Inflation Versus Recession

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Gold hit its second highest price ever yesterday. Interestingly, the U.S. dollar is not close to its all time low. For any given dollar level, gold prices have been rising over time. Inflation is when a currency decreases in value and this has been happening for the dollar when measured against gold. Looking at the value of one currency versus another can obfuscate that inflation is taking place. All fiat currencies are declining in value against gold and this indicates that a widespread global inflation is taking place.

The trade-weighted dollar fell as low as 77.02, but closed at 77.19 yesterday. This is well below the 78.33 breakdown level. The dollar is at an 11 month low and even if it stays at current levels or rises somewhat will hit a yearly low within 3 weeks. This will be very bearish. The U.S. dollar is already at a yearly low against the euro and Australian dollar, both of which hit new highs yesterday.

While inflation is taking place, the same thing can't be said about an economic recovery. Consumer spending accounts for 72% of U.S. economic activity and under current conditions can not improve in the foreseeable future. Consumer Credit for July was released yesterday and it fell by $21.55 billion or at a 10.4% annual rate. Credit card debt fell at an 8.5% annual rate. It was the 11th straight monthly drop. While consumer credit is contracting, so is consumer income. At the same time, the savings rate is rising. All three indicate less consumer spending and ongoing contraction in almost three-quarters of the U.S. economy.

The one-month drop in consumer credit in July was four times greater than the entire consumer debt in the U.S. in 1944. The 60 plus year post World War II expansion was fueled by ever increasing consumer credit. Like all expansions inevitably do, this one has come to an end. Initially, there was real growth that went along with the expansion, but in the last three decades U.S. growth has been based on increased spending made possible through excess credit. Going forward inflation is going to make this impossible.

NEXT: CFTC Kills Off DXO

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Probable Future Outlook for the United States

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Guest Blogger: Trevor Gauntlett from 'Running the Gauntlett'

What concerns me most is looking at the highly probable future outlook for the U.S. …

The government is taking over Freddie and Fannie, which will help out new, but not existing home buyers. By assuming responsibility for their debt, the gov’t is using inflation adjusted tax dollars to keep these companies operating . However, a $500 billion dollar short fall is projected this year in the budget and the U.S. national debt is already at about 9.7 trillion and growing ever so rapidly. If we tack on unfunded liabilities, we are talking anywhere from 50-70 trillion in obligations. Effectively the government is insolvent. Now what happens when government revenues begin to decline due to the slowing economy, baby boomers start to take money out of social security and access Medicare when they retire, and the continuation of the Iraq war / Afghan war / maybe Iran war?

I’m failing to see the light at the end of the tunnel.

During the housing boom, U.S. consumers purchased houses because money was cheap. Everyone felt rich so they purchased more consumables for immediate gratification. These weren't investments with productive value that would add to the economy in the future and they experienced immediate depreciation. Once U.S. consumers could no longer get money out of their homes through refinancings and HELOCs (home equity lines of credit), we started using our credit cards. Look at who is producing and who is consuming… we in the USA are primarily guilty of the latter and it is all funded through the rest of the world’s savings. At some point other countries are going to refuse to continue supporting the U.S. spending binge - this might already be taking place.

As for housing it will have to come back down to reasonable values. If we encounter a period of hyperinflation then housing could be a good asset to hold onto (although this was not the case during the hyperinflation in Wiemar Germany in the early 1920s). On the other hand, if we have a depression I could argue the opposite.

People are already losing their HELOCs because banks are worried that consumers won’t be able to afford them. Legal or not this is happening. I also heard from a Real Estate agent in Seattle that banks are asking for 25% down on new mortgages. In an earnings call in late January 2008, Bank of America executives said credit card delinquencies in California, Florida, Arizona, and Nevada—states with high foreclosure rates—increased five times as fast as in other states, suggesting that consumers struggling with their mortgage debt are also finding their credit card bills hard to pay. “We’re focused on getting paid for the risk we take,” said Joe Price, chief financial officer. - US News and World report 2/28/2008.

What happens if the United States dollar loses its status as the reserve currency? Then everyone with dollars will flood the market to get rid of them. The dollar is a commodity just like gold and silver, but unlike gold and silver any amount of it can easily be created. It has no intrinsic value and is a exchangeable commodity and legal tender because of government fiat (hence paper money is fiat money or fiat currency). If people want dollars, the price rises and as people desire them less, the price falls. Loss of reserve currency status would mean the demand for U.S. dollars would fall significantly. Why would anyone want dollars when you look at the future for the US economy except because of necessity or political reasons?

The GSE bailout will help to prolong the issues that the financial industry is facing. The United States government will do everything in its power to support the system through money creation and taxation, giving individuals and institutions more time to pull their money out of the dollar. An immediate collapse would make that very difficult and costly.

I’m getting the sense that things could get a whole lot worse than any of us imagine.

NEXT: The Banks and Brokers Most Likely to Fail - The Big Players

Daryl Montgomery

Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - Origins

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.


Our video for this posting can be found at: http://www.youtube.com/watch?v=Ennn4Qq8MUY.

After the market close on September 4th, 2008, it was announced that the U.S. government would likely be taking over mortage giants Fannie Mae and Freddie Mac in what would be the biggest financial bailout in U.S. history. Congress had already passed a bailout bill a month earlier making this action possible. The New York Investing meetup had already predicted that the need for the bailout the previous fall. This topic was raised in the December 2007 meeting and in the April 2008 meeting, Fannie Mae and Freddie Mac were on our list of the dirtiest dozen financial companies.

The origins of Fannie and Freddie were innocent enough and didn't presage their ultimate blowup many years later. New Deal mortage progams actually started with the FHA, which was created in 1934 to insure mortgages that had less than a 20% down payment (most mortgages in the 1920s had much higher down payments). Fannie Mae was then established in 1938 to buy FHA mortgages, creating a secondary mortgage market. For the first 30 years of its existence Fannie Mae had limited impact on the U.S. housing market because it had acess to little credit and significant restrictions on the size and type of mortage it could back. All of that changed around 1970 however.

That year, the U.S. government ranamed the existing Fannie Mae, Ginnie Mae, and then created a new Fannie Mae that would be a quasi-govenment backed company that could purchase riskier mortgages (Fannie's charter allowed it buy even 100% mortages as long as the amount over 80% was insured). The reason for making Fannie Mae a publicly traded company was the government wanted to provide expanded mortgage services, but didn't want the debt on its own books. In tandem with Fannie Mae's creation, Freddie Mac was also created as a GSE (government supported enterprise). Its purpose was to package mortgages into bonds, known as mortgage backed securities (MBSs) and sell them to investors thereby recycling the capital available for mortages. Freddie didn't become a fully traded public company until 1989.

The scope and extent of Fannie's operations expanded greatly in the 1980s and 90s. In 1978, Fannie was allowed to back mortgages for multifamily dwellings. In 1981, it added adjustable rate mortgages to its operations and in 1983, even riskier second mortgages. At the same time, the maximum amount of a mortgage that Fannie could back was also rising going from
$108,300 in 1980 t0 $252,700 in 2000. After 2000, this amount increased at a much faster clip, reaching $417,000 in 2006 and $730,000 for awhile in 2008. By raising the mortgage caps repeatedly, the U.S government created a bubble feedback loop that made the U.S. housing bubble possible - housing prices went up; the amount of a mortgages that could be gotten by a homebuyer went up; housing prices went up again; and the amount of a available mortgage went up again and so on and so on.

Between 2001 and 2007 alone, the amount of mortgages backed by Fannie Mae went from 2.5 trillion to $5.0 trillion. U.S. housing prices approximately doubled as well during this same period. Most amazingly, all of this took place even though one of Fannie and Freddie's major purposes was to increase home ownership for the poor. Acting to constantly support higher and higher U.S. housing prices didn't seem to be a particularly efficacious approach to accomplishing this goal.

NEXT: Exposing Fannie Mae and Freddie Mac - Corruption

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21