By Dudley Baker and Lorimer Wilson –
SAN ANTONIO (Precious Metals Warrants) — We have assembled some interesting comments from some of the leading economists, financial analysts, economic research firms and financial commentators and what they are saying about our current economic situation and what is most likely to unfold in the months and years ahead. This is a summary of the ominous warnings, dire predictions and perceived devastating consequences as they see it.
We trust you will find this a must read to more clearly understand and appreciate the financial state of the union, the impact it will likely have on various investments, and how better to allocate ones assets. Nobody has a crystal ball, but to just ignore the following warning signs and hope that everything will turn out okay would simply be foolish. Below is Part 1 of our 6 part series of articles.
Ominous Warnings and Dire Predictions
Alan Greenspan, an ‘original gold bug’ and former Chairman of the Federal Reserve, is going to say “I told you so!” as soon as he feels at liberty to comment further on what he already warned us might/will happen to the economy. He will no doubt expand on what he saw as the:
1. Potential for a derivative crisis: “I would suspect there are potential disasters running into … the hundreds.”
2. Potential drop in asset prices: “This vast increase in the market value of asset claims [stocks, bonds, houses] is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. But what they perceive as newly abundant liquidity can readily disappear … history has not dealt kindly with the aftermath of protracted periods of low risk premiums.”
3. Housing bubble: “Nearer term, the housing boom will inevitably simmer down. As part of that process, house turnover will decline from currently historic levels, while home price increases will slow and prices could even decrease. As a consequence, home equity extraction will ease and with it some of the strength in personal consumption expenditures.”
4. Coming crisis in Social Security: “The imbalance in the federal budgetary situation, unless addressed soon, will pose serious long-term fiscal difficulties. Our demographics – especially the retirement of the baby-boom generation beginning in just a few years – mean that the ratio of workers to retirees will fall substantially. Without corrective action, this development will put substantial pressure on our ability in coming years to provide even minimal government services while maintaining entitlement benefits at their current level, without debilitating increases in tax rates. The longer we wait before addressing these imbalances, the more wrenching the fiscal adjustment ultimately will be.” “When you do the arithmetic of what the rising debt level implied by the deficits tells you and add interest costs to that ever-rising debt at ever-higher interest rates, the system becomes fiscally destabilizing. What you will end up with is a stagnant economic system.”
5. Oil supply risk: “The current situation reflects an increasing fear that existing reserves and productive crude oil capacity have become subject to potential geopolitical adversity. These anxieties are not frivolous given the stark realities evident in many areas of the world.”
6. Rising budget deficit: “Large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years. Unless that trend is reversed, at some point these deficits would cause the economy to stagnate or worse.” “Monetary policy, for example, cannot ignore the potential inflationary pressures inherent in our current fiscal outlook, especially those that could rise in meeting commitments to future retirees. However, I assume that these imbalances will be resolved before stark choices again confront us and that, if they are not, the Fed would resist any temptation to monetize future fiscal deficits. We had too much experience with the dangers of inflation in the 1970s to tolerate going through another bout of dispiriting stagflation. The consequences for both future workers and retirees could be daunting.”
7. Rising long-term interest rates: “The fiscal issues that we face pose long-term challenges, but federal budget deficits could cause difficulties even in the near term. Rising interest rates have been advertised for so long and in so many places that anyone who hasn’t appropriately hedged his position by now is desirous of losing money.”
8. Record-high current account deficit: “Given the already substantial accumulation of dollar-dominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents….Net claims against residents of the United States cannot continue to increase forever in international portfolios at their recent pace…Given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point. The trade deficit cannot continue to increase forever at the recent pace.
9. Excessive household debt: Debt in modest quantities does enhance the rate of growth of an economy and does create higher standards of living, but in excess, creates very serious problems.
10. Falling U.S. dollar: Although I doubt that the U.S. dollar will lose its status as the world’s reserve currency any time soon, there are in my judgment lessons to be learned from the experience of sterling as it faded as the world’s dominant currency.”
It is interesting to note that at one time Greenspan was an ardent gold bug and a true believer in the gold standard as his following words attest: “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. Deficit spending is simply a scheme for the ‘hidden’ confiscation of wealth. Gold stands in the way of the insidious process.”
Richard Fisher, President of the Dallas Federal Reserve, noted on Feb.6, 2006 that “U.S. consumer spending could suffer if the property market cools too fast but that is unlikely because of the high number of home owners with fixed rate mortgages acting as a buffer against the small fraction of those with variable rate mortgages. It is not unreasonable to think the situation is manageable, albeit worth watching closely.”
Regarding the record U.S. current account deficit he said “those urging the United States to rein in its spending should be equally full-throated in prodding countries with excess savings and trade surpluses to create conditions for growing their domestic demand. If they fail to do so, and the U.S. suddenly becomes more virtuous on its own, the global economy could sink into a deep funk.”
Paul Volcker, a former Federal Reserve Board Chairman, is on record as saying “I think we are skating on increasingly thin ice. On the present trajectory, the deficits and imbalances will increase. At some point, the sense of confidence in capital markets that today so benignly supports the flow of funds to the United States and the growing economy could fade. Then some event, or combination of events, could come along to disturb markets, with damaging volatility in both exchange markets and interest rates. Indeed, there is a 75% chance of a major financial disaster within the next few years.”
David Dodge, Governor of the Bank of Canada, earlier this month said “global imbalances, such as the record U.S. current account deficit and the ballooning surpluses in some Asian countries, are persisting and if not resolved in an orderly way, we face the threat of great disruption with periods of outright recession.”
Stephen Roach, Managing Director, Chief Economist, and Director of Global Economic Analysis of Morgan Stanley, has stated that “America’s record trade deficit means the dollar will keep falling, interest rates will rise further and U.S. consumers, in debt up to their eyeballs, will get pounded with no better than a 10% chance of avoiding economic Armageddon.”
Kurt Richebacher, former Chief Economist of the Dresdner Bank, has stated that “the bubble-driven consumer-spending boom we are currently in represents artificial, unsustainable demand and further rate hikes by the Fed will prick both the carry trade bubble in bonds and the bubble in housing. A financial Apocalypse will follow. The U.S. economy will lose its chief liquidity source with disastrous effects on a wide range of asset prices.
The U.S. has such serious structural problems they preclude any possibility of a sustained economic recovery. These structural problems include a corporate profits decline, a record savings shortfall, a capital spending collapse, an unprecedented consumer borrowing and spending binge, a massive current account deficit, ravaged balance sheets and record high debt levels. Tops among them are the depression of profits and capital spending which will propel each other downward in a vicious spiral.
In addition, U.S. stocks are still overvalued. The worst part of the bear markets is still to come and it will result in the wholesale destruction of the financial wealth derived from the bubble economy.
The U.S. financial system today is a house of cards built on nothing but financial leverage, credit excess, speculation and derivatives. A recession is coming and it will prove unusually severe and long. The length and severity of recessions or depressions depend critically on the magnitude of the dislocations and imbalances that have accumulated in the economy during the preceding boom and, as such, the U.S. economy is in for a very hard landing. The excessive monetary looseness has only postponed and magnified the coming inevitable crisis.
Growing disillusionment with the U.S. economy is the trigger. The huge capital inflows have become the U.S. financial markets’ single most important pillar. Take this pillar away, and those markets will instantly collapse with devastating effects for the U.S. economy, turning quickly into a savage credit crunch. The exposure of the U.S. financial markets to foreign investors and lenders has grown to such preposterous magnitude during recent years that a controlled gradual dollar devaluation no longer appears feasible. The dangers that loom on the currency front are immense. The grossly over-leveraged U.S. financial system is hostage to a strong dollar and permanent, huge capital inflows. The U.S. trade deficit and the accumulated foreign indebtedness have reached a scale that defies any possible action by central banks. The fate of the dollar is beyond any control.”
Financial Train Wreck
Nouriel Roubini is Professor of Economics and International Business at New York University’s Stern School of Business; Chairman of Roubini Global Economics; Research Fellow at the National Bureau of Economic Research; Research Fellow of the Centre for Economic Policy Research; Member of the Bretton Woods Committee, the Council on Foreign Relation’s Roundtable on the International Economy and the Academic Advisory Committee, Fiscal Affairs Department of the International Monetary Fund; former Senior Economist for International Affairs on the Staff of the United States President’s Council of Economic Advisors; and co-author of several books on the economy.
Roubini has stated that “if the U.S. does not take policy steps to reduce its need for external financing, before it exhausts the world’s central banks willingness to keep adding to their dollar reserves then the large, growing and unsustainable fiscal deficit and U.S. current account deficit will become twin financial train wrecks for the U.S. economy and will lead to a sharp hard landing of the dollar, a sharp increase in long term interest rates, a significant increase in the inflation rate and a sharp slowdown of the U.S. and global economy.
A dollar crash/hard landing would be associated with a bond market rout and would have serious consequences on all other risky and overvalued assets (equities, housing, high-yield debt, emerging market debt).
The effects in the U.S. of higher short and long rates on the housing market, both flows of new housing and new home demand on the value of existing housing, would likely be severe.
Oil prices will skyrocket above $100 per barrel. Then we will get a U.S. and global recession that will pale compared to the one in 1980-82.
I am not being alarmist or unrealistic when you consider our reckless fiscal and public debt policies, the absence of adult policy supervision in Washington and the mediocre or nonexistent U.S. economic leadership.”
David Walker, Director of the U.S. General Accounting Office and Comptroller general of the United States, has stated that “our projected budget deficits are not manageable without significant changes in status quo programs, policies, processes and operations and were such action implemented it would most likely adversely affect the quality of life of every American now and in the foreseeable future. The U.S. faces a demographic tsunami that will never recede.”
We would recommend investors strategically position themselves in a wide variety of assets including precious metals, mining shares and long-term warrants. Nothing like taking what the experts say to heart and investing accordingly.
© Copyright Precious Metals Warrants 2006
Dudley Baker is the owner/editor of Precious Metals Warrants, a market data service which provides you with the details on all mining & energy companies with warrants trading on the U.S. and Canadian Exchanges Visit us soon.