PIM of SPAIN, sorry to have to flag this story, however, it appears to be copied verbatim from the book The Demise of the Dollar.
The Downfall of the Dollar
The Industrial Revolution moved economic power in ways that continue to affect economic balances to this day. And now we face another great shift, away from the U.S. dominance of world markets and toward new leaders – China and India.
We can only anticipate how changes will occur based on what we observe today. Does this mean the age of America is ending? No, it simply means that someone else will bend the economic muscle in the future.
Nowadays it takes more dollars to buy the same thing (in other words, prices are higher) but incomes have not risen to meet that price inflation. That’s what happens when the value of the dollar declines. Economic history is a history of bubbles – and bursts. The great damage being done to Americans by the financial media is that they are not being offered the opportunity to learn more from what is going on. They are losing buying power, but apart from a few painful spikes at the gas pumps, it’s mostly invisible.
This problem is global. While there is, of course, more to it than just the value of the U.S. dollar, here is how it works:
1. The dollar’s value falls due to Fed policy of ‘free’ credit, due to artificially low interest rates.
2. Eventually, we cannot afford to buy as many foreign goods.
3. Foreign manufacturers, unable to sell at previous levels, have excess inventory, which causes an inflationary outcome.
4. Foreign governments, in an effort to counteract this inflation, blame the fallen dollar for the problem and begin moving out of U.S. instruments (value papers as bonds/shares).
5. As debt returns to the United States, the system is unable to absorb it. This creates more severe recession at home as we see today. The whole thing is connected. This is similar to what happened worldwide at the end of the 1920s. The worldwide Great Depression that had numerous aspects, but most notable among them were two things: a huge transfer of funds from World War I reparations, and far too much credit that went beyond the borrowers’ ability to repay. All of that credit – essentially, printed fiat money created a false demand. We see the same effects of this policy today in housing as anywhere else. The whole mess is traced back to the origin of the Fed’s policy encouraging debt spending as a means to artificially create the appearance of productivity. That happened during the last decennia.
This Fed malicious policy has four aspects:
1. The Fed has lent money below inflation. Fed lending rates have been far below inflation (even as measured by the consumer price index, not to mention any real inflationary measurements). In a very real sense, the Fed has lost money on these loans. When inflation is higher than the lending rate, it is a loss. Like a business cannot stay open when it sells goods below cost, the Fed cannot continue to maintain the view that it isn’t real money. The point is, that money lent out at bargain rates is real credit, and that on its turn is corrupted when given away too cheaply.
2. The low interest rates have created the mortgage bubble without any matching industrial investment. The basic is: if you borrow money to invest in productivity (new plants and equipment, for example) it is a profitable use of money. But those low interest rates were spent on cheap ‘consumptive’ long-term mortgages. Homeowners have refinanced and spent the additional money to buy SUVs, and many first-time buyers came into the market because of the low rates that made housing affordable.
3. The mortgage bubble has inflated the housing market (home prices went up every quarter) in a blown up manner, creating the illusion of increased equity for its ‘owner’. All that cheap money has created two troubling changes in the housing market. First a higher demand for owner-occupied housing based on the low cost of borrowed money rather than on any natural market force. Second the resulting increased equity value from rapid expansion of market price in residential property. But all was a bogus because of the too low interest rates. Like all (Ponzi) pyramid schemes, the whole thing eventually crumbles under its own weight. There is no endless stream of new home ownership-demand, quite the contrary. The baby boomers mostly own homes already, and a reduced number of people that are coming into home ownership age will ultimately result in an oversupply of housing stock. Once the mortgage bubble busted, the consequences are meanwhile obvious: Defaults on existing loans. As rates on variable mortgages started to raise many of those marginal loans went into default. Many Americans were barely able to afford the mortgage payments that were based on a too low interest qualification. Because borrowers’ incomes had been overstated. Many existing loans are and will be defaulted as a result. Reducing the market value of houses even further because of the already oversupply of housing. At this point, when the bubble went burst, everyone realized that too many homes were built too quickly, for an anticipated demand that simply wasn’t there. Leaving behind properties without equity thus only debt. The reduced market value in homes is not going to be limited to a simple supply and demand cyclical change. Because the supply- and-demand cycle has been manipulated through interest rate policy of the Fed. And that is the reason why now real equity in the property market for too many participants is below zero.
There is no incentive anymore to continue making payments while the dollar’s buying power is dropping. In these cases, marginal buyers are going simply to walk away from their properties. Why stay when there is no equity in it any longer – or worse, negative equity = money owing? Where does all of that mortgage debt end up? Your local bank or savings and loan don’t hold it. It all was sold to Ginnie Mae, Freddie Mac, and other mortgage pools, which then packaged it up and sold it on to investors, many of them from Europe and Asia. And here the foundation was laid for the ‘sub-prime’ credit crunch. Because the pooled mortgage debt did not perform, which on its turn increased the foreclosure rate and consequently lowered market values. A high rate of foreclosures in an overbuilt market is today’s housing sector is today’s situation. While a normal supply and demand cycle may have lasted three to five years on average, this down turn is worsened, and will last much and much longer into the future. The actual length of this housing recession yet is unpredictable.
4. The lack of industrial investment and a flat manufacturing trend are damaging the U.S. competitive position in the world market.
Imagine an economic situation in which enterprising homeowners refinanced their homes when rates fell and invested that money in small business expansion in creating an internationally competitive economic climate, likewise after WWII in Germany Ludwig Erhard* in charge of the economy created the German ‘Mittelstand’ (small businesses), which created the ‘economic miracle.’
Well, this is look like the rosy picture the Fed may have in mind with its monetary policies, in creating a small business environment, which most likely won’t be the case. By artificially lowering interest rates and enabling homeowners to get at their equity, the idea is that on a broad range of economic trends (housing, business investment, savings, etc.) there will be a strong growth spurt, an economic recovery that will return the United States to its leading position. Unfortunately that won’t happen. Not additional liquidity but restructuring of the economy is necessary.
Today’s lack of investment is doing great damage. Because the whole economy still is credit-based, starting with the Fed losing on below-inflation loans and ending up with credit based consumptive spending but not creating any real productivity.
The Fed policy is based on the idea that lower interest rates will bring down inflation, however the opposite is the case!
* Ludwig Erhard:
From September 1949, as economics minister of the new Federal Republic of Germany under Chancellor Konrad Adenauer, Erhard was commissioned to continue his policies of reconstruction. In the following years he applied his “social market system” to the problems of economic renewal with phenomenal results, achieving what has often been called the German “economic miracle.” By creating the ‘Mittelstand’ thousands of small enterprises and businesses that refloated the economy into a healthy expansion for many years to come. All this was based on free-market capitalism his system included special provisions for housing, farming, and social programs.
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