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Financial Markets - Time to Pay Attention, China Trade War, Housing, Iran and more

Economics / US Economy Apr 03, 2007 - 12:12 PM GMT

By: Dr_Martenson

Economics

There's so much happening in the markets both financially and geopolitically, that I hardly know where to begin.

Probably the most shocking news of the week was not the tension in the Middle East around Iran. No, as disturbing as is the possibility of another shooting war in immediate proximity to 25% of the world's daily oil shipments, the reality of a trade war with China announced on Friday (March 30 th , 2007) was even more disturbing:

The Bush administration, facing heavy pressure to deal with soaring trade deficits, will impose economic sanctions against China as a way of protecting American paper producers from unfair Chinese government subsidies, a Commerce Department official said Friday.

The action will reverse 20 years of U.S.trade policy by treating China, which is classified as a nonmarket economy, in the same way that other U.S. trading partners are treated in disputes involving government subsidies.

The decision was to be announced by Commerce Secretary Carlos Gutierrez. Department official said Friday.


Holy smokes! Can you believe this? The US is utterly dependent on China for a huge proportion of its daily financing and yet we're slapping sanctions on China . This is not unlike insulting your banker the day before applying for an unsecured loan. It doesn't seem very wise. 

Within seconds of this announcement the dollar took a dive, stock markets swooned, gold launched and interest rates gyrated wildly before some measure of market stability returned. 

Here's the deal. In 2006 the US bought $800 billion dollars more stuff from overseas than it sold. US dollars left its shores and had those dollars had not been returned and used to buy US Treasury paper (government debt) two things would have happened – the dollar would have weakened (even more) and interest rates would have gone up (possibly by a lot). If you think the housing market is struggling now, just be glad it is not also facing 10% interest rates.

So what was truly shocking about the China trade war announcement was the possibility that the Bush administration does not quite appreciate the advantage of having a trading partner that happily exchanges real goods for fake money. Or if they do, then I suppose I am even more stunned that they'd risk a dollar and/or a bond market crisis to achieve some narrow political aim.

But here's where it gets really interesting; many of us in the financial world keep a very close eye on foreign participation in our bond auctions watching for any sign that their interest in recycling our dollars has softened.

Oddly, this is exactly what we saw in the auction of 2-year treasury notes on Wednesday, March 28 th , just two days prior to the China trade sanction announcement:

WASHINGTON -- U.S. Treasuries fell Wednesday after the government's auction of 2-year notes drew fewer bids from foreign investors than last month's sale, raising concern that overseas buyers might be pulling back from government securities.

Indirect bidders, the class of investors that includes foreign central banks, were awarded 29.3 percent of the auction, down from 52.2 percent in February.

I say ‘oddly' in the sense that I would also consider it bizarre if the local fire department arrived and poured gasoline on a brush fire. At any rate, that's a pretty hefty decline in the foreign purchases of our US debt paper. We'll be watching the next few auctions even more closely.

Housing

By now, unless you've just returned from a month-long spelunking expedition, you are well aware that some serious problems have surfaced in the housing market. Rather, I should say that the housing problems that have been utterly obvious for the past 2 years have finally managed to penetrate the dense shield of Unobtainium 325 that seems to protect most of our erstwhile journalists from any contact with reality.

But now that it's "OK" to write articles about all the past housing transgressions there are literally dozens upon dozens of them appearing each week chronicling the meltdown in the subprime and not-so-subprime mortgage markets, vast increases in inventory (up over 500% in some Florida markets over the last year), declining prices, revelations of fraud, and broken hopes. Financial councilors are reporting being overwhelmed by a flood of homeowners facing foreclosure.

The data being reported at the state and county level speaks of an unfolding disaster many, many times larger that what is being reported on TeeVee. There are daily updates of housing related media links here and here (both excellent sites) for those that care to read more, so I won't go and deeper into the gory details. 

My opinion is that the housing crash that is now before us will last far longer and be far worse than is commonly recognized. If we are lucky, the housing market will bottom in 2010-2011. When all is said and done I expect as much as a 90% price crash in some markets and an average of 40%-50% across all markets. I see nothing in the trajectory of this housing bubble to suggest a reason to suspect it will play out any differently financially or psychologically than any other bubble in history. In short, it's NOT different this time. It's very probably the same. If, however, we're unlucky, housing, retiring boomers and peak oil will press their serious demands upon a concurrent stretch of the future and housing will never reclaim the peak seen in 2005. 

If I had to boil the main problem down to one issue, what would it be? Affordability

House prices are now far, far beyond what wages can sustain. In some areas, the median house can only be afforded by the top 10% of the local population. Since the textbook definition of a bubble is ‘when asset prices rise beyond what incomes can sustain' we can conclude that housing was most certainly in a bubble that is now correcting. The math is simple. House prices have to come down ~40%-50% or wages have to climb by 80%-100%. Given that American families have had to endure essentially flat real wage growth for the past 3 decades which do you think is more likely? Will wages suddenly rocket up 100% or will house prices come down 50%? If you are interested in how real wages for average families have been depressed all these many decades you are in luck. Last week Circuit City laid off 3,500 workers in order to hire them all back at a fraction of their prior wage providing you with a textbook example of how it's done. 

What to watch for? Over the next few months it will become obvious that all the ‘experts' currently predicting that housing woes will not impact other areas of the economy are dead wrong. When a housing bust happens, it's not just the carpenters and mortgage brokers that get laid off. It is the people who sold them cars and served them food, and took their vacation reservations. The ripples extend far wider than is being currently acknowledged by an unfortunately large and vocal proportion of our financial marketing infrastructure.

Am I a lone nut in the wilderness? Yes, but that's beside the point since there are now many other credible voices making the same predictions.

For instance you might find some value in this account by a 25 veteran of the real estate industry who, after making many great points, concludes:

In my opinion, the ultimate affect of the real estate bubble -- and its mostly unanticipated implosion -- is that the entire asset class will fall out of favor for many years, possibly for a generation. Only a select few will benefit -- those who had the foresight to sell now and squirrel away the money safely before the real anguish begins.

Or maybe you prefer your estimates of 30% to 50% declines in house prices to come from a widely respected economic research institute . Or perhaps you think our country will be able to negotiate a different outcome to our bursting housing bubble than the Japanese who this March finally recorded the first rise in land prices in over 16 years. Or you may only trust people from Yale University in which case you may want to heed Robert Schiller (who famously predicted the stock market top and crash in 2000) who recently said : "This isn't going to be over in a year. Housing prices could be declining for years and years."

Whatever your preference, I would advise you to carefully weigh the data if you are holding excess real estate or are thinking of moving from a position of non-ownership to ownership. Also, it goes without saying that if you are planning to sell and then buy, be sure that you've sold before you buy.

In summary, there are numerous reasons for you to be extremely careful in you financial decisions. There are cross currents, downdrafts, and vortexes of financial information out there to navigate. Please pay close attention over these next few months!

As always, pay down your debts, free up some cash, save what you can, and sit back and watch for a while. And, of course, you already have gold in your physical possession. 

All the best,

By Dr. Chris Martenson
http://theendofmoney.com

P.S. Next time I will be writing about a large and growing body of data regarding peak oil, specifically the crossover of supply and demand. It is far closer than I thought. In the meantime, if a shooting war breaks out with Iran, I will be sending out a special alert.

Copyright © 2007 Dr Chris Martenson
Dr Martenson is the creator of The End of Money economic seminar series, has extensive experience analyzing and communicating financial information.  Dr. Martenson combines a scientist's attention to fact and analysis (PhD, Duke University, Pathology and Toxicology) with a solid understanding of finance and economics (MBA, Cornell, Finance) with strategic thinking (4 years as a management consultant) to produce an insightful and powerful lecture. He is currently devoted to researching, writing and presenting economic and financial analyses delivering his message via his website, lecture series and is currently working on a related book & movie.


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