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EScroogeJr (< 20)

Impending destruction of the US Economy



December 14, 2007 – Comments (4)

Morgan Housel has launched his attach against the US economy:

His argument is very simple: If we increase rates, we lose all our housing equity, and if we lower rates, we lose our foreign investors who have been financing our spending, ergo, we're up (censored) creek without a paddle. Simple and convincing.

Every time you hear an argument that simple and that convincing, you should ask yourself what it is that you're not being told. 

The housing part of Housel's argumentcould not be more true. In fact, I have repeatedly stated my belief that the billion crying voices of homeowners, lenders, brokers and investors make it all but impossible for the Fed to raise interest rates even by 0.25%. So the rates can either stay the same or go lower. Once they go down and do their job of inflating house prices, they can't go up. Let us agree with Housel on this point.

Now, the other part: foreign investors. Housel is right to point out that the dollar has become an unattractive currency. But before we sign the dollar's obituary, let us ask ourselves what are the other currencies that Housel considers attractive.

The euro? I'm sorry to bring you bad news, but Europe is even closer to a recession than we are. Why? Because with the euro costing $1.5, you can't produce anything in Europe and sell it to America. And vice versa, there is no way to protect your domestic market from American imports (to say nothing of China).  The only way for Europe to avoid a recession is to lower its own interest rates and devalue the euro. After all, our two economies are very similar, and the same forces that compel us to devalue the dollar are equally felt by the European central bank. The same is true for the British pound, and to make matters worse, the housing bubble in England is every bit as nasty as here. 1/3 of the British population say they would like to leave the country to escape their mortgage payments. What else? The yen? It's the same old story: the moment the yen gets any higher against the dollar, Japan slips into depression that brings the yen back to its current value. Chinese yuan? This is the only currency that can and will appreciate against the dollar, but it won't happen too fast, the Chinese central bank will control the process. Anyway, the Chinese are financing us because they need to export their surplus capital, and that need will not go away, so it's not a competition of $ against yuan, but rather a competition of $ against the other currencies. Of the remaining currencies, only Latin American currencies hold any promise, but then again, once these countries get an influx of capital, they are going to develop their own housing bubbles which then will need to be maintained by lower rates and currency devaluation (this has already happened to Russia and the Ukraine, and now their central banks are printing money like there's no tomorrow). To summarize, when you look at America separately, it does seem that the dolar has to plummet, but then, once you remember that you can only fall relative to something, this leaves you wondering what is that other currency the dollar is going to plummet against becuase all the other countries are either in the same stage of the cycle or on the way there.

Plus, even if foreign capital did leave the US, how would that damage the economy? What is this capital doing here anyway? Toyota is one exception when foreign capital builds car factories in America, increasing the industrial output, but it is the exception that confirms the rule. For the most part, this capital was invested in American CDOs of all varieties and flavors. If it leaves, well, nothing will change for those few extant Americans who are still producing real things. And as for the mortgage lenders, they will cry at first, and then Bernanke will turn on his printing press and replace the lost foreign capital that buys mortgage securities with the same amount of capital, only produced domestically. And the mortgage lenders will smile and live happily ever after. Because regardless of the global situation, with printing presses working and with Bernanke's hand on the helm, capital is the one thing that America can always produce cost-effectively. 



4 Comments – Post Your Own

#1) On December 15, 2007 at 4:05 AM, cluelessmorgan (82.22) wrote:

Good post.

Just a few notes on inflation: It should be built into your portfolio in the first place between 3-5 % right?  So nothing really too out of the ordinary in that sense. 

Last time it was about where it is now was 1991. Was in the 6% range in 1990 (Sept-Dec)


Bank prime rate at that time (1990-1991) was between 9-10%

Just some info to ponder.


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#2) On December 15, 2007 at 5:12 PM, GS751 (26.87) wrote:

Graham says the number one enemy of the investor is inflation.

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#3) On December 16, 2007 at 3:57 PM, abitare (30.11) wrote:

A video to match your title:

The inevitable collapse of the dollar: 

"capital is the one thing that America can always produce cost-effectively. "

lol.  The US is selling assets in order to maintain its glutton lifestyle. 

Eventually, the US will have to cut back.

Warren Buffett makes the call in 2003 of what the US can do: 

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#4) On December 16, 2007 at 5:30 PM, EScroogeJr (< 20) wrote:

Interesting. And yet:

-the value of houses has doubled since Buffett made his call 

-the value of publicly-traded stocks has almost doubled. 

-so the percentage of net worth owned by foreigners has stayed roughly the same.

-foreigners failed to increase their share because they were robbed by the increased M3 supply, which resulted in asset inflation.

-Americans were insulated from this inflation becuase they were invested in stocks in houses. Except the minority of Americans who were invested in cash and who therefore fared just as miserably as the  foreigners. Anyway, they have been pauperized by now, so they won't count for the future net worth calculations.

-Foreigners who were smarter than the average could have done better by investing in American real assets rather than bonds, but they did not because they rightly figured that their own stock markets offered even greener pastures.

-It's unlikely that foreigners will ever own a large portion of American real estate, stocks, farmland, etc. becuase owning foreign property is only safe when you can control that foreign country's domestic policy, making sure that this country will protect your property rights. It is always safe for Americans to own assets in Nicaragua, but it's far less safe for Nicaraguans to own assets in America.

-The reasons foreign governments have been accumulating American bonds have always been more political than economic. To discontinue this policy would require a political decision, which has kind of always been looming on the horizon but for all we know, may never materialize. 

-The trade deficit is already beginning to narrow, the dollar has fallen far enough,  the farm economy is already fully competetive, the industrial machinery segment is on the way there, European exporters have lost competetiveness across the board, other exporters are losing it in every sector except commodities, only the Chinese exporters are still holding on.

Has the dollar exhaused its depreciation potential? Probably not. But the bottom is nearer than some panic-stricken people imagine. 

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