 Casey Files:
Where Is the Economy Going
in the Next 6 Months?
Bud Conrad
Chief Economist
The
Casey Report
Jul 25, 2008
As investors, the question
we have to focus most of our attention on just now is what impact
the credit crisis, the bursting housing bubble and the actions
of the U.S. government will have on the economy and investment
markets in the next six months.
We have seen the Fed and the
federal government move to panic mode as they try to keep the
system afloat. As expected, they have cut rates, as well as having
given away checks and rearranged the Federal Reserve's entire
balance sheet.
The underlying problems have
not been fixed with this massive bailout. There are still many
credit pot holes out there and new lending remains highly constrained.
Even the government tax rebate checks, rather than boosting the
domestic economy, were largely absorbed by higher oil prices.
The resulting cut-back in consumer spending, coupled with ongoing
constrictions in lending, will cause a severe slowing of the
economy.
But the much bigger implication
is that the Fed is busy pouring more gasoline on the fire by
fighting the collapsing housing bubble, a housing bubble created
by excess liquidity, with yet more liquidity. That is the key
point that should be taken from this mess. The dollar is now
firmly on an even steeper slope to its ultimate demise. Other
currencies will be sliding down the same slope, so another paper
currency is not the answer.
This, then, is a high-level
context for many of our investment recommendations in the months
ahead.
Short Term Projections
1. The housing decline is not
yet done, because we will need another year to unwind foreclosures
in the pipeline. In addition, the exuberance shown by appraisers
at the height of the housing bubble still has a long ways to
go to fully deflate. What is that house on the market down the
road really worth? At this point, no one knows... and no one
will know until it and many others are bought by willing buyers
(as opposed to unwilling lenders taking them onto their books
in a foreclosure).
2. Consumers in the U.S. are
not able to expand credit and are increasingly concerned about
the outlook for the economy, so they will slow spending both
at home and on imports.
3. The financial/banking system
is weaker than understood. The complexity of the global system
and the ubiquitous presence of interlocking financial and credit
instruments and literally trillions of dollars in derivatives
has left the world's banks teetering on the edge.
Adding a push from behind,
we have broadly rising inflation and soon the persistently higher
interest rates that are the bane of fixed-income investors and
financial institutions in general. As the dollar continues its
fall, and the banks continue to come under pressure, the lack
of confidence in these keystones of the modern financial system
will deepen. Already, the Sovereign Wealth Funds that rushed
in early in the credit crisis to prop up the big investment houses
are now signaling that, at least for the time being, they are
going to step back and watch how things shake out.
4. A slowing economy - recession
- coupled with inflation, creates a condition often referred
to as stagflation, presenting much bigger policy challenges for
the government than one or the other alone.
5. The food crisis. Shortages
of food production come from rising energy and fertilizer costs.
Rising demand comes from a shift in diet, especially in emerging
markets, where increasing prosperity leads the citizenry to add
more protein to their diets. Important shortages in grains have
arisen that don't allow for a bad crop year. Most concerning
is that these shortages are occurring despite good crop production
last year, an occurrence that can be blamed, in part, on the
diversion of some agriculture production for ethanol and bio-diesel.
These food shortages have already
contributed to a doubling and tripling in the price of grains
over the last two years. But even these elevated prices have
not been sufficient to offset the higher costs of the energy
required to produce the crops. And, despite today's higher prices,
agriculture still lags the price increases seen in many other
commodities.
[For more information on the
subject of food, watch my recent appearance on FOX Business News
here.]
The result of this is that
the inflation rate, interest rate, food, energy and precious
metals are heading higher as the dollar is debased.
Higher rates are not good for
housing and stocks. In the long term, they will recover in nominal
terms, though not in actual terms. That's because, while their
nominal prices may return to current or near current levels,
the dollars used to express their value will have much reduced
purchasing power... making those assets a mediocre investment
for the foreseeable future.
Finally, it is important to
recognize that the world remains in the throes of a deep and
serious crisis. While many analysts will express the view that
the worst is over or that, after a modest downturn, things will
bounce back just like they always have, our view is that what
we will actually witness going forward is a fairly steady occurrence
of crisis and panic. The crisis will accelerate, moving faster,
even, than in previous major shifts such as that witnessed in
the 1970s.
While history may find we are
too pessimistic at this point in time, in our view it is far
better to prepare for a worsening crisis and hope that it does
not materialize, than to expect business as usual.
Bud Conrad is the Chief Economist of Casey Research,
LLC., publishers of Doug Casey's International Speculator
which provides unbiased research and recommendations on the highest
quality junior exploration companies.
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