Last Gasp of a Doomed Currency 28 comments
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In the latest example of financial market madness, the recent government “bailout” of Freddie Mac (FRE) and Fannie Mae (FNM) has perversely resulted in a sharp rise in the value of the U.S. dollar.
If the markets were functioning rationally, the transference of staggering new liabilities to the U.S. Treasury would have been immediately seen as catastrophic for the dollar. Instead the markets have ignored the obviously negative long-term implications and have remained fixated on the more immediate effects. However, rather than solving the problems, the government’s actions merely confirm my worst fears, and increase the chances for a hyper-inflationary outcome.
By transforming $5.5 trillion of suspect mortgage-backed securities into seemingly bullet-proof Treasury bonds, the move has sparked a relief rally in the dollar as foreign investors no longer have to worry about defaults or markdowns.
In fact, to holders of Fannie and Freddie debt, it no longer matters what happens to the housing market. Home prices can drop another 50%, every single homeowner can default on their mortgage, and bond holders will not lose one dime. This has emboldened foreign investors, and temporarily increased demand for both dollars and Freddie and Fannie debt.
Had the government done the right thing and not guaranteed Freddie and Fannie debt, I believe we would now be experiencing an outright financial crisis. The dollar would be falling sharply along with real estate prices, gold would be soaring and the recession would be deepening. However, by nationalizing Freddie and Fannie, the government has merely delayed the crisis. The borrowed time will cost us dearly, as the day of reckoning will now likely involve much steeper losses for our currency.
The Freddie and Fannie takeover does nothing to address the underlying problems that forced the companies into bankruptcy in the first place. All of the bad mortgage debt still exists. In fact, based on this bailout, there will be trillions more in bad mortgages insured over the next few years.
The only thing that has changed is how the losses will be distributed. Instead of falling solely on bond holders, who had chosen to invest in mortgage debt, they will now be dispersed among U.S. taxpayers and all holders of U.S. dollars, who made no such choices.
Over the next year or two, my prediction is that several trillion dollars of existing mortgages, not currently insured by Freddie or Fannie, will be transferred to the pile. Going forward the vast majority of new mortgages made to Americans will be bought by Fannie or Freddie.
Therefore in a few short years the $5.5 trillion of initially transferred liabilities could grow to more than $10 trillion of new obligations for the U.S. Treasury.
The defenders of the bailout claim that Fannie and Freddie debt does not represent true obligations because they are fully collateralized by homes. But anyone with a casual interest in the current real estate market knows that homes are now only worth a fraction of outstanding mortgage debt.
And that fraction gets smaller every day. My guess is that $10 trillion of federally insured mortgages could result in $2 trillion of losses, which amounts to more than $25,000 per American family.
Also, there is no reason to believe that the bailout merry-go-round will end with Fannie and Freddie. Faltering investment bank Lehman Bros. is now positioned to receive the kind of Federal backstop that smoothed the purchase of Bear Stearns back in March. Bailouts of automotive and airline companies can’t be long in coming. Once the market perceives a Federal magic wand, it becomes politically impossible to stop waving it.
In addition to adding new sources of debt in the form of mortgage backed securities, the government is also piling on debt the old fashioned way…through budget deficits. Recent projections put the 2008 deficit at $410 billion, not counting the Iraq war or any costs related to financial bailouts.
It is my guess that the annual Federal budget deficit will soon approach, and then exceed, $1 trillion, and that the national debt, including actual bonds and guaranteed mortgages, will soon exceed $20 trillion. When these untenable obligations force Treasury and agency investors to shift focus from default risk to inflation risk, a mass exodus from both Treasuries and mortgage-backed securities (now Treasuries in disguise) will ensue. The stampede will trample the dollar.
When the dust settles, the Federal government will be left with staggering liabilities that will be impossible to repay with legitimate means (taxation or borrowing). To make good, they must rely on the printing press to create money out of thin air. The rapid expansion in money supply will push the dollar down mercilessly.
Right now every asset on the planet is being sold except the U.S. dollar. To me this rally looks like the last gasp of a dying currency. Just like a toy rocket ship, once the dollar runs out of fuel it will crash back down to Earth.
Disclosure: none
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This article has 28 comments:
The feedback I have received from people I know in the real-estate Industry is that prices of both bank-owned and non-bank owned properties have bottomed out. Secondly, the intrinsic value of real-estate is very close to the selling price (construction costs have gone up and therefore the market value of a property is closer to the replacement value of the building).
Also, inflation in the US is much lower compared to other countries. Further, reduced value of housing costs puts a deflationary pressure on the overall cost of living.
The government could try to fix the problem with a bottom-up approach, rather than a top-down approach: for example by putting tough regulations against people running away from their mortgage payment obligations, just because the value of their houses have gown down.
I believe that this week will be telling the story... the meeting in N.Y. on how,why,if,should........ the most important who should step up to the plate to and save ... lehman, AIG, WM, .... its a bottom less pit that we need. The public is "bone dry", scared, and loosing jobs.... there homes have another 30% to go down.... and the Banks and Investment Houses dont want to step up and participate!
So when the dust starts to fly... where do you think the $ is going to go?
Why do you think there is a shortage of Gold coins?
You dont need a degree from MIT to figure it out.
The fact is that he has touted foreign securities, gold and betting against the dollar for a long time, and he made money in the past doing this. He's touted this type of investing all the way through the collapse in stocks from emerging markets.
Instead of getting his investors out at the top of the market, he's led them to big losses and he must have gotten further crushed as the dollar appreciated, which is something else he never saw coming.
I am a Realtor and member of the NAR and will be the first to admit that you cannot believe a "damn" thing most Realtors tell you as most are struggling to survive. I will give you an honest assessment in my area is that the industry is in crisis and it will be a lengthy drawn out period b-4 it improves.
What other Nation in the World lies so blatantly about its inflation rate? What other Nation excludes Food and Energy from its inflationary statistics? Name Just One.
Amerika is rapidly evolving toward a monopolistic, state-controlled economic system (socialism/fascism) under a democracy (mob rule) political system, which always evolves further into oligarchy (rule by the elite few). The bankster-financed career politicians in both major political parties are both responsible for this God-awful mess. They need to be fired without mercy and the Federal Reserve abolished.
Juan McAmnesty and Hussein Osama offer no change, only a choice between slow death and fast death. Chuck Baldwin, nominated by the Constitution Party (America's third largest and fastest-growing political party), offers real change, but the corporate media cartel has imposed a near-total blackout of his candidacy and party.
If we do not return to our framers' vision of individual liberty, constitutionally limited government and free enterprise economics soon, we're done. Our children will be shackled with the chains we have forged.
C. Burt Linthicum, CPA, Tampa, Florida
Moreover, market corrections (such as the recent dollar appreciation) are a normal occurrence. In fact, the most recent dollar correction was no more in magnitude and time than the 12/2004-2005 correction, at least for now. What is obvious, is that the pivot point was July 15, the day the initial support for the GSE's was voiced by Treasury. That was also the morning when crude fell abruptly at 9:30. Perhaps a good catalyst for what would have happened on technical grounds anyway. One might find another hint in the fact that, according to Treasury stats the EURO reserve position (not overall) fell abruptly by about 6.5 billion dollars some time in June. Where did it go? Intervention? The dollar will run its course, down that is, since its 20 year mean is still in the area of 90 (as expressed by the DXY) and I would not be surprised to see it teetering out at DXY 60 not too far down the road.
As for commodities, perhaps it is in order to put history in perspective:
The commodities bubble of the 70's, which lasted about 8 years, was followed by about 20 years! of "nothingness" in that sector. So why should it be so different this time? The market always sells dreams and the incalculable, and since people got hurt on stoxx in 2000 it had to re-invent itself with the inflation phantom as a catalyst. How boring would it be to peddle GE with it's relative predictiveness, when one can "make" 400 and 1000 % in gold and crude? So the market invented another theme : Inflation. The only inflation we can observe, is the self created one, caused by rampant speculation of the leveraged traders and the moronic state pension funds that needed to find a tool that bailed them out due to underfunding. Inflation, however, was the evil of the seventies and the Central Bankers, who had their founding years during that period are still obsessed in "controlling" it. What else would their justification be? They have managed to kill most major economic cycles with they arbitrary ivory tower theories. The seventies were a closed economy (sans the entire Communist bloc) we did not trade with majority of the world and the flee flow of goods was interrupted for about half a century, which afforded labor the big stick to blackmail employers (the auto industry still pays the price), with the advent of "free" world trade, this stick is gone and with it the threat of inflation.
The Government (kings/congressmen, politchicks, pick a label) now becomes the lender and as such potential owner of most of our houses, at least the mortgaged ones. But this was always the case with the states, who will own your house if you do not pay your property taxes. Now the central Government is in the mix.
And so what? It has been Government policy, a result of enlightenment, to encourage home "ownership" as a method of giving the citizen a "vested" interest in The American Pie. Simple fact is that you don't "own" your home. You occupy it subject to the government's hand in your pocket. "Ownership" language is a sop for the weak thinking. "Vested" interests in your home are subject to defeasance in a very short order, either for mortgage default or tax default, take your pick. Think you not? Visit Stockton in the Golden Bear Republic or whatever they call it nowadays.
And here's a thought not considered, or not as I have seen mentioned: in forclosure state property taxes are not extinguished (wonder who wrote that rule?). So the federal government forclosing finds itself in an inferior creditor position to the states. That is intolerable to the central government as decided by rivers of blood and fire during the Late Republican Unpleasantness.
And sewage flows downhill, immutably, so the state will pass along that risk to, well, even a socialist can guess.
But as I always say, every silver lining has a cloud wrapped around it. The silver lining herein is that at least nowadays you have the chance every four years to remove the King and his minions.
And I must add you have a rather a more civilized manner of doing so than that we saw in my late liege, Charles I.
Buying time is not so stupid as time will heal all wounds in this case.
People will want homes going forward and home prices will rise over time.
seekingalpha.com/artic...
Let's put the blame where it really belongs ! !
The debt accumulated over the past decade or so , which will continue to rise , cannot be repaid.
As a result , Peter , myself , and many others recognizing this have looked to hard asset investments as a safety/profit vehicle in this scenario.
But what we have not factored in to the "certainty" of our calculations is the timing.
For how long can a strong government continue unabashed , even if financially untenable?
Thus the recent downdraft in gold , resource stocks , etc.
The problem is that everyone (correctly) can ascertain the fundamentals ,
But NOBODY can ascertain the timing - though many think they can.
This recent downdraft proves that.
ALL the resource guys are in shock.
Maybe the debt burdens will cause the dollar to disintegrate next year -
OR MAYBE IN TEN YEARS!
Nobody freakin knows .
So balanced investing , including partial profit taking , is necessary.
Another thing that "Nobody Freakin Knows" -
Will a $ breakdown create "Blood In The Streets" ,
As some hypothesize ,
Or rather a slowly lessening of standard of living , eventually tapering off at a lower plateau than now?
The latter would allow for a gradual accepting of "less" ,precluding the scenario of an environment prone to disorder.
Remember , we've come a long way from the lifestyle of the Kramdon's in "The Honeymooners" , and yet they were able to accept their level of lifestyle .
We may be just TOO BLOATED , and a peg down wont hurt.
Real Estate values will eventually taper off and find a bottom , and that market will eventually stabilize at lower levels as dictated by its own internal supply/demand characteristics (likely helped by less supply coming on to the market) ,
But this wont help the problem of unrepayable (and continuously increasing) debt ,
And so Real Estate stabilization WILL NOT be the key to better times -
Rather just to a stable Real Estate market.
The government's current inflationary policies seriously jeopordize those expectations. In a hyper-inflationary economy wages will not keep up with the dollar's loss of purchasing power and retirement savings in IRAs, 401Ks, etc. will just disappear. These bailouts will not be paid for by taxpayers but rather by wage earners and savers,
As to your calls to buy China, well, Chinese are not going to change their spending habits any time soon. They are also leveraged gamblers too as can bee seen by their mania chart stock market. Had you read Prechter's book on deflation you would have understood that credit destruction is a much more powerful force in the short term than fed induced inflation. That is why gold is down, not because of fannie/freddie. But the cries for public bail outs will soon become very loud and new sources of credit will spring up to silence them. This new credit, on top of a greatly expanded money supply, will send gold into the ionosphere.
The best way to make money until that happens is to short the living daylights out of any company which has high debt, little cash and a stock chart that looks like a biotech startup that has peaked.
But they've been saying that every month for the last 2 years. I'd figure eventually even the most gullible people catch on to that. Guess I figured wrong.
They should have let the Market blow up with Bear Sterns. What would have happened, sure a massive stock shock but what else.
Stock and Commodity markets around the world would have closed as Governments intervened. They would have sifted through the rubble and reopened.
What would have changed?
Damn if I know, but I do not think the Government would have been put into a future quandry of assessing who to loan money to.
LEH...around for 150 years, Pffft.
Meanwhile, what should scare the hell out of individuals, Is the safety of their deposits. The Treasury has suspended the Rule regarding the Sanctity of deposits. Banks will be allowed to use them as needed to shore up their finances.
Makes one look for matresses, small, and large.