market will pay. That ain't zero but it ain't $500 either. Gold is also not supply constrained at higher prices just like oil. There may be only just so much $550 gold in the ground but there is a whole heck of a lot more $800 gold so the price cannot run up ahead of long term supply.

Feb 1, 2006, 5:39:00 AM  
Blogger sf jack said...

fred -

I knew it was sarcasm.

So was mine.

junkie -

Of course, you are right!

(some sarcasm; not a lot)

Feb 1, 2006, 11:12:00 AM  

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