The International Forecaster - World Markets
Bob Chapman
June 10th, 2006
www.theinternationalforecaster.com
We find it of great interest that the Federal Reserve tells us whether or not they will continue to increase short—term interest rates based upon upcoming data. They have to know as we do that the data, at least from the Bureau of Labor Statistics, has been altered. The question is do they use the altered data? Does the Fed have its own unaltered data? We don’t know because the Fed won’t tell us. It is a secret, just like M3 is now a secret. The Fed has partial transparency, so it’s very difficult to discern on what they are basing their decisions. It’s certainly not completely on data as they say it is. Based upon past performance the Fed is still a year behind what has already happened in the economic and financial worlds.
That brings us to today’s monetary world. If the Fed carries through and raises interest rates ¼% in June and ¼% in August, the dollar index probably at this time won’t brake down through the long-term support level of 80. On the other hand, if the Fed pauses, the professionals in the bond market will sell Treasuries and drive yields up anyway and the dollar could break 80. This is not an enviable position. The best avenue for the Fed is to make the two increases. That would put the US ten-year Treasury note at 6 7/8% to 7 1/8%. That would slow the economy, would slip into recession. The Fed would continue to increase money and credit trying its best to hide what it is doing. That means an inflationary recession, known as stagflation (stagnation and inflation simultaneously.) Historically the Fed has always tightened too long and too much and they’ll probably do so again. In addition, this time not only have they created monetary aggregates, but they have also continued to do so. This time they have to deal with a dollar that has to be depressed by 30% to 50% - probably 50%. In addition, both government and consumer debt, both of which are at record highs, has to be serviced at an ever more expensive rate. As housing prices flatten out and then decline, so will consumer spending that makes up 71% of GDP.
There are a number of reasons for real estate to decline, besides being well overpriced. Staggering inventory, higher interest rates and affordability. April’s affordability index was the lowest since July 1990. Last week’s 30-year fixed rate mortgage averaged 6.66%, the highest in some time. In 1990, the median house price was 2.7 times the median family income. Today it is 5.9 times. A year ago real estate began challenging the law of diminishing returns. Today the growth in prices is almost gone and by September it will be gone and the slide will be underway. Interest rates are not going to spike higher, but they will gradually go higher. At no time in the immediate future can rates fall. If they were too the dollar would be decimated. As an aside, the dollar will be under constant pressure as Russia, Iran and Venezuela sell oil-denominated in euros and rubles. The very foundations of the dollar as the world’s reserve currency will be under constant threat. As the dollar depreciates goods and services being imported into the US will be more expensive. That means a reduction in consumer spending and higher inflation. As house prices slide equity s reduced. That means fewer equity loans and cash outs, which have been adding billions in spending by consumers - sixty percent of which kept consumers from financial difficulty. We have had wage and salary increases but they have been limited. Income rises 3% and inflation rises 10%. That means even less purchasing power or less discretionary money available for spending.
Over the past four months the economy has started to slow down and that doesn’t help matters. The momentum has been lost. Just look at the new orders index. It fell from 61.9% in February to 53.7% in May. Prices have risen ten months in a row. In just four months that index has risen from 62.5 to 77. The choice is higher prices and inflation or less corporate profits. We believe most of the higher costs and inflation will be passed on to the consumer. During the third and fourth quarter there will be a peaking out which we predicted early in the year. A poor real estate high season will be a shocker to many, as will persistent inflation.