Category: News & Opinion (General) Topic: Business & Economy
Synopsis: U.S. economic collapse looming for 2005
Source: Idaho Observer:
Published: January 1, 2001 Author: William Engdahl
For Education and Discussion Only. Not for Commercial Use.
U.S. economic collapse looming for 2005
by William Engdahl
The U.S. Senate just reconfirmed 78-year-old Alan Greenspan to an
unprecedented fifth term as chairman of the world's most powerful
central bank, the Federal Reserve, or the Fed as it is known. The fact
that President Bush renominated Greenspan underscores how vulnerable
the global financial edifice is, and not how excellent a central
banker Greenspan is.
Perceived global economic growth tied to U.S. dollar
On the surface, world growth appears to be expanding finally, after
severe recession and the 60% fall of the U.S. stock market in
2000-2001. The Federal Reserve says it is so confident that growth in
the U.S. economy is taking firm hold, that it raised its key interest
rate from a record low 1% to 1.25% last month, signalling it would
slowly bring rates up to “neutral” levels of 3.5-4.5% over coming
months.
Around the world, strong growth of exports are being reported from
Brazil to Mexico to South Korea. Growth in China is so strong the
government is worried it is overheating. In Europe, the UK is
expanding at the fastest pace in 15 years. France expects GDP to grow
by 2.5%, and even Germany is talking about stronger export growth.
The problem with this optimistic picture is the fact it is entirely
based on the dollar and unprecedented creation of cheap dollar credit
by Greenspan and the Bush Administration. Their only short-term goal
has been to keep the U.S. economy strong enough to assure re-election
for George Bush in November. Washington reports are that Bush made a
deal to re-appoint Greenspan on the promise Greenspan would keep the
economy growing until the elections. They have done this by a
combination of historic low interest rates, rates only seen before in
times of war or depression, and by stimulating the economy by record
budget deficit spending and issuing government bonds to finance it.
The world has been flooded with cheap dollars as a result.
What is clear now is that this unsustainable effort is likely to come
to an end sometime in 2005, just after the elections, regardless of
who is President. Given the scale of the money-printing by the Fed and
the U.S. Treasury since 2001, it is pre-programmed that the
“correction” of the latest Greenspan credit excess will impact the
entire global financial and economic system. Some economists fear a
new Great Depression like the 1930s. The world today depends on cheap
U.S. dollar credit. When U.S. interest rates are finally forced
higher, dramatic shocks will hit Europe, Asia and the entire global
economy, unlike any seen since the 1930s. Debts that now appear
manageable will suddenly become unpayable. Defaults and bankruptcies
will spread as they did in the wake of the 1931 Creditanstalt collapse
in Germany.
The U.S. home bubble
The official U.S. myth is that the recession of 2000-2001 ended in
November 2001 and “recovery” has been underway ever since. The reality
is not so positive. Using record low interest rates, the Fed has lured
American families into debt at record rates, creating what might be
called a “virtual recovery,” financed by record amounts of new
consumer debt. There has never been a recovery in which debt levels
increase!
The American dream of owning your own home has been the source of the
record lending, helped by the lowest interest rates in 43 years.
Greenspan has often boasted this has been what has propped up the U.S.
economy since 2001.
When families buy a home, they buy furniture, employ construction
workers, electricians, engineers, and the economy grows. Record low
interest rates have made it very easy for families to get a bank loan,
using their home equity as collateral or guarantee. These loans, tied
to the rising real estate prices, allowed American families to finance
new furniture, cars, and countless other items.
In 2003 banks made a record $324 billion in such home equity loans, on
top of $1 trillion in new mortgage loans.
All this economic consumption has created the illusion of a recovering
economy. Behind the surface, a huge debt burden has built up. Since
1997, the total of home mortgage debt for Americans has risen 94% to a
colossal $7.4 trillion, a debt of some $120,000 for a family of four.
Bank loans for real estate purchases have risen since 1997 by 200%, to
$2.4 trillion. Average U.S. home prices have risen by 50% in the
period since 1998. In 2003 alone a record total of $1 trillion in new
mortgage loans were made. In 1997 mortgages totalled $202 billion.
In many parts of the U.S., home price inflation has become alarming.
An apartment in better parts of Manhattan is now above $1 million.
Home prices in Boston have risen by 64% in five years. California real
estate prices are soaring. On average U.S. home prices have risen 50%
in six years, an unprecedented rise, driven by Greenspan's easy
credit. In seven years to 2004, prices of U.S. homes had risen on
paper by $7 trillion to a total of $15 trillion, the highest in U.S.
history. The problem is so obviously dangerous that Greenspan recently
was forced to deny existence of any real estate “bubble,” much as he
denied a dot.com stock bubble in 2000.
Debts keep bubbling along
But that is exactly what he has created with his low interest rates.
The dot.com bubble has been transformed into a larger and more
threatening real estate bubble. Families have been convinced to invest
in a home as an alternative to buying stocks for their pension years.
The rise in home prices has been driven by cheap interest rates and
banks rushing to lend with abandon. Two semi-government agencies, the
Federal National Mortgage Association (known as FannieMae) and the
Government National Mortgage Association (or GinnieMae) buy up the
banks' mortgage contracts, taking the risk from the local banks. As a
result, the local lending bank is more flexible in arranging loans to
higher-risk customers.
The U.S. Congress has passed new laws making it even easier for banks
to help families to buy homes without requiring them to use any of
their own money as a “down payment.”
This has meant a huge rise in mortgage loans to economically marginal
or risky families. The number of such risky or “sub-prime” mortgage
loans has risen by 70% this year alone, and now makes up 18% of all
U.S. mortgages. Many of these risky mortgages are made under
“adjustable rate mortgages.” Today adjustable rates are low, just
above 4%. Because of this some 35% of all new mortgages are adjustable
today.
So long as rates stay low, the roulette wheel of debt rolls on. The
problem begins when interest rates rise and families, lured into
buying a home with variable interest rate payments, suddenly find
their monthly cost of paying the mortgage has exploded as interest
rates rise. At that point, U.S. banks will face a serious bad loan
problem, far worse than that of 1990-92 when several of the largest
U.S. banks were on the brink of failure.
U.S. interest rates began to rise significantly in May, and the Fed
was forced to raise its official rate on June 30 for the first time in
four years. Many banks have loans written in adjustable mortgage
rates. A wave of mortgage defaults will likely be triggered as U.S.
interest rates continue to rise over the next 12 months or so. Some
industry experts fear a “bloodbath” in 2005.
Institutionalized American indebtedness
The American family is highly indebted, not just for their home. The
Federal Reserve data show a total U.S. debt level now above $35
trillion, or some $ 450,000 for a typical family of four. Average
consumer debt for credit cards, autos and such is at record highs. Car
makers continue to offer car loans, with loans for up to six or even
seven years. Many Americans owe more on their car than it is worth.
As long as Fed rates are at 43 year lows, the debt is manageable. When
U.S. rates rise, it becomes unmanageable for many -- and the rise has
begun. There are two ways rates are likely to rise from here.
First, the Fed itself has been forced to act, raising its Fed funds
rate, for the first time in four years, to 1.25% from 1% on June 30.
It had no choice. Greenspan has claimed for months that the U.S.
recovery was “strong” and that rates would return to “normal” soon. It
was a calculated bluff. Had he not acted as U.S. jobs data convinced
investors recovery might be real, he faced a major crisis of
confidence in the dollar.
The Bush administration reportedly manipulated employment statistics
to show better job growth for the election.
A trapped Fed
Ever since raising rates, Greenspan has calmed nervous markets by
stating that future rises will be ever so gradual. In other words:
don't worry, speculators. But if he is to keep the confidence of the
large bond markets, he must convince them that he is still vigilant
against inflation. That is tough when prices for everything from
copper to oil to lumber to soybeans and scrap steel are rising from
50% to 110% over recent months. His only anti-inflation tool is higher
interest rates, or promise of same. The longer he fails to raise rates
as prices rise, the greater the risk of a dollar crisis, as foreign
investors fear the worst, namely that the U.S. economy is in far worse
shape than officials admit. The Fed is in a trap.
Higher interest rates threaten to explode the $3 trillion dollar home
mortgage debt bubble, where home values are estimated to be at least
20% overvalued nationally.
U.S. debt for sale
When private bond investors such as major pension funds and banks lose
confidence in Greenspan's inflation commitment, the only other source
of support for low interest rates would be the willingness of Japan
and China above all, to pour billions more of their dollars into
buying U.S. bonds.
The largest buyers of U.S. government debt have been the central banks
of the Asia-Pacific. The central banks of Japan and China alone hold
more than $1 trillion of U.S. Treasury bonds as foreign currency
reserves.
Worldwide foreign central banks hold some $1.3 trillion of U.S.
government debt. If private debt is added, the United States is the
world's largest debtor nation, with some $3.7 trillion in net foreign
debt as of the start of this year. It is likely to have increased to
well over $4 trillion by now.
In 1980 when Ronald Reagan was elected, the U.S. was the world's
creditor with a plus of $1 trillion.
Nations depending on the large U.S. export market, recycle their trade
surplus dollars back into buying U.S. Treasury debt to keep their
currency fixed to the dollar. Because Japan and China and others
continue to buy record sums of U.S. debt, paying with their
hard-earned trade dollars, U.S. interest rates can remain far lower
than what would be realized without foreign “investment” through
purchase of U.S. bonds. Were foreign buying of U.S. bonds to reverse
or even slow, the U.S. Treasury would have to offer higher interest
rates to lure investors to buy the debt. That would make interest
rates on homes more expensive very fast. Millions of homeowners would
face default. Prices would collapse in many regions, leading to higher
unemployment.
This will not be like the dot.com crash, which was a deliberate crash
caused by the Fed raising rates to deflate that bubble. In 2000
interest rates were 6.5% and the Fed had room to lower to 1% and
create the housing bubble alternative for money to keep the economy
afloat on a sea of debt. This time, rates are at historic lows, debt
at historic highs and U.S. economic dependency on continued foreign
capital is unprecedented.
Speculation has become global as never before. The cheap credit in the
dollar world has led to cheaper credit worldwide. The economies of
Brazil, Mexico and even Argentina benefit from banks and speculators
like George Soros who borrow at the super low U.S. or Japanese
interest rates to invest in bonds in high interest rate lands like
Brazil or Turkey or Argentina.
These so-called emerging markets have been booming in the past year on
Greenspan's promise to keep U.S. rates so low. That now is beginning
to look very risky. As well, Bush Administration talk of possible
terror attacks around election-time is making many major investors
fear risking investments in U.S. stocks or bonds. They are instead
beginning to cash in their recent profits from the Greenspan stock
boom of 2003-04, and holding it in safe cash.
Myth of recovery
That is a major reason the U.S. stock and other markets have been
falling steadily in recent weeks. The U.S. debt bubble depends on
maintaining the myth of a U.S. recovery to lure foreign capital to
invest, helping keep the dollar from collapsing. Should foreign
pension funds of the central banks of China and Japan be convinced the
U.S. recovery is in danger, there could be a major shift of funds out
of dollars.
Yet China and Japan, fearing the dollar crisis, have recently begun
heavy buying of commodities, from oil to iron ore to copper to gold.
They are using their trade dollars to buy real commodities, instead of
U.S. Treasury debt, which is mere paper. Chinese panic buying of oil
for stockpiling reserves is a major factor pushing oil prices again to
record levels of $42 a barrel despite two major OPEC quota rises.
Steel prices have also exploded due to China demand.
When Bush became president he inherited a federal budget in surplus,
largely owing to the taxes from a booming dot.com stock bubble
economy. Since then he has created the largest deficits in U.S.
history, near $500 billion in 2004 and estimated to reach $600 billion
in 2005.
In 1971, when Nixon took the dollar off the gold standard and opened
the way for printing unlimited volumes of dollars, the Federal budget
deficit was an “alarming” $23 billion.
These huge deficits are financed by the U.S. Treasury selling
government bonds or similar paper to investors. Since 2001, the
central banks of Asia, led by Japan and China, have bought huge sums,
some 43% of all U.S. government debt. They in effect recycled their
trade dollars gained from exporting cars, electronics, textiles and
other goods to the U.S. consumer.
In the 12-month period from April, 2003 to April, 2004, the Bank of
Japan spent a record $200 billion to buy U.S. dollar bonds or, in
effect, to finance the cost of Bush's Iraq war. The Banks of China,
South Korea and Taiwan have spent nearly as much on dollar bonds as
the Japanese.
They did this for clear reasons: Their currencies are linked to the
dollar, and were the dollar to fall against the Yen or the Yuan, Asian
exports would suffer a decline, endangering their economic growth and
leading to explosive rises in unemployment across Asia. By recycling
their trade dollar surplus into buying U.S. Treasury debt, they argue
they are looking after their own needs. Should a dollar crisis in
early 2005 occur, a global financial crisis would likely follow.
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