U.S. interest rates continue to rise and even though we are seeing a slight decrease in economic activity,
the Fed is concerned about the continuing and growing use of home loans to finance a lifestyle that is beyond the means of
many Americans. This will have a very deleterious effect on the economic growth environment in the U.S. as interest rates
rise.
U.S. consumers have been living beyond their means. They have been financing their spending programs with
periodic refinancing of their homes. As interest rates declined for twenty-three years, this type of behavior was rewarded.
Recently, a new layer of unreality has been added to this pattern. Debtors have been buying speculative real estate with the
proceeds of low interest loans on their existing properties. In our opinion, speculation in real estate can be successful
only when the cost of money is below the rate of inflation.
INFLATION
This brings up the question what is the rate of inflation in the U.S.
There are two rates of inflation:
1) The number published in the government statistics.
2) The rate by which people believe their cost of living is rising.
Today, the public at large is scornful of the unrealistically low government inflation numbers, which show
inflation at 3.1% over the last twelve months. Instead, they have chosen to react to the cost of the basket of goods they
personally purchase, which they believe to be about 6 % per year. If the cost of money is below 6%, then they believe that
they can make money borrowing to buy real estate. Further, tax benefits and low down payment real estate financing options
have clouded their view. The combination of these factors have led to speculation and rapidly rising prices in many urban
areas of the U.S. Further, exacerbated by wealthy foreigners who want the security of real estate outside of their home countries.
Now, mortgage rates are closing in on 6% and the door is closing on this type of speculation.
ECONOMIC IMPACT OF HIGHER INTEREST RATES
In the U.K., when real estate prices stopped rising rapidly, consumer spending began to decline decisively.
I believe that the same syndrome will be felt here and the Fed will then have a serious problem on their hands. If the U.S.
consumer stops spending when their source of cheap cash from an ever rising home price dries up, how will the Fed be able
to stimulate the economy? Since the U.S. consumer has been an important component of the world economic expansion, this could
cause a slow down in global economic growth. Fortunately for Mr.Greenspan, it will probably be his successor who will catch
the blame for the problems.
By the way, did you notice that one of the U.S. Senators was trying to blame Greenspan for the tax cuts and
their devastating effect on the budget deficits? Greenspan endorsed the tax cuts with the caveat that if deficits rose, the
tax cuts should be abandoned. According to the Senator, the Fed chairman should have known that his advice on stopping the
cuts if deficits rose, would be ignored.
Although I fault Mr. Greenspan for conditionally agreeing to the tax cuts in the first place (as Chairman
of the Federal Reserve, his job is monetary policy not tax policy), it takes a lot of gall to blame someone, who warned you
about a possible problem, when the problem arises. But of course, politicians do have a lot of gall.
CURRENCIES, CHANGE IN VIEW
We have held the view that the dollar would rally for a few months and the bottom in the foreign currencies
would be at the end of March, or in April. Our view has changed, and the reason is higher U.S. interest rates. The higher
interest rates in the U.S. are strengthening demand for the dollar, and simultaneously decreasing foreign anger over the valuation
of the Chinese Yuan, which is pegged to the dollar. We anticipate that U.S. interest rates will rise for a few more months.
Thus, we expect the U.S. dollar to remain strong versus foreign currencies for at least a few more months.
NATURAL RESOURCE ACQUISITION BINGE CONTINUES
The great natural resource acquisition binge continues as China and India and others try to line up resources
to continue their rapid growth. They have purchased assets in Canada, Latin America, Australia and Africa, and alliances have
been put in place to assure a flow of resources and energy to these fast growing nations. Now, it looks to us as if the spike
in base metals’ prices is ending as demand moderates into a steady growth pattern. We have not owned base metal stocks
for many months, but we may purchase them later.
FINANCIAL ACCIDENT ON THE HORIZON?
In my last memo, we printed a summary of a statement by former Federal Reserve Chairman Paul Volcker. He mentioned
the possibility of a financial crisis. We believe that gold may act as an anchor to windward in periods of financial crisis,
and is therefore a natural resource which may be sought by China, India and other asset rich nations desiring to diversify
away from paper currencies. I have heard from three friends who I respect that a crisis is brewing in the derivatives market.
It may be insurance derivatives, or it may be speculation against the Chinese Yuan, which has cost some big hedge funds enough
money to precipitate a crisis.
The above is commentary from an independent source and dos not necessarily
reflect the opinion or view of www.viewfromsiliconvalley.com. Invest at your own risk. Consult a financial advisor before initiating
any investment.
