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Last edited by Deogol; 08-09-2006 at 05:54 AM.





Opinions and politics aside, the points raised in your link are not unique.
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(snip)"Pondering the U.S. economy's unusually high addiction to credit and debt
growth in relation to GDP growth, we are sure of another evil factor -
Ponzi finance. Principally, every increase in spending brings about an
equivalent increase in incomes. But this is not true in three cases of
spending: first, spending on existing assets; second, spending on imports;
and third, Ponzi finance.
Ponzi finance means that lenders simply capitalize unpaid interest rates.
Ponzi finance creates credit, but it is bare of any demand and spending
effects in the economy. In the conventional American view, balance sheets
of private households are in their very best shape because increases in
asset values have vastly outpaced the sharp increases in debts. So
Americans see no problem.
With such great optimism about the U.S. economy still prevailing, it is a
safe assumption that lenders have been more than happy to capitalize
unpaid interest rates as new loans, at least until recently. As widely
reported, lending standards have been extremely lax for years.
Nevertheless, there is bound to come a point where Ponzi lending stops.
The crucial difference is in the ghastly difference between runaway debt
growth and nonexistant real disposable income growth as the income
component from which debt service has to be paid. In 2000, consumer debt
growth of 8.6% compared with real disposable income growth of 4.8%. During
the first quarter of 2006, private household debt growth of 11.6%,
annualized, compared with zero real disposable income growth.
These numbers suggest that, in the aggregate, all debt service occurs
through Ponzi finance. Essentially, borrowing against existing assets is
required to service debt. Another striking evidence of extensive Ponzi
finance is the unusually large difference between rampant credit growth
and much slower money growth. Capitalizing unpaid interest rates adds to
outstanding credit and debt while adding nothing to bank deposits (money
supply).
To get an idea of the actual extent of Ponzi finance, we make a simple
calculation. Total outstanding debts in the United States amount to $41.8
trillion. Assuming an average interest rate of 5%, this implies an annual
debt service of about $2 trillion. This compares with an increase in
national income before taxes of $616 billion in 2005. Consumer incomes are
even stagnant.
Under these conditions, the only question is the severity of the impending
U.S. recession. In this respect, we are a great believer in the axiom of
Austrian theory that every crisis is broadly proportionate to the size of
the excesses and imbalances that have accumulated during the prior boom.
Our basic assumption is that the American consumer is bankrupt when house
prices fall 20 - 30%.
The most important thing to realize is that the spending and debt excesses
that have accumulated in the U.S. economy and its financial system on the
part of the consumer during the past 10 years are altogether of a size
that vastly exceeds the potential for debt service from current income.
With stagnant real disposable income and double-digit debt growth, the
American consumer is caught in a vicious debt trap. What, then, makes most
people so optimistic of further economic growth? Apparently, there is a
widespread view that households have sufficient equity cushions in their
balance sheets to not only weather any storm ahead, but also to continue
higher spending.
In our view, the most important thing to see is the fact that the consumer
has accumulated debts at a level vastly exceeding his abilities of debt
service from current income. Probably many never had any intention of such
kind of debt service. The general idea, certainly, has been to settle debt
and debt service problems simply by selling later to the highly
appreciated greater fool. That is what most economists take for granted.
What all these people overlook is, first of all, the vicious dynamics of
Ponzi finance through compound interest on unproductive indebtedness.
During 2000, total financial and nonfinancial credit and debt growth
amounted to $1,605.6 billion. In 2005, it had accelerated to $3,335.9
billion; and in the first quarter of 2006, it has run at an annual rate of
$4,392.8 billion, and this now with zero income growth. Note that this
debt explosion has happened with little change in GDP growth.
Given this precarious income situation on the one hand and the debt
explosion on the other, it should be clear that at some point in the
foreseeable future, there will be heavy selling of houses, with prices
crashing for lack of buyers.
As to the level of asset prices in the United States, an additional
comment is probably needed. Normally, the money for asset purchases comes
from the savings out of current income. In the U.S. economy, with savings
in negative territory, all asset purchases essentially depend on available
domestic credit and capital inflows. Buying assets on credit used to be
the exception. In America today, it is the rule. For good reasons, the Fed
is fearful to make money truly tight; it would crush the markets.
A study by the International Monetary Fund published in 2003 under the
title "When Bubbles Burst" examined the differences in economic effects
between bursting equity bubbles and bursting housing bubbles. It left no
doubt that the latter are the far more dangerous specimen:
Housing price crashes differ from equity price busts also in three other
important dimensions. First, the price corrections during house price
busts averaged 30%, reflecting the lower volatility of housing prices and
the lower liquidity in housing markets. Second, housing price crashes
lasted about four years, about 1 1/2 years longer than equity price busts.
Third, the association between booms and busts was stronger for housing
than for equity prices.
The situation today in the United States reminds us strongly of late
December 2000. At its previous meeting in November, the Federal Open
Market Committee directive had called future inflation the economy's
greatest risk. But then, all of a sudden, the bottom fell out of the
economy. At its next meeting, on December 19, the FOMC changed the bias,
declaring that the risk of economic weakness was outweighing the risk of
inflation.
Two weeks later, Jan. 3, 2001, shocked by worsening economic news, the Fed
dropped its funds rate, through a conference call, by 0.5% - twice the
usual rate.
As we have stressed many times, the U.S. economy today is incomparably
more vulnerable than in 2000. All the growth-impairing imbalances in the
economy - the trade deficit, the savings and incomes shortage and the debt
levels - have dramatically worsened.
Very rapid interest rate cuts and prompt massive government deficit
spending succeeded in containing the recession. The phony "wealth effects"
derived from the escalating housing bubble became the key source of demand
creation in the United States. But the unpleasant longer-term result of
the new policies was an unusually weak and lopsided economic recovery,
particularly seeing drastic shortfalls in employment and income growth.
Regards,
Dr. Kurt Richebächer"
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The Fed's decision today to stop the steady increases in interest rates is taken by many to mean that the Fed is now more concerned with tanking the housing market and thus aggravating the coming recession than it is concerned with controlling inflation and/or supporting the US dollar exchange rate. This in turn is speculated to mean a decline in the US dollar (with a corresponding increase in the US dollar price of imported/world commodities and products), higher domestic price inflation (as US businesses attempt to hold profit margins versus rising US dollar denominated raw material and energy costs), but a lessening of downward pressure on the US housing market (with corresponding lessening in pressure on holders of ARM mortgages and floating rate consumer debt).
However, as Dr. Richenbacher points out, whatever 'reprieve' heavily indebted US consumers and the US economy in general have just been granted by today's shift in Fed policy is likely to be short-lived, because the fundamental economic problems (i.e. negative savings rate, zero income growth especially after tax) have not been addressed. IMHO the statement "The general idea, certainly, has been to settle [consumer - sic] debt and debt service problems simply by selling later to the highly appreciated greater fool. That is what most economists take for granted." sums up the situation pretty well.
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for a very detailed analysis and 'prediction' on central bank action, you might check out



You can't help but think the change in policy is housing related. Why else? The US simply needs higher rates.
It is also hard to imagine that this is anything but a limited move to postpone the inevitable. You mention the greater fool theory, I'd imagine that there are very few of those left in the US housing market right now.
Conversley, the UK housing market seems to have started up again. It beggars belief. Once more, London is leading the charge. How anyone can afford property in London now is beyond me. It isn't just buying either.
If I were to rent a small to average sized one bed appartment in the area I am from, it would cost maybe £400 to £450 per month. To rent an identical place in large areas of London, would cost the same - per week!!!! In Europe, everywhere else is cheaper, with the possible exception of Paris.
A really good friend of mine has just been offered a job in the city. Her annual salary will be £49,000 ( about US $92,000 ) which is about double the national average wage. She really isn't sure she can afford to move.
Whilst I realise that this seems off topic, it relates closely to the inflation / cost of housing / cost of living / personal debt debate. If you can only just survive whilst earning 50k and working 50-55 hours per week (plus commuting time) what on earth is wrong??? The people of London must be wearing their credit cards thin!!!
Since US house prices seem to be falling, you guys are getting to the crunch sooner. As UK house prices rise, the inevitable is postponed.





^^^ Stuart, for whatever reason, there seems to be an American passion towards home ownership ... regardless of the comparative financial equation between the costs and risks of renting versus the costs and risks of owning. Why this is I really can't explain - probably something in the national culture akin to Germany's passion for fast cars.
As to the 'greater fools', the 'tin foil hat' crowd would tell you that there is never a shortage of potential 'greater fools', only a shortage of available credit which prevents the 'greater fools' from acting foolishly. It would appear that certain lenders i.e. the Japanese Central Bank, Arab Petrodollars etc. are still willing to lend their excess US dollars to the 'greater fools' ... providing of course that the implicit US gov't backing of Fannie Mae and Freddie Mac makes the US taxpayer responsible for picking up the pieces when the 'greater fools' go belly-up !
I suspect that the bottom line in London, Paris, New York, California etc. is that the rising tax burden has been causing a declining standard of living for middle class people for some time now in terms of real after tax earnings versus real spending / expenses. Refusing to accept a declining standard of living, middle class people in these areas have 'supplemented' their paychecks with home equity extraction at very low historical interest rates, have spent that extracted equity to maintain their standard of living, but have piled up huge amounts of additional debt in the process. Whether through inflation or deflation, sooner or later the imbalance has to be rectified.
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Last edited by Melonie; 08-09-2006 at 02:15 AM.





another amazing coincidence which occurred immediately after the Fed stopped raising interest rates ...
I think that somebody has figured out that when mortgage lenders have to hold interest rates the same while delinquencies are rising, their profits evaporate !
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