The Trillion Dollar Question: Interest Rates
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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