MASSIVE WORLD SPECULATION DOMINOS

Last year, many Asian and other foreign stock markets went up as much as 50%. There is a synchronized world housing bubble that is a very analogous follow on bubble from the Japan collapses in the early 90’s, and the Fed loosening following 9-11.

We had the tech bubble crash in 2000/1, and a have now a general US stock bubble that is yet to really pop. Right now, we are about at the same DOW level before the market collapses in 2001/2.

There is a massive US and Japanese bond bubble because interest rates are so low, and have been for over ten years, at least from Japan’s perspective. Japan has acted as a virtual central banker for the world, with their zero interest rates. That has caused both a multi trillion dollar value Yen carry trade (borrowing cheap yen then lending the money in the US for example for a net gain of about 3%). The massive Yen carry trade has also financed much of the world stock bubbles as of this point. Also, that money has found its way into the world real estate market bubbles through various forms of mortgage backed securities. This list is endless for the Yen carry trade.

For bonds, in general there is a huge increase in risk taking because interest rates world wide are so low. Fixed income investors like insurance companies, mutual funds and individual savers have no choice but to send their hard earned money into the under priced bond markets. There is no other place to get ‘safe’ returns.

The ultra low US interest rates of late have created the huge US and world real estate bubbles, and these are all synchronized and are going to crash together within 6 months of a public/investor consensus that a pop in the real estate bubble has occurred. This public and investor consensus has not completely formed yet, but is now forming. Housing data is now coming out every week with very significant statistics that prove the housing bubble is cooling. With over 30% of homes in the last few years being purchased as second homes or investment/speculation properties, the now 6 months backlog of houses on the market is going to cause a rush to the exits for speculators. That will ultimately bring down the housing market all by itself, even if many people did wish to keep their overpriced homes for a few years.

There is an unprecedented derivatives atom bomb waiting to collapse. The derivatives outstanding according to the Bank of International Settlements (BIS) has grown from roughly $20 trillion of value in the early 1990’s to about $300 trillion now. The Fed and US banking authorities have had two meetings in the last year to address the fact that there is a very large percentage of these derivatives agreements that are not closing their paperwork within even a month of their creation! The Fed and other regulatory agencies are very concerned that the Banking industry cannot handle the volume.

Warren Buffett has stated that derivatives are weapons of financial mass destruction, due to their incredible leverage. Every year now, we hear of old time banks and new ones going broke in a day or two when a derivatives trade goes south for them. The recent victims are the Chinese petroleum procuring company that lost about $700 million in some air fuel hedges gone wrong. The trader responsible has been arrested, as I recall, and probably going to rot in a Chinese work prison.

What would happen if there was a real interlinked derivatives domino collapse and not just one affecting two or three banks only? A financial catastrophe of unimaginable scope.

Now I am going to stop here listing the dominoes that are all synchronized world wide, because my fingers are getting tired, and I don’t plan on typing all day and night to even to begin to list all of these. I just wanted to list enough to give you a good idea because:

All of these dominoes are going to crash together in a period of less than a year of each other and perhaps even within 3 months of each other! I’ll tell you why in a moment.

Also, at this juncture, I wish to say again that there is a big ETF mania going on in all financial and commodity realms. The hot ticket is supposedly hard asset ETFs, to include gold. Many investors are turning to ETFs because they are a hot new idea. Hedge funds and other speculators are pouring money into ETFs, and increasing volatility in the metals markets.

My point is that ETFs are a hot investing vehicle, but are not suitable to people who want to own metals for monetary and wealth safety reasons. For speculators, I suppose ETFs are fine. In fact, most of the activity in ETFs now are speculators anyway and they are not in them for the monetary reasons, but to obtain speculative gains. I go into this in more detail in a special ETF report out this week at the PrudentSquirrel newsletter.

The issue at hand about the world stock, bond, and real estate bubbles is that they are all peaking together. They are all at historic highs. And they are all peaking at the same time in every nation on earth. Developed nation or not, many world stock markets had incredible gains in excess of 50% just last year!

That, combined with maturing real estate bubbles world wide, and the fact that bonds are at a high peak because interest rates have been so low mean that, when any one of these lets go, it will cascade into the other like markets around the world. That cascade in the like markets will lead to stampedes out of the other bubble markets as well.

Then we will see a massive financial collapse with all the synchronized bubbles world wide, real estate, bonds, stocks collapsing in one fell swoop.

This will not be just a national or regional collapse, it will be a total world economic collapse because all these bubbles are now synchronized.

Kondratieff studied bubbles of all kinds, from population growth to economic. He found that bubbles invariably rise until a catastrophic collapse. It is my view that we are in the last stages of a world synchronized Kondratieff bubble that has subsumed all of the world stock, bond, and real estate markets. The inception of the final stage of this bubble occurred in the 1990’s when Japan opened a decade long policy of zero interest rates. That money ultimately acted like a global central bank liquidity wave that has found its way into all world markets, and has synchronized them in conjunction with the tech revolution and the emergence of globalization. The US participation since 1998 and after 911 only heightened the process and magnitude. © 2006 Christopher Laird

Here are a few "chicken littles" who are NOT selling gold. Please note the academic and business credentials of these "chicken littles."

Rodrigo de Rato, Managing Director of the International Monetary Fund at a recent speech at the University of California at Berkeley, stated that “while global current account imbalances have been widening, the fact that they have been financed easily thus far seems to be inducing a sense of complacency among policy makers. I think they should be more concerned. This is not to say that the risk of a disorderly adjustment is imminent, but the problem is growing, and if a disorderly adjustment does take place, it will be very costly and disruptive to the world economy.

The most visible aspect of the global imbalances problem is a very large deficit in the current account of the balance of payments of the United States – amounting to about 6.25% of GDP. The main problem is that in the United States savings are too low. These global imbalances could unwind quickly, and in a very disruptive way, with either an abrupt fall in the rate of consumption growth (i.e. increased savings) in the United States which is holding up the world economy or by investors abroad becoming unwilling to hold increasing amounts of U.S. financial asset, and demand higher interest rates and a depreciation of the U.S. dollar, which in turn forces U.S. domestic demand to contract.”

Economic Pain

Timothy Adams, Undersecretary of Treasury for International Affairs, stated recently that “the world economy is dangerously imbalanced and the U.S. current account deficit is now at levels that many experts fear could trigger a run on the dollar, soaring interest rates, and global economic pain.”

Severe Consequences

Robert E. Rubin, director of Citigroup Inc. and former Secretary of the Treasury; Peter Orszag, Senior Fellow at Brookings Institution; and Allen Sinai, Chief Global Economist at Decision Economics Inc., made a presentation to a joint session of the American Economic Foundation and the North American Economics and Finance Association recently.

They stated that “the scale of the nation’s projected budgetary imbalances is now so large that the risk of severe consequences must be taken very seriously. Continued substantial deficits could cause a fundamental shift in market expectations and a related loss of confidence both at home and abroad. This, in turn, could cause investors and creditors to reallocate funds away from dollar-based investments, causing a depreciation of the exchange rate, and to demand sharply higher interest rates on U.S. government debt. The increase of interest rates, depreciation of the exchange rate, and the decline in confidence could reduce stock prices and household wealth, raise the cost of financing to business, and reduce private-sector domestic spending.”

Wild Ride

Paul Kasriel, Director of Economic Research at Northern Trust and co-author of the book ‘Seven Indicators That Move markets’, has stated that “If foreign creditors should question our ability and willingness to repay them without resorting to the currency printing press, there could be a run on the dollar, which would lead to sharply higher U.S. interest rates, which would do great harm to household finances and the housing market, which would put a crimp in consumer spending, which would increase unemployment, which would result in a spike in mortgage defaults, which would likely cripple the banking system given that a record 61% of total bank credit is mortgage related, which would, in turn, render future Fed interest rate cuts -expected on or about September 20th, 2006 - less potent in reviving the economy.

We have the most highly leveraged economy in the postwar period and the Fed is still raising rates and in the past 30 years or so, whenever the Fed has raised interest rates, we have usually had financial accidents. Our federal government is spending like a drunken sailor so my advice is to put on your safety harness as it is going to be a wild ride. My bet is that we are going to end up on the rocks.”

Category 6 Fiscal Storm

Isabel V. Sawhill, Vice President and Director and Alice M. Rivlin, Senior Fellow of Economic Studies at the Brookings Institution have said that “the federal budget deficits pose grave risks – a category 6 fiscal storm – to the U.S. economy. The current course is simply not sustainable. Promises to the elderly, especially about medical care, cannot be kept unless taxes are raised to levels that are unprecedented or other activities of the government are slashed. Postponing such action would be reckless and short-sighted.

Massive amounts of capital have flowed in from around the world, financing much of America’s federal deficit, as well as its international (or current account) deficit. While this inflow of foreign capital has kept investment in the American economy strong it means that Americans are accumulating obligations to service these debts and repay foreigners out of their future income. As a result, the future income available to Americans will be lower than it would have been without the government deficits. Foreign borrowing also makes the United States vulnerable to the changing whims of foreign investors. There is a risk that Asian central banks, or other large purchasers of dollar securities, will lose confidence in the ability of the United States to manage its fiscal affairs prudently and shift their purchases to euros or other currencies. Such a shift could precipitate a sharp fall in the value of the dollar, which could cause a spike in interest rates, a plunge in the stock and bond markets, and possibly a severe recession. The risk of such a meltdown is unknown, but it seems foolish to run the risk in order to perpetuate large fiscal deficits, which will ultimately reduce Americans’ standard of living.”

Drastic Fall

Sebastian Edwards, the Henry Ford ll Professor of International Business Economics at UCLA’s Anderson School of Management and a research associate of the National Bureau of Economic Research and has been a consultant to the Inter-American Development Bank, the World Bank, the OECD and a number of national and international corporations, has stated that “The future of the U.S. current account – and thus of the dollar – depend on whether foreign investors will continue to add U.S. assets to their investment dollars. Any major reduction in the USA’s ability to obtain sufficient foreign financing would cause the dollar to fall by 21% to 28% during the first three years of any adjustment period, cause a deep GDP growth reduction, and push the USA into recession.”

Substantial Macroeconomic Consequences

Ian Morris, Chief US Economist at HSBC, has said that “about half the US housing market may be overvalued by as much as 35-40%. When these housing bubbles begin to deflate, it is likely to have a substantial macroeconomic consequence.”

Serious Collapse

Ian Shepherdson, Chief US Economist for High Frequency Economics, has warned that “house price increases are going to slow much further dragging down expectations for future price gains and therefore raising real mortgage rates. This, in turn, will be the trigger for a serious collapse in home sales. The housing market is a bubble, and it will burst.”

Systemic Banking Crisis

Richard Duncan, a former consultant for the International Monetary Fund, current Financial Sector Specialist (Asia) at the World Bank and author of the book, ‘The Dollar Crisis’, writes that “the United States’ net indebtedness to the rest of the world, already at record highs, will continue to increase every year into the future until a sharp fall in the value of the dollar against the currencies of all its major trading partners puts an end to the gapping US current account deficit or until the United States is so heavily indebted to the rest of the world that it become incapable of servicing the interest on its multi-trillion dollar debt.

In the meantime, as long as the US current account deficit continues to flood the world with US dollar liquidity, new asset price bubbles are likely to inflate and implode; more systemic banking crises can be expected to occur; and intensifying deflationary pressure can be anticipated as low interest rates and easy credit result in excess industrial capacity and falling prices (i.e. deflation).”

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