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2008: Penance for 2007

Currencies / US Dollar Dec 17, 2007 - 01:09 PM GMT

By: Paul_Petillo


Should auld acquaintance be forgot,
and never brought to mind ?
Should auld acquaintance be forgot,
and auld lang syne ?

The timing of these year-end prediction columns is often of little importance. Believe it or not, what happens in December tends to meld into January. This blurring of the lines between one year and the next will not be your usual holiday hangover.

We tend to be a forgetful sort when it comes to turning the calendar. What happened in 2007 should, by all rights, stay in 2007. But that will not be the case in the upcoming year. In fact, we will pay for past transgressions well into the new year and possibly beyond. Which is unfortunate when you consider the phrase “auld lang syne” was meant to be interpreted as “once upon a time”.

Let's begin with the credit debacle of 2007. While we will not spend too much time rehashing that event in detail, it is important to review what occurred. Basically, the downfall of the home lending business was the result of the insatiable thirst for risk and greed.

It is difficult to pinpoint the exact start date but it is fairly safe to say that this sort of risky behavior began here in the United States when the surplus disappeared and the deficit reared its ugly head. Once the horse was out of the so-called barn, the American people, aided by the recently disingenuous and very talkative Alan Greenspan's quest to give money away when he had the top spot at the Fed, spent what they could not repay. In fact, following the President's lead, they spent borrowed cash as if they never intended to pay it back.

The trickle down effect of following the president and the Fed chairman led the American people to believe that a buying spree, funded by their homes was okay. Housing prices were headed higher and this fueled speculation followed by greed. But we know most of that. In 2008 however, the fallout from that behavior which began in August will make 2007 seem downright mild by comparison.

In order for the government to spend with abandon, we issued debt. The buyers of that promise of “good faith and credit” became, in essence our global bookie. When the bet on the ever-climbing real estate market fell on hard times in 2007, these lenders, as all good sharks will attest, began looking for ways to be paid what they were owed.

In order for the consumer to spend with abandon, the Fed stepped in and lowered rates. When the current Federal Reserve chairman took the helm, he began the long and arduous climb back to a more sustainable rate. Trouble was, so much of that debt was tied to indexes governed by those Fed moves, that what should have been a prudent and well-mannered return to normalcy failed. Foreclosures ensued.

That debt, still very real and with very real properties tied to it, has now been reduced in net worth by two-thirds in many instances, some times more. Underlying these billion dollar write-downs are many unsuspecting homeowners and far too many that knew better. And because there is still some unknown, unidentified problems on various balance sheets, these losses will continue to be written down by large financial institutions in the near future.

Two things will happen. First: Despite the efforts of Ben Bernanke to reignite the economy by enabling it, much the way his predecessor did, it will take more than simply coercing banks to loan to those with damaged credit, foreclosed properties or worse, to folks who have fallen a payment or two behind. These will be part of a growing segment of collateral damage in 2008. Even if potential borrowers with good credit do apply, they are not likely to be able to borrow so much as a dime – at a reasonable rate.

Secondly: In the 2008 that scenario will trickle down leaving businesses in somewhat of a dilemma. The last several years saw stock buybacks and dividend increases largely due to borrowing. Now, those opportunities will become much more expensive in the coming year. The next question banks will ask: “How do you make the case for refinancing your current debt when they cannot see any improvement in the financial health and well-being of their customer base?”

Not that a recession is eminent, but you can expect the consumer to withdraw into their collective selves in 2008. While there will be pockets of resistance in the economy – not every one has a bad mortgage or damaged credit – those that are doing okay or slightly better will not be so anxious to pursue any reckless spending sprees. There may be bargains to be had, but once business realizes that lowering prices, coupled with rising inflation means a decrease in profits, they will think twice. They will also be taking note of one undeniable truth: no economy thrives on consumer caution.

These same businesses will come to the realization that getting the money they need to survive even a mild downturn means selling portions of their business to those that have money to spend – namely sovereign wealth funds, the game is over.

Now these funds were the glad recipient of all of those dollars we sent overseas for oil and manufactured goods. And for a time, they happily reinvested those dollars in our debt. But that wind has shifted.

Despite what some may speculate about these big buyers in American companies (strongholds like Dow Chemical (most recently), Citigroup or Bear Stearns), these people are smart money and they have an agenda that goes well beyond just juicing our spending habit. Further alliances with other financial institutions will continue well into the new year.

Some of these sovereign funds, it should be noted, are state owned and because of that, globalization will take an interesting turn in the year 2008. No longer will publicly traded actually mean controlled by the public that invested. Instead, it will result in what is about to become the popular buzzword for the coming year – renationalization.

Once countries like Saudi Arabia, Russia, or Abu Dhabi become shareholders with an active voice, the smallest shareholders will be forced to the background. So despite what the central banks around Europe and Canada are trying to do, following our Fed's effort at putting additional cash on the table, it will have come too late to make difference.

For businesses facing the possibility of losing what ground they gained with cheap money, banks will no longer be seen as such an amicable lender, especially compared with the deep pocketed investors that sovereign investors are. But the illusion of financial health will be short-lived and not so illusory.

The stock market will suffer in 2008. There have been some predictions that the financial sectors of the markets will rebound and that the aforementioned credit problems will be mostly behind us. Contrary to that sort of wishful thinking, the market will begin to loss steam as many of these companies, unable to affordably refinance cut guidance, slash dividends and at one point, simply stop growing at the pace they did in 2007.

While the Dow will continue to post gains well into the first couple of months, the free ride is over. Some readers will point out that this is simply a generalization but it is based on what I see as a growing investor malaise and when that happens, big investors will make bad choices.

In my 2007 predictions titled “The Year of Investing Dangerously”, only one thing failed to materialize: resource nationalism. We did become aware of our global environmental problems in 2007 but we did not see the controls put in place soon enough to do the damage I had seen as very possible: raw materials held hostage by their respective countries of origin.

Unless of course you talk about oil. Now I predicted oil at sixty-plus dollars a barrel at last years end and did so without accounting for the continued decline of the dollar. With oil poised to push past $100 and the oil producing countries seeing the current levels of production as more than adequate, the economic problems that face the US because of such policies cannot be ignored.

We have seemed to adapt quite nicely so far but that cannot continue. We are too dependent in too many ways to ignore the inflationary effects of those prices in 2008. As oil producing countries look to their own economic development, they will be come the new large customer of their own wares. Expect oil to not only top $100 but to do so again by half. So much for your targets Mr. Bernanke.

The dollar will not rebound because of any re-jiggering of currencies or currency baskets overseas. I did note that the buck would fall but only because of the Bush administration's mindless pursuit of a “fully deregulated business environment.” I did not expect it to fall as far as it has. Do not expect 2008 to be much kinder to the dollar. With Messrs. Paulson ( Secretary of the Treasury ) and Cox (Chairman of the S.E.C.) continuing to chip away at many of the protections that investors now have, you can expect it to fall further.

2008, the final year of fiscal irresponsibility for the current White House will see further attempts at making the US more attractive to foreign investors. The “For Sale” is on the more than the front lawns of two plus million homes, it is on our nation's doorstep as well.

For auld lang syne, my dear,
for auld lang syne,
we'll take a cup o' kindness yet,
for auld lang syne.

It is an election year and that makes predictions doubly hard. I do see a Democrat taking the helm and that will be largely due to the current president's disregard of who elected (appointed) him. That will give optimism a boost and with any luck, give 2009 something to look forward to. But until then, we will find ourselves strapping in for a long and difficult ride in 2008.

By Paul Petillo
Managing Editor

Paul Petillo is the Managing Editor of the and the author of several books on personal finance including "Building Wealth in a Paycheck-to-Paycheck World" (McGraw-Hill 2004) and "Investing for the Utterly Confused (McGraw-Hill 2007). He can be reached for comment via:

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