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The Trillion Dollar Question: Interest Rates

By Richard Russell,          Printer Friendly Version

For The Gold Report
May, 2004

Let's start with a paragraph from today's New York Times. The article headline, "As Household Debt Rises, New Risk in Higher Rates." And here is the paragraph –

"A management consultant in Denver, Mr. Thomson bought at $500,000 townhouse last Friday in the suburb of North Cherry Creek. As many other first-time home-owners have done, Mr. Thomson put no money down. Instead he took out a first mortgage for 80 percent of the purchase price and paid the rest by taking a home equity loan against the new house. To reduce his monthly payments, and to qualify for a big enough loan, he took out an adjustable rate mortgage that requires him to make only interest rate payments."

And what happens if we get a spike in interest rates? The bank will own the house, that's what will happen. Is this the kind of financing that has given us a good portion of the big real estate boom or as I call it, the enormous "real estate bubble"? Yeah, I'm afraid it is.

So the trillion dollar question ahead, as I see it, is interest rates. If rates head up from here, there's going to be hell to pay. There is now about $22 trillion in domestic debt. On top of that there is an estimate seven times that outstanding in derivatives. Roughly 85 percent of all derivatives are interest-rate oriented. So the truth – nobody knows what will happen if rates start up, and more importantly if rates spike up. Nobody, I repeat, NOBODY including the Fed, has the answer to what could or will happen if rates suddenly start to spike.

The debt situation in the US is ballooning. At the Federal level the national debt is rising at almost a 10 percent rate annualized rate. Total debt in the US is now about 300 percent of the US Gross National Product, a situation never seen before. A goodly chunk of the debt has been financed at the Fed's low 1 percent rate. The situation, as I see it, is extremely dangerous. I've said that the Fed, in keeping rates at 1 percent, has built a fantastic "debt-bubble." When this bubble bursts, and it will burst, the US could go into a long period of deflationary "unwinding," a period which would see a panic for liquidity and dollars with which to carry or pay off debt.

This is the frightening situation that now faces the Greenspan Fed. How to raise rates to halt the current inflationary pressures – and at the same time not panic the money markets. Let me tell you something – the process of building debt is inflationary UP TO A POINT. But past that point – the debt situation become DEFLATIONARY. These must be the thoughts of Alan Greenspan as he wonders whether or not to "gently" raise rates.

But here's the danger – by holding rates down artificially month after month, Greenspan has gone against the "natural" laws of economics. The longer rates are held artificially low, the greater the power of the ultimate upward "adjustment" as rates surge higher (unwinding) following their long "confinement."

Why will rates surge higher? The need for cash, the panic for cash to pay off the debt once the economy tops out. And by the way, my studies of the stock market suggest that the stock market has topped out – and when the stock market tops out it's a forecast on the part of the stock market. It's a forecast that's telling us that it's only a matter of time before the economy itself tops out.

(May 4, 2004)



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