The Big Picture on Gold, Silver, Real Estate, and the U.S. Dollar

I have come to the conclusion that the nascent implosion of the U.S. residential real estate bubble is going to have some far-reaching macroeconomic consequences. We are just starting to see the beginning of the real estate collapse. The adjustable rate mortgage (ARM) reset clock is ticking, and the home foreclosure rate is just starting to spike. I predict that in just three or four months, the housing market collapse will be just as big a news story as the Savings and Loan crisis of the 1980s. There will be plenty of hand wringing and finger pointing. The lenders that foolishly loaned billions of dollars to home buyers that weren’t actually credit worthy will get most of the blame. There will be congressional investigations. There will also probably be some Enron-esque collapses of banking and derivatives trading giants. Followed, of course, by some sort of bailout at taxpayer expense. (Some pieces of of American history keep repeating. I still remember the $1.2 Billion Chrysler bailout and the $481 Billion S&L bailout.)

In 1978, the total debt burden of households in the U.S. was less than $1 trillion. But as of 2007, it is more than $13 trillion! We drowning in debt. As house prices collapse, so much money will be lost (on paper) in such a short period of time that the debt merry-go-round will suddenly stop. There will be an enormous, collective gulp and an un-spoken: “Oh my Lord, what have we done?” For roughly the past five years, American homeowners have been using their houses like ATMs, “extracting” cash from them, usually through “home equity loans” or in a wad of extra cash when they re-financed their mortgages. These are called “Mortgage Equity Withdrawals” (MEWs), in banking circles. MEWs have pumped an extra two trillion dollars into the economy in the past five years. A lot of this money has been squandered on big screen televisions and other useless Schumer that folks have wheeled home from Wal-Mart. When the MEW money merry-go-round stops, the economy will surely go into a deep recession. (Since consumer spending is the biggest driver of the economy.) As the economy tanks, the Federal Reserve Open Market Committee (FOMC) will eventually have no choice but to cut short term interest rates. By doing so, they will be creating new money on a grand scale.

As the housing bust develops further, there is the real risk of a stagnant economy, even with very low interest rates. (A classic liquidity trap) If consumers still feel squeezed and if they still worry about lay-offs, they will curtail their spending. Ben Bernanke has publicly stated that he will drop greenbacks out of helicopters if he has to, so don’t be surprised if you see the Fed resort to some very unusual moves. This could include monetizing large chunks of the Federal debt. The combined effects of lower interest rates and debt monetization will constitute a massive shot of liquidity–perhaps the only way that “Helicopter Ben” can keep the economy afloat in the midst of the housing collapse. This does not bode well for the U.S. Dollar, which was already losing ground in the first quarter of Aught Seven against most other world currencies–most notably the British pound, the Euro and the Yen. (For example, it now costs more than $2 to buy one Pound Sterling.) So what does the “big picture” show us? For the next three years, there will likely be a bear market in real estate, stocks, and the US Dollar Index. Meanwhile, there will be a bull market in food prices, fuel prices, gold, and silver. The economy could very well turn stagnant, with high unemployment coincident with high inflation–similar to the “stagflation” economic conditions of the 1980s. Double digit currency inflation is likely. Plan accordingly. Protect yourself. Minimize your debt burden. Have plenty of cash on hand, in case you get laid off. And if you haven’t yet diversified your investments into precious metals, then I recommend that you do so immediately.

Speaking of impending crises, I highly recommend the book Financial Armageddon by Michael J. Panzner. In it, Panzner does a fine job of spelling out four impending crises that within the next decade will challenge our financial well-being and perhaps threaten our entire way of life. These four crises are: The debt bubble (public and private), pension plans, government guarantees, and derivatives.