Signs of the Economic Apocalypse 7-4-05

From Signs of the Times 7-4-05:

Since Friday was the mid-point of 2005, let’s review the year so far. In the U.S. stock market, the Dow Jones Industrial Average closed at 10,303.44 on Friday, down 4.7% from 10,783 on December 31, 2004. The NASDAQ closed at 2057.37 down 5.7% for the year so far (from 2175). The yield on the ten-year U.S. Treasury bond was 4.04 percent at Friday’s close, compared to 4.22 on December 31, 2004 and 3.92 a week ago. The dollar rose from 0.739 to 0.840 euros so far in 2005, a rise of 13.7% (or 1.7% for the week compared to last week’s clsoe of 0.826). Gold closed at $429.30 an ounce, dropping 2.9% for the week (it closed at $441.60 a week ago) and dropping 1.8% for the year (compared to $437.10 on Dec. 31). Gold in euros closed at 360.51 euros to an ounce of gold on Friday, down 1.2% compared to 364.90 a week ago but up 11.8% for the year compared to the close of 322.32 euros per ounce of gold on Dec. 31. Oil closed at $58.75 a barrel on Friday, a rise of 35.2% for the year. Oil was down 1.9% for the week compared to $59.84 on the previous Friday. In euros, oil was up sharply for the year going from 32.09 euros on the last day of 2004 to 49.34 on Friday, a rise of 53.8% (but down slightly for the week from 49.45 a week ago). The gold/oil ratio (how many barrels of oil an ounce of gold will buy) went from 10.06 to 7.31 in 2005 (7.38 a week ago) a drop of 37.6% for the year.

Most surprising to me was the drop in the euro, which implies some strength in the dollar, but probably more weakness in the concept of the euro and of the European economy right now. Longer-term, however, the Euro Zone still has potential to serve as an alternative highly developed core to the United States, particularly if it can work out preferential access to oil from the Russian Federation. Competition for oil between China, Europe and the U.S./U.K./Israel/Japan/India axis, however, will be intense and the results will most likely be unpredictable.

I also expected gold to have risen in the first half of 2005, but, along with some sharp ups and downs, the price of gold in dollars fell 1.8%, also implying strength in the dollar. What this shows is that the United States has been able to keep its economy growing through continuing deficit spending and debt-driven, housing price bubble-driven consumer spending. How long that can go on with rising short-term interest rates in the United States and with signs, increasingly hard to ignore, of a military defeat is anyone’s guess.

Stephen Roach of Morgan Stanley is now saying that the bubble-like asset inflation economy of the United States could go on for a while longer, making the ultimate reckoning even worse:

I suspect the US interest rate climate is likely to remain surprisingly benign and, therefore, supportive of yet another wave of debt-intensive asset inflation. As a result, the housing and bond bubbles could well continue to expand, allowing asset-dependent American consumers to keep on spending. US economic growth, in that climate, may well remain surprisingly firm -- even in the face of $60 oil. All this would be a textbook example of another period of “bad growth” -- the last thing an unbalanced US and global economy needs. Likely by-products of another spate of bad growth include more debt, further reductions in income-based saving, and an ever-widening current account deficit. Eventually, the balance-of-payments constraint will take over -- triggering a renewed weakening of the dollar and a sharp back-up in real interest rates. But the emphasis, in this case, is on the word “eventually.” The bear case for rates that I now support is likely to come later rather than sooner -- and off lower levels of longer-term rates than I had previously thought possible. Because of that hiatus, there’s little to stop the Asset Economy for the time being.

Meanwhile, the excesses in the US property market are now starting to display all the classic symptoms of a mania -- underscoring the inherent vulnerability that Yale professor Robert Shiller has long warned of. It’s not just the growing profusion of exotic financing schemes -- the interest-only and negative-amortization mortgage loans that have become the rage in the hottest of real estate markets. Equally worrisome is evidence that “asset flipping” is now reaching Ponzi-like proportions. The latest rage is http://www.condoflip.com/ -- a website dedicated to creating an electronic market whereby “buyers of preconstruction condos resell or assign those condos to new buyers.” Debuting in Miami, expansion is set shortly for Las Vegas, Los Angeles, Dallas, Chicago, and New York. If you hurry, you may even be able to own a “Condo-Flip” franchise of your own. Five years later, this is nothing more than a reincarnation of the day-traders of the dot-com era.

As former Fed Chairman Paul Volcker noted recently, the saddest thing of all is that no one in a position of responsibility wants to put an end to this madness (see his 10 April 2005 op-ed in the Washington Post, “An Economy on Thin Ice”). Congress is focused on fiscal profligacy and China bashing. The White House is fixated on “transformational politics.” The Fed remains steeped in denial. And the rest of the US-centric world is begging for another spin around the track. Sadly, bad growth begets more bad growth -- until it’s too late. Following this week’s likely rate hike, the US central bank will have only 325 bp in its arsenal -- literally half the ammo it had five years ago when the first bubble popped. With the aftershocks of the property bubble likely to be far more worrisome than those of the equity bubble, this time the Fed may be ill equipped to face what is shaping up to be an increasingly treacherous endgame.

The future of the United States as an economic power, however, will most likely depend on its actions as a military power, and those, unless the Bush gang can be forced from power, will most likely prove disastrous.