The great unraveling..

[blazespinnaker]

Well, folks. The party is getting underway. The time of ka may be at hand.

It begs The Question:


- will the CPI numbers pressure ben to pause long enough to drive the global economy into real (but perhaps shorter term than the alternative) misery? or

- will ka start in earnest?

Anyways, place your bets, because now's the time to do it.

[Harry Pottery]

Re: The great unraveling..

I've been lurking here for a while, because I usually find the discussions to be insightful. But I finally have to chime in on the housing situation. Here's my two cents:

It seems to me (amatuer economist that I am) that the Fed is stuck between a rock and a hard place. Either it must keep interest rates up just high enough to prevent a crash in the value of the dollar (a la Volker and Greenspan), as China et. al. have no reason to buy U.S. treasuries if the interest rates are falling. Of course, this means bad news for the housing market, as it removes the fuel that has kept home values outpacing wage gains (which are non-existant).

The alternative is to lower rates to generate an ample flow of money into the housing market, and this means bad news for the dollar (see above).

My prediction is that (like Volker and Greenspan) the current Fed admin will protect the dollar at all costs. Whether or not it causes massive domestic problems or not has never really concerned the Fed in the past. They see their job as protecting the value of money, and that is what I see them doing now. Of course, this won't stop the slide in the dollar; it will just make it slower and steadier. All of this is compounded by the fact that the U.S. will ultimately accept it's failure in the middle east, and Sunni controlled oil fields will sell their product directly into Euros and Yuan--putting a steady and controlled end to the era of the dollar as the "adjustable peg".

I'm not saying this with any particular joy (or dispair), but I see the U.S. position in the world today as similar to the British Empire toward the end of the Victorian era. The U.S. is watching it's position as hedgemon come to an inevitable end. There is just no way around it. It doesn't not have a sustainable national economy to support it's preposterous military budget and prison population. Particularly when that military cannot accomplish it's current objectives anyway. No other nation in the world has any special interest in seeing the U.S. continue to dominate--when everyone else stands to gain something if it falls.

The only real solution to prevent housing prices from rapidly deteriorating is to somehow get some sizable gains in stable employment and wages for U.S. workers. And my argument isn't based on some feel good rhetoric about the plight of the worker. I'm just talking economic reality. Housing prices have been rising so rapidly during the last 10 years, while education costs and price inflation have risen as well. This simply means that young people entering the world today have little choice but to assume debt and hope that they can use their financed educations to make bigger wage gains down the road. Meanwhile boomers are buying second and third houses thinking to themselves what marvelous investments they are--after all, real estate never goes down in value, they say. It doesn't take a rocket scientist to figure out that the boomers don't have anyone to sell their properties (and stocks etc.) to. If wages don't go up, then prices of homes and other commercial paper will come down.

Since there are no wage gains on the horizon, real estate has no where to go. And now that lenders are deciding that they should apply some standards to their issuance of new loans, they are going to quickly find that there are few people to make loans to. It's a downward spiral that is caused by oversupply.

Keep in mind that the media will do it's best to cheerlead a recovery at every possible sign of good news, whether fabricated or not. But the trends will continue for several years, and its going to get ugly. People laughed at me several years ago when I predicted the fall in the value of the dollar and stated flatly that the Euro will be the next adjustable peg currency. They weren't laughing last fall when the dollar hit it's 15 year low. Some laughed in my face when I said that real estate values were far to high compared to wages (that was several years ago as well). It took longer than I thought, but the drop in home values has begun. This global economy has been headed for a massive "correction" for a very long time. Its not founded on reasonable principles of economics anymore--its built on the principles of "every man for himself", and real economies just don't work that way. I've already begun to see people I know get slapped by reality as they realize that they are in far over their heads in their houses, and they have no one to sell them to--leaving them to be modern day sharecroppers working to pay off never-ending debts that have no value.

Unfortunately, change won't come from the current political admin on either side of the aisle. Change will only come when enough people at the top have lost enough money and enough people at the bottom have caused enough trouble to make the political admin react. That will take years most likely. Although you never know...sometimes history surprises us.

[grapejelly]

Re: The great unraveling..

Nice post, Harry Pottery.

I think the Fed policy is to prevent a deflationary collapse at virtuall any cost. They will re-inflate like crazy to forestall the barest whiff of deflation. That is what they have done since 1987 and that is what they will continue to do.

This puts a bid under all assets over time.

Yes, it can't continue forever. But as we've seen with other bubbles, it can go on far, far longer than anyone dreams possible.

One thing perhaps you are not taking into account is that there will be a big bailout of the real estate lenders.
It may take a trillion dollars but they will be bailed out.

Here is how this could shape up:

1. Congress forms a GSE patterned after Resolution Trust Corporation of the S&L crisis. Call it RTC2

2. RTC2 issues bonds. It buys portfolios of loans from lenders. It issues long term forebearances to homeowners -- their resets are indefinitely postponed, workouts into new loans with zero fees, and so forth.

3. The middle class cheers. Politicians get re-elected.

The casualty? A falling dollar. But as long as the dollar index doesn't fall below 80, who cares. Meanwhile, as the dollar trends towards 80, perhaps in a selling panic, the exporters such as Euroland, Japanese and the Chinese intervene and cheapen their own currency and the danger is past. They will not allow the US$ to fall this low.

Why do they do this? Because they believe in the need to export to America at any cost.

When will it stop? Dunno. Michael Hudson believes some exogenous event will intervene, an event that is by definition impossible to predict. But until then, the game will continue.

Because I view this scenario as almost a certainty, I no longer believe residential real estate will crash in the US in nominal terms.

In real terms it will slide lower and lower over the years. Think the US stock market since 2000 in gold terms.

Eventually, inflation comes to the rescue. Real wages won't be higher but nominal wages will be. And with all the forebearances and postponements, at some point, residential real estate will become affordable again.

[Harry Pottery]

Re: The great unraveling..

You make an excellent point about the bailout scenario. Yes, I can see this too. But the only point I disagree on is that China feels it must indefinitely export to America. I see how this is true right now and in the short-term future, but it seems that at some point other emerging markets will provide China it's much needed consumers--like China itself or India or Europe.

If all that's needed is bodies to consume, then those can be gotten anywhere. And as the dollar value drops, other currencies relatively gain--thus making their consumers have stronger buying power. So why the special status for American currency? It used to be that there was no other stable alternative currency, and the dollar was stable due to the U.S. dominance of all seas and nearly all land at the end of World War II. This is no longer the case, as modern warfare is rendering traditional military might nearly useless (i.e. the undeclared "war" in Iraq). What Englishman could possibly have taken the fall of Sterling and the end of the Empire (upon which the sun never set) seriously in 1890? The idea was absurd at the time.

I'm not rooting for the collapse of the U.S. Its just that, in reality, I don't really think there is any such thing as the U.S. anymore. I'm a big fan of William Greider, and I think his book "One World--Ready or Not" pretty much hits the nail on the head. There is a lot of talk about America this and that, but in truth there really is no such unified entity anymore. The Virtual Senate of global finance has replaced any previous notions of statehood, and America is not exempt from this. That's why our politicians so brazenly ignore popular sentiment on issues ranging from the "war" to "health care". For instance, isn't it odd that America fights it's global "war" on terrorism with weapons whose manufacture (parts and labor) is internationalized into every conceivable part of the globe? There isn't a single product labeled "Made in America" that is, in fact, actually made entirely in America. After reading the above-mentioned book, I can no longer take seriously any politician's (or economist's) rhetoric about the "American Economy". There just isn't any such thing. That's why our politicians aren't acting in it's best interest; they act based on the dictates of those who get them elected--see the above mentioned Virtual Senate.

So, we are probably on the same page...the future is likely to be a continuation of weakening dollar (slowly and surely) and, at least, a stagnant housing market.

The thing that gets me about inflation is: what kind? No one usually addresses this. Price inflation? how? Where does the consumer keep finding these extra dollars to cover the rising costs of necessities? Wage inflation? Might be a good thing, even just in nominal terms. Both? The previous period of "inflation" (the 70's) benefited debtors, because wage gains were made simultaneously as the dollar value weakened (because America still had unions earning workers new contracts). Remember how Volker and Reagan put an end to that ride? Today, that's just not the case; we have been riding the Volker/Reagan wave for almost 30 years, so that dog just has no more bite. Frankly, the student loan generation needs some straight up inflation of the 70's variety, if the boomers intend to sell their assets during retirement. But we just aren't seeing that. In fact, pressure on wages keeps driving them in the opposite direction, thus ushering in deflation, which obviously the Fed wants to avoid at all costs. If it can't operate from it's previous playbook, what can it do?

I just don't see any easy way out of this mess, and finding an even somewhat reasonable discussion of this situation on mainstream media outlets is laughable, so it's not like this is going to be addressed in the next "elections".

[jk]

Re: The great unraveling..

i'd like to address your remark, harry pottery, that the fed will defend the dollar because "they see their job as protecting the value of money." if you change that to "protecting the banks and financial system," you come to different conclusions. in times past those two goals might have been compatible and congruent, but no longer.

think about the financial superstructure that has been built on the back of the housing market: the mbs and specifically rmbs [residential mortgage backed securities], the cdos composed of deconstructed rmbs, the cds on the cdos, the synthetic cdos made up of rmbs and cds. this whole edifice is in danger. other threads here discuss the various dangers in housing - not just the sub-primes but the alt-a's and the primes as well. i think gj's rtc2 scenario is quite likely, but the fed will have a role, too, and must not raise rates. they are indeed between a rock and hard place, and your notion of a steady but sedate drop in the dollar is the best we can hope for. but gj, i am skeptical that 80 will hold. gj, you say that foreign cb's will intervene to preserve the u.s. export market, but if the u.s. housing market is, at best, frozen, where will the dollars come from to support u.s. consumption? with no wage growth, rising costs for energy and food [luckily not part of core inflation :rolleyes:], and no home equity to draw on, how is joe sixpack supposed to pay for that plasma screen he wants? so, yes, i think that domestic demand in europe and especially asia must grow, but i think the u.s. export market is going to become decreasingly relevant in the thinking of global cbs.