Is a US dollar dump underway?

Zero Hedge notes the US Federal Reserve provides a weekly update known as the H.4.1.

Observers of the Federal Reserve's Custodial Treasury account follow these updates with keen interest. Recently they have been somewhat perplexed.  There has been a continued, weekly selloff of $56 Billion of US Treasury's.

Is the continued drop an asset rotation - under duress or otherwise - out of bonds and into stocks, to prevent the collapse of the global ponzi? Or, as Zero Hedge pondered, has the dreaded D-day in which foreign official and private investors finally start offloading their $2.7 trillion in Treasurys with impunity arrived?

Recall that a few months ago China has made it abundantly clear it will sell its Treasury holdings, the only question is when.

The most recent came out on January 4th and a further $17.7 billion has been "removed" from the Fed's custodial Treasury account.

The alarm bell that is going off her is that in six consecutive weeks, foreigners have sold off more government bonds in a sequential period of time than ever before. It means that someone, somewhere is very displeased with US paper, and, far more importantly, they want to make their displeasure heard loud and clear.

It is an interesting development worth watching.  The consolidated outflow notional is now a record high $77 Billion (beating the previous record of $52 Billion). Should the selloff accelerate, look for the Federal Reserve to have to step in.

The real question is what they are converting the USD into? And how much longer it will go on for?

The last thing the US can afford is a wholesale dumping of its Treasury's. The traditional diagonal rise in foreign holdings of US paper has not only pleateaued, but it is in fact declining: a first in the history of the post-globalization world.

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What's wrong with this picture?

Did you ever play Monopoly as a kid and, as the designated banker, succumb to the temptation to simply remove some money for yourself if you were strapped for cash?

Wouldn't it be great if you could do that in real life?  Solve your money problems by simply creating more cash for yourself?

That's basically what the United States is doing.

As CNSNews.com notes, at the close of business on Tuesday the debt of the US federal government exceeded $15 trillion for the first time - with the largest single owner of the publicly held portion of that debt being the US Federal Reserve.

Over the past year, as the Federal Reserve massively increased its holdings of U.S. Treasury securities and entities in China marginally decreased theirs, the Fed surpassed the Chinese as the top owner of publicly held U.S. government debt.

In its latest monthly report, the US Federal Reserve said that as of Sept. 28, it owned $1.665 trillion in U.S. Treasury securities. That was more than double the $812 billion in U.S. Treasury securities the Fed said it owned as of Sept. 29, 2010.

Meanwhile, as of the end of this September, entities in mainland China owned $1.1483 trillion in U.S. Treasury securities, according to data published today by the U.S. Treasury Department. That was down slightly from the $1.1519 trillion in U.S. Treasury securities the Chinese owned as of the end of September 2010, according to the same Treasury Department report.

Thus, at the end of September 2010, the Chinese owned about $339.9 billion more in U.S. Treasury securities than the Fed owned at that time. By the end of September 2011, the Fed owned about $516.7 billion more in U.S. Treasury securities than the Chinese owned.

Perhaps the most astonishing statistic is that since Barack Obama has been President, the US debt has gone from $10,626,877,048,913 on January 20, 2009 to $15,033,607,255,920 as of yesterday. That's a stunning increase of 41.5%, or $4.4 trillion.

No wonder the US Federal Reserve is now the largest holder of debt.  Who else, besides the ones who are printing the currency, is there to buy it?

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Snapshots

Let's take a peek around the internet today, shall we?

First up is the lastest stats from the Real Estate Board of Greater Vancouver (REBGV).

December stats reveal that the bubble is blowing ever higher and the average price of a detached home in the Village on the Edge of the Rainforest now sits at an astounding $952,927.00!

(click on image to enlarge)

Will we hit a million dollars? Possibly.

Canadian Banks continue to ignore the warnings from Carney and Flaherty to be 'prudent' with lending. Offers to get you in for zero down, such as this one from TD Canada Trust, continue to exist.

And realty companies, like Royal Lepage, continue to pump the market by suggesting that buying now will result in an 7.2% increase in value of your purchase this year in the Lower Mainland... "so long as the expected mid-year rise in mortgage rates isn’t a dramatic spike."

But that's the rub, isn't it?

That's the entire essence of the warnings we have been blurting out for the past year: rising interest rates will destroy you if you buy now.

And the warnings continue unabated.

The National Post chides today that "happy times for interest rates can't last forever".

So dire is that potential problem that the Post notes that a simple 1% increase in rates could dramatically affect you bottom line. "For a home buyer, rate increases mean hefty payment boosts. For example, it will cost $3,252 more per year to pay down a $500,000 mortgage balance when the interest rate rises from 3.5% to 4.5% , assuming a five-year term and a 25-year amortization."

The 25-year amortization comment is particularly important given the fact the Finance Minister is sounding warnings that the permitted amortizations could be reduced from the current 35 year maximum. Before 2006, that maximum was 25 years.

It means those with a mortgage face the double whammy of increased interest rates plus a shorter amortization period when they renew.

A simple 1% rise in rates could translate into $3,252 increase in yearly payments on that $500,000 mortgage.

When you consider that the conservative estimation on what will happen to interest rates is that we will see a minimum of a 2.5% spike in rates, it means the cost of renewing adds up quickly.

With that theme in mind, Report on Business is also warning mortgage holders to "Fasten your seatbelts".

They suggest you have roughly six to nine months to get a personal plan together for dealing with higher interest rates.

Yikes! At least they try and offer several strategies to get ready.

And it's not just in Canada that warnings are being issued.

In the United States, the FDIC has now come out with an 'Interest Rate Advisory' for institutions.

US Banks are being reminded "of supervisory expectations for sound practices to manage interest rate risk (IRR)."

The warning is very specific:

"In the current environment of historically low short-term interest rates, it is important for institutions to have robust processes for measuring and, where necessary, mitigating their exposure to potential increases in interest rates."

The only real question is how high might it go?

And THAT, of course, turns us once again to the issue of the US Dollar and US Treasury sales to foreign countries - particularly China.

With that in mind, consider this article from 'The Business Insider' which lays out a series of charts showing clearly that "China's Dumping of the US Dollar has begun". The yellow line represets the plunging level of Treasury purchases by China.

(Click on image to enlarge)

To sell sovereign debt, the purchasing of that debt is going to have to be made very attractive.

And there's only one way to do that: increase the yield. That means higher and higher rates on home mortgages.

We've been through this before... in the late 1970s.

22% mortgages, anyone?

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Another Prognostication

Predictions are fun to make despite the fact they are so often wrong.

Now... we've already established that the theme for 2010 is Debt... debt and the recession.

In reality a severe recession would be a good thing for us.

After having gone through a decade of borrowing to consume, Canada needs to rebalance.

This recession was caused not by too much inventory but by too much credit and leverage in the system. And the world is in the process of deleveraging. It is a process that is nowhere near complete. While the crisis stage is over (at least for now), there is still a lot of debt to be retired on the consumer side of the equation, and a lot of debt to be written off on the financial-system side.

Total consumer debt is shrinking for the first time in 60 years. And the decline shows no sign of abating.

That's why the recession is the solution, not the problem. The problem was the bubble inflating, blowing up. Not the deflation. Now it's time to allow the pain, no matter how unpleasant it is, to correct the imbalances.

And it's not just consumers who are attempting to deleverage. The corporate sector is trying to deleverage too, as Bloomberg notes in an article today. The amount of corporate debt outstanding globally shrank for the first time in at least 15 years in the first half of 2009 as U.S. banks reduced the size of their balance sheets.

Tetsuo Ishihara, a senior credit analyst for Mizuho in Tokyo, analyzed data from the Bank for International Settlements and noted that “it’s unprecedented that the global debt market shrinks. When redemption's and buybacks are greater than new issues the outstanding size can shrink, which appears to have happened here.”

Financial companies in the Americas had $1.1 trillion of losses and writedowns since the credit crunch started in 2007, about 65% of the global total, according to data compiled by Bloomberg.

But in Canada, none of that deleveraging has happened... and it's all because of the Federal Government.

As this blog has already covered, the Feds slashed interest rates to dirt and empowered CMHC to expand their assistance into risker and risker home mortgages. It used to be that the mission of CMHC was to try and make home ownership affordable. Now their mission is to keep home prices high.

And this is where the government is making a huge mistake. The reality is that the best thing that can happen to our economy is for these high prices to come down.

But the government’s solution was to keep high prices through low mortgage payments subsidized by the government.

The free market solution would have been allowing the market to correct to bring us low prices.

If real estate prices go down, you don’t need to borrow that much money to buy a house. And if they do, it doesn’t matter that interest rates go up a bit, because your payment will be lower anyway.

But that didn't happen. Carney and Flaherty intervened and their actions have kept homes unaffordable. It ensures Canadians have to mortgage themselves to the hilt to buy a house.

Rather than help Canadians, Carney and Flaherty have made it worse. In 2010 we will see that this will become the foundation of our financial crisis.

The government looked at the problem as being one of falling real estate prices. That’s wasn't the problem, that was the solution.

The problem is that they went up to begin with.

The reality is that the world is just starting to go through a massive – and necessary – recession. Some think it is just ending. It isn't, its just getting started and we have barely gotten a taste of it.

What we really need is for the government to eliminate the deficit and go to a surplus. We need the government to stop spending money and depleting our savings (by taxing us to death).

We need consumers to stop spending money and rebuild their savings.

We need to have the government say to us, “this is the price we pay for years of indulgence and reckless spending, now comes the sacrifice. And there is nothing the government can do about it.”

We also need sound money.

Unfortunately that will mean we need high interest rates.

Kenneth Rogoff, Professor of Economics at Harvard, Former Chief Economist at the International Monetary Fund recently said, “It’s a question of how do you achieve the deleveraging. Do you go through a long period of slow growth, high savings and many legal problems or do you accept higher inflation? It would ameliorate the debt bomb and help us work through the deleveraging process.”

The developed world is drowning in debt and there are only two viable options – a global economic depression or very high inflation.

It seems policymakers have chosen the latter option and over the next few years we seem destined to experience the trauma of severe inflation regardless of Ben Bernanke's assurances to the contrary.

The American government is staring at total obligations of US$115 trillion, their debt to GDP ratio is off the charts and the American public is also up to its eyeballs in debt.

Inflation seems to be the chosen solution.

And that means Canada will be forced to deal with a readjustment that hasn't been prevented at all... just delayed.

It is notable that America is not alone in pursuing inflationary policies; most nations all over the world are printing money and debasing their currencies.

In this era of globalisation, no country wants a strong currency and everyone is engaged in competitive currency devaluations.

Given this reality, its hard not to agree with those who believe that this money and debt creation will cause an inflationary holocaust over the coming years.

Which brings us to our next prediction for 2010: Gold.

As we have noted before, Gold is not money... nor is it a hedge against inflation (it performs that role very poorly). What gold is, however, is a hedge against the mismanagement of the state - which at this time and place is the United States with it's world's reserve currency status.

It is almost a certainty that the United States will be forced to continue Quantitative Easing next year when they cannot find enough buyers for their $2.1 trillion Treasury sales.

As a result, gold's decoupling from the ups and downs of the US dollar may come as soon as next year as nation states and investors panic.

Because of that, I predict a gold price of over $2,000 an ounce by the end of next year.

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Whole lotta pain

Yesterday I talked about US debt and today the theme continues.

Specifically... US Treasuries and how few people acutally bought them in 2009.

Eric Sprott, the Toronto-based money manager whose Sprott Hedge Fund returned about 496% in the past nine years, has been trying to figure out that very question.

In a report entitled 'Is it all just a Ponzi scheme?', Sprott and David Franklin suggest that it's impossible to find who was the second largest buyer of Treasuries in 2009.

Of the $1.885 trillion dollars in public debt the US added in 2009, $704 billion (annualized) was bought by "Other Investors", a collection of buyers defined in the Federal Reserve Flow of Funds Report as the "Household Sector".

Interestingly, the $704 billion is 35 times more than this sector bought in the prior year, 2008.

Sprott and Franklin did some digging and here is what they found:

• Amazingly, we discovered that the Household Sector is actually just a catch-all category. It represents the buyers left over who can't be slotted into the other group headings. For most categories of financial assets and liabilities, the values for the Household Sector are calculated as residuals. That is, amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the Household Sector. To quote directly from the Flow of Funds Guide,
  
  "For example, the amounts of Treasury securities held by all other sectors, obtained from asset data reported by the companies or institutions themselves, are subtracted from total Treasury securities outstanding, obtained from the Monthly Treasury Statement of Receipts and Outlays of the United States Government and the balance is assigned to the household sector."
  
  So to answer the question - who is the Household Sector? They are a PHANTOM. They don't exist. They merely serve to balance the ledger in the Federal Reserve's Flow of Funds report.
  
  Our concern now is that this is all starting to resemble one giant Ponzi scheme. We all know that the Fed has been active in the market for T-bills... they bought almost 50% of the new Treasury issues in Q2 and almost 30% in Q3.
  
  It serves to remember that the whole point of selling new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing debts that are maturing. We are now in a situation, however, where the Fed is printing dollars to buy Treasuries as a means of faking the Treasury's ability to attract outside capital. If our research proves anything, it's that the regular buyers of US debt are no longer buying, and it amazes us that the US can successfully issue a record number Treasuries in this environment without the slightest hiccup in the market.

As we discussed yesterday, the actual number of US Treasuries sold to foreigners was next to nothing. As the Sprott report points out, the US Treasury and/or the Fed has been buying US treasuries themselves, in much larger numbers than they acknowledge.

The coming year of 2010 will be known as the year of the Debt.

It will bury entire nations. Nations like Greece and Ukraine, and states like California, and it will threaten to topple scores more.

As was posted yesterday, the looming question is who is going to buy the $2.06 trillion worth of US Treasuries next year?

China, Japan and the UK have increasing doubts about amassing USD denominated paper including Treasuries, Japan also plans to be as aggressive a seller as the US when it comes to debt. And of course there are many other countries who desperately need to sell sovereign bonds in order to pay for their already accepted and implemented budgets - not the least of which is Canada.

And that's just the nation states.

Corporations and lower levels of governments, in every nook and cranny of the planet, want to sell you their debt. Badly.

So the story of 2010 is going to be all about debt and the rapid rise in interest rates to cover it.

It's impossible to foresee at this point how high the rates may rise, but it looks patently obvious that it is going to be a lot more than a few percentage points... and there will be a lot of pain involved when they do.

A whole lotta pain.

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The Day After... so what now?

Yesterday was a significant day.

Besides the 80th anniversary of Black Tuesday, the day marked an important signpost on the winding road of interest rates.

As reported in Bloomberg, the US Federal Reserve's seven-month $300 billion treasury purchase program ended on Thursday.

The treasury purchase program was responsible for keeping interest rates artificially low in the face of global concern about the dollar, U.S. deficits, and the U.S. financial system.

Most importantly, lower interest rates have helped keep both Canadian and U.S. mortgage rates down, thus supporting the housing market.

Now questions abound.

What will happen to U.S. treasury rates, and by association the economy, housing, and asset markets, once this program ceases?

Will the US move to authorize more purchases?

Interestingly there is a possible political showdown in the offing with a couple of important dates on the horizon.

On November 4th the Federal Open Market Committee (FOMC) meets. This committee is comprised of the 'bigwigs' of the US Federal Reserve and most likely will discuss the timing for the exit from economic stimulation. The Committee will meet only days before the next G20 meeting.

On November 7th, that next G20 meeting will take place.

In attendance will be the BRIC nations (Brazil, India, and China) who will anticipate a cessation of quantitative easing (QE) and a commitment to establish a currency alternative to the US dollar.

The proposed alternate to the US dollar would take the form of Super Sovereign Currency. This is not an intended as an immediate substitute for the dollar as a reserve currency but rather an alternative in new commitments.

As for QE, back in the middle July at the USA/Chinese Washington Financial Summit, China supposedly struck a deal to buy US Treasuries so as to let the Fed back off their US Treasury instrument auction QE.

As I understand it, the BRIC countries, not China alone, have given the US until early November to deliver on that pledge. The most influential BRIC nation, China, has been clear in it's desire to see the end of the US Federal Reserve's policy of Quantitative Easing.

Will they get both of these things? The first indication will come on November 4th at the FOMC meeting.

Jim Sinclair, perhaps the most successful commodities trader of all time and a frequent CNN and CNBC commentator, has been counting down the days to these two meetings and November 7th in particular.

That's his picture at the top of the post.

Back in August, Sinclair postulated on his website that these meetings will be the trigger for a dollar collapse.

Sinclair argues that there is a conflict brewing between the US Federal Reserve and the US Treasury on whether or not it's time to end the financial stimulation. Sinclair believes Bernanke will loose the battle to Geithner, a development which will not sit well with China et al and Sinclair believes the fallout will be significant.

Sinclair reiterated this forecast on Tuesday.

Now make no mistake, Sinclair is a hard core gold bug and the gold bugs have been seeing the collapse of the dollar everywhere recently.

But even so, ya gotta love anyone who gives a definitive date for such a dramatic event and announces a "countdown to the implosion of the dollar" on his website almost three months in advance.

Sinclair believes the impact on the price of gold will be immediate. "I know $1224 and $1650 are certain," he says.

Just for the chutzpah value alone, it's worth watching to see what happens.

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More economic observations

Let me expand on Saturday's concerns about the economic outlook.

The most recent data on outstanding credit card and auto loan amounts was released on Friday.

US consumer credit fell for the fifth straight month as banks maintained more restrictive lending terms and households remained reluctant to borrow money for major purchases.

How can the U.S. economy expand if consumer credit continues to contract?

From Bloomberg;

• Consumer credit fell $10.3 billion, or 4.92 percent at an annual rate, to $2.5 trillion, according to a Federal Reserve report released today in Washington. Credit dropped by $5.38 billion in May, more than previously estimated. The series of declines is the longest since 1991.
• Stagnant wages and falling home values mean consumer spending, about 70% of the economy, will take time to recover even as the recession eases.
• “This string of declining credit should continue as long as the economy eliminates workers at an elevated pace,” said Richard Yamarone, director of economic research at Argus Research Corp. in New York. “We’re 20 months into the recession and the economy is still losing a quarter-of-a-million jobs per month.”

It's important to note that consumer credit contains no housing related debt at all. So it begs the question... how sharply are outstanding home equity lines of credit and home equity loans contracting?

I bet you that they are contracting even faster than consumer credit and auto loans.

Again I urge you to ask yourself the question, how can the U.S. economy expand if consumer credit (home equity loans, home equity lines of credit, consumer credit and auto loans) continues to contract?

Speaking of homes, interesting presentation by the San Diego County Assessor/County Clerk David Butler on Notice of Defaults (NODs) and foreclosures in the county.

The following is a handout from the presentation (click on image to enlarge).

San Diego real estate broker Edgewood121 attended the presentation and advised that San Diego county is "expecting a wave of foreclosures in the near future and they are gearing up for it" (quoting Edgewood121 paraphrasing Butler).

Butler thinks the banks are holding back, probably because of the various government programs.

Edgewood 121 was left with the impression that "it is [only] a matter of time before more properties become available." And that the only reason prices appear to have stabilized "is because of the artificial choking-off of inventory, thereby creating urgency and multiple-offer scenarios."

This situation is being repeated all over the United States.

Clearly banks are hoping that the modification programs will reduce the number of foreclosures. However, as we said last week, most loan modifications just capitalize missed payments and fees (so the banks can pretend they are still whole), and reduce interest rates for a few years (so the homeowner can pretend they still own something of value).

Extend and pretend... that's all the banks are really doing right now. Which is fine until the coming wave of commericial and prime mortgage defaults hits.

Meanwhile there is the topic of personal bankruptcies.

Last week I commented that bankruptcies in the United States were up 600%. Now comes word from the UK newspaper, the Independent, that the United Kingdom registered a record 33,000 people insolvent in the second quarter of the year, the largest number ever recorded.

Insolvency experts warned that the combination of rising unemployment and the lack of stigma attached to insolvency options meant the number of people affected would go on rising.

Mark Sands, director of personal insolvency at Tenon Recovery, predicted 140,000 people in the UK would be declared insolvent during 2009, 30% more than in 2006 – the worst year on record so far – when the figure was 107,000.

"The overall record level of personal insolvencies, whilst at first shocking, hides the detail which suggests the worst is yet to come," Mr Sands warned.

'The worst is yet to come'... hmmm.

On that note, did you catch Treasury Secretary Timothy Geithner's missive to Congress on Friday?

Geithner urged elected US officials to raise the $12.1 trillion debt ceiling since, according to current projections, that limit may be reached as soon as mid-October.

Said Geithner, "It is critically important that Congress act before the limit is reached so that citizens and investors here and around the world can remain confident that the United States will always meet its obligations."

Ummm... anyone care to explain to me what is the point of having a 'ceiling' if, as you get near that limit, you simply raise it time after time again?

Seriously.

How twisted is the logic that passes for policymaking in Washington that it becomes critically important that the limit be increased before it is reached?

Geithner says its important because investors may lose confidence in the entire system if it isn't raised.

Say whaaa?

You mean to say investors won't lose confidence because the United States has a spiraling debt so large that the government has to raise the absolute 'ceiling' they have imposed on that debt every few months?

And investors won't lose confidence because there seems to be a total lack of any realistic plan that would see the money repaid?

But somehow these same investors will, apparently, lose confidence because lawmakers hadn't paid close enough attention to the relationship between the debt and the debt 'ceiling'. And if lawmakers fail to move the ceiling upward when conditions required such action, this will trigger a loss of confidence?

Alrighty then.

As I said on Saturday, this economic maelstrom is not over, we are experiencing the calm that comes when the 'eye' of an economic hurricane passes over us.

As any weather watcher knows, once the 'eye' passes the back end of a big storm always hits harder than the front end.

Brace yourselves.

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More on China

Longer break than anticipated... but I am back.

More on China.

Everyone seems to think that investments by China will help developing economies regain their growth momentum in the second half of this year, pulling the global economy out of the worst worldwide recession in six decades.

On July 8th the International Monetary Fund forecast that China’s expansion will accelerate to 8.5 percent next year from 7.5 percent in 2009. But more and more evidence is croping up to doubt this will happen.

The latest evidence came in last week's debt sale by China (yes... despite the fact that China owns the largest foreign amount of US debt - 790 Billion - China still needs to raise funds by selling it's own debt).

Last week China failed to attract enough bidders in a government debt sale for a second time on speculation record bank lending by Chinese banks will spark inflation in the world’s third-largest economy.

The Ministry of Finance sold 25.1 billion yuan ($3.7 billion) in bills of the 35 billion yuan it had sought, according to statements on the Web site of Chinabond, the nation’s biggest debt-clearing house. The government fell short of its target in a bond sale for the first time in almost six years on July 8.

The auction’s failure reflects concern that Premier Wen Jiabao’s 4 trillion yuan stimulus package will cause bubbles in stock and housing markets, forcing the central bank to tighten monetary policy. The People’s Bank of China this week pushed up money-market rates and drained cash from banks, the biggest investors in the nation’s $2.2 trillion debt market.

“The central bank’s open-market operations suggest concerns that the rapid surge in new bank lending in the first half of this year could fuel inflation,” said Tommy Xie, an economist at Oversea-Chinese Banking Corp. in Singapore. “Some people speculate the central bank will raise interest rates this year but I don’t think they can as global growth slows.”

So what we now have is two very interesting conditions emerging. A perfect storm for inflation in North America with the US Federal Reserve's unprecedented increase in the US money supply and China' rapid surge in new bank lending which is fueling an irrational surge in worldwide stock markets and setting the stage of inflation on the other side of the globe.

This is how you set the stage for worldwide events that slip away from one single central bankers control.

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The Great Inflation Debate (Part 2)

Continuing from yesterday...

The Chinese, the Japanese and the Russians have three of the biggest piles of US bonds in the world.

What would you say if you owned $800 billion worth of bonds? Wouldn't you tell the world what a great investment they were?

...and then sell them quietly, when no one was looking?

Most observers fear this exact scenario. And if it starts to happen the US Federal Reserve will be forced to do what they don't want to do. They'll have to buy their own bonds in great quantities to keep rates down. Then, they'll have to buy more...because others will be selling them. Finally, they'll have to monetize a huge percentage of them...ultimately causing inflation rates to soar.

That's the scenario you don't ever hear the US Federal Treasury talking about. Sure they say they can yank the stimulus money quickly if the economy turns around. But that is only one scenario that scares inflationists. There are many others.

And last week Peter Schiff outlined some of those other concerns in an article in Canada's MacLeans Magazine. You can read the full article here. I highly encourage you to take the time to read it.

From the article:

• Many scoff at the idea that China will suddenly say “no more” to buying U.S. debt. After all, the two countries have had a mutually beneficial relationship for years. China lends money to the U.S. and the U.S. buys masses of consumer goods from China. What’s more, it’s a long-standing relationship and many doubt that China would want to upset the status quo. Schiff sees no logic in that argument. “That they’ll keep lending indefinitely makes about as much sense as the argument that real estate prices have been rising, so they’ll rise forever,” Schiff says. “Nothing that is unsustainable will go on forever.”
  
  But the thing is, China doesn’t have to entirely cut off the U.S. to cause problems. Even if China decided to pull back slightly there would be consequences. The U.S. would still find itself short of the cash it needs to pay its bills, and like a homeowner who misses a mortgage payment, it would have to find that money somehow.
  
  Regardless of precisely how and when this all unfolds, the dollar will inevitably become less valuable and interest rates will rise as the U.S. scrambles to attract new lenders. That will translate into inflation and higher interest rates for the average person, too. The cost of living will go up and the value of people’s savings will decline. Canada would likely get dragged into the mess too, just as it was affected by the current downturn in the U.S. The question is how severely this will all hit.

Finally there is the law of unintented consquences.

That's the wild card element that scares inflationists the most.

We'll look at that tomorrow.

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The Great Inflation Debate: What's it all about (Part 1)

Had a phone call this morning from a colleague who has been reading this blog lately and he wanted me to explain to him my thoughts on inflation.

He has read the blog, read other blogs and has been trying to get a grip on why people are concerned about the threat of inflation. "A bunch of people are saying it isn't a concern. A lot of others are saying we should be 'very afraid."

In that he has a very large mortgage coming due for renewal, he is wisely trying to understand the issue.

The fact of the matter is that Canadian interest rates are directly tied into what is happening in the United States. As we saw last week, despite the fact the Bank of Canada never changed it's key lending rate, Canadian Banks raised their rates based on yields for 30 year US Treasuries having risen. The yield on the 30 year Treasury is directly linked to US mortgage rates.

So what happens in the US directly affects us here in Canada, whether we like it or not.

US Bond and Treasury sales are the way the United States government finances it's balance sheet. They come up with a budget, raise money through taxes, and any shortfall (the deficit) has to be covered by selling bonds and treasury bills.

As these bonds and treasuries are sold, a yield (or interest rate) is attached to them. If buyers are scarce, the yield has to be raised to sell them.

Higher yields mean the cost of borrowing money rises. This trickles down to the money lent by banks to you for your mortgage.

The United States Federal Treasury has kept interest rates close to zero since last December. They have achieved that through a number of means including buying their own Treasuries and bonds by (in effect) printing more money. The Fed has also lent money to financial firms in return for all sorts of assets in order to keep credit flowing through the economy.

When any other nation does this, confidence in their currency collapses resulting in hyperinflation.

So how can the US get away with it? Because the US dollar and economy has been so strong for 60 years that the US dollar has been adopted by the world as it's reserve currency. Everyone has such faith in the US that it has become the foundation upon which all other currencies are traded.

And the United States has been able to leverage that status to their advantage while keeping International confidence in their policies high.

International confidence aside, some analysts fear that as the United States swells bank reserves well above typical levels with the printing of additional money, these reserves will serve as rocket fuel for future inflation. Simply put, excessive money in the banks will lead to runaway consumer inflation.

Those who dispute the future inflation argument assert that the reserves are so large because the demand is large. When demand drops off, that money will not find it's way into the general economy to fuel inflation because the Fed will be able to drain the reserves off.

And that's the crux of the whole issue: Can the Fed do that? Can they remove the reserves before the funds find their way into general circulation and fuel inflation?

We know that the Fed's balance sheet has exploded (to $2.07 trillion). Defenders of Fed policy point out that is only half the story. Data from the St Louis Fed shows that the "monetary multiplier" has collapsed from a decade-average of 1.6 to the depths of 0.893. This means the 'velocity' of money has slowed to a crawl because those reserves are not making it into general circulation.

Apartently the banks are keeping that money in their reserves to keep themselves solvent. Without that money flowing, there can be no inflation.

And without the money flowing, the economy continues to contract. So the Fed continues to engage in 'quantitative easing' (the buying of bad debt) so that banks will gradually start to let money flow.

The problem, as Professor David Beckworth from Texas State University notes, is that the Fed's efforts to boost the money supply are barely keeping pace with the deflation shock. Stimulus is not gaining traction. The credit system remains broken.

"Where will the inflation impulse come from given that capacity use is at a post-war low of 68%c in the US, and nearer 60%c worldwide? The immediate threat is wage deflation", said Beckworth.

Tim Congdon – a hard-money Friedmanite from International Monetary Research – says the Fed is still not easing enough, perhaps because it is spooked by so much criticism or faces a mutiny by its own hawks. "If Ben Bernanke and his officials are listening to this sort of stuff and taking it seriously, they are making the same mistake as the Fed in the early 1930s," he said. The US 'output gap' is near 7%. That is a powerful lid on inflation.

Mr Congdon's prescription is what Britain did in 1931 and 1992: monetary stimulus à l'outrance (today: bond purchases), offset by spending cuts. This mix – easy money/tight fiscal – would halt debt deflation without ruining the public finances of the US, Britain, and Europe in the way that Keynesian schemes ruined Japan.

But here's the dilemma. The Fed buys their own US bonds to keep interest rates down.

If they don't buy them, the government's huge demand for credit drives up yields: greater supply of bonds leads to lower prices (and higher yields). Higher yields mean higher interest rates.

But if they do buy them, investors begin to fear inflation. Then, investors sell bonds... driving up yields: and less demand leads to lower prices (higher yields).

That's why the Fed is talking about 'keeping a lid on bond buys.' In doing so the Fed reassures investors.

The Fed is, in effect, also playing a giant confidence game with the money supply. Which brings us back to the topic of international confidence. The US enjoys a rare position as the world's reserve currency.

If that confidence erodes, the dollar could collapse and the US would be unable to finance it's debt without dramatically increasing the yields on it's bonds and treasuries.

The key people the US has to convince are the Chinese, Japanese and the Russians (the largest holders of US debt).

Last week we saw the Japanese and Russians come out and say they are one hundred percent behind the dollar and US bonds. The Japanese even say their faith is "unshakeable."

These comments helped send demand for bonds back up... after demand had dropped and yields on the 10-year note had reached 4% last week.

This, in turn, pushed yields (and interest rates) back down.

The Federal Reserve in the United States insists it can continue to walk this fine line with no problems. And when the economy does rebound, the extra money they created as stimulus funds can be withdrawn without those funds entering the general money supply (thus triggering inflation).

Not everyone believes that can be accomplished. Tomorrow we will hear from one of those doubters and why he thinks disaster looms on this colossal currency confidence game.

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Ride The Wayback Machine for a Peak at '70s Inflation

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So let's join Sherman and Mr. Peabody and hop into the Wayback Machine, shall we?

Destination: March 24th, 1980.

That was the date of this Time Magazine article titled 'Jimmy Carter vs. Inflation'. Many faithful readers do not recall those days so if the topic interests you, click on the link and you can read the entire 10 page article.

Here is the 'Coles Notes' version...

As Jimmy Carter stepped before the television cameras in the East Room of the White House last Friday, his task was not just to proclaim another new anti-inflation program but to calm a national alarm that had begun to border on panic. Inflation and interest rates, both topping 18%, are so far beyond anything that Americans have experienced in peacetime—and so far beyond anything that U.S. financial markets are set up to handle—as to inspire a contagion of fear.

For three weeks the White House struggled to develop a plan that would restore the public's confidence that the Government could bring the economy under control... But the dramatized search for an anti-inflation program proved slow and frustrating. So on Friday afternoon, Jimmy Carter strode into the East Room, having carefully waited until half an hour after the major financial markets had closed in the East, to (speak to the nation).

Speaking earnestly and somberly, Carter opened by stating that "persistent high inflation threatens the economic security of our country," and that "this dangerous situation calls for urgent measures."

The troubles had been building up for more than a decade, said Carter, and they could be traced largely to "our failure in Government, as individuals and as a society to live within our means." Glossing over his own record of rapidly rising spending and huge deficits, both of which contradicted his firm campaign pledges of 1976, he proclaimed his born-again fiscal faith: "The Federal Government must stop spending money we do not have and borrowing to make up the difference."

He acknowledged that his program would be "difficult politically" and, by implication, "onerous and burdensome" to some needy people, though less so than continued inflation would be... But his new plan would succeed, though three previous ones failed, he asserted, because "the nation is aroused now as it has never been before, at least in my lifetime, about the horrors of existing inflation and the threat of future inflation."

In follow-up press conferences Saturday morning, Federal Reserve Board Chairman Paul Volcker proclaimed that "the greatest risk beyond doubt" facing the economy is accelerating inflation. "There is no way we can deal with the problems... other than by placing restraint on people who individually would like more credit."

As this barrage of resolute rhetoric might indicate, inflation is not only a frightening economic problem but is rapidly becoming Carter's most dangerous political liability as well. Front Runner Ronald Reagan has been hammering increasingly harder on economic issues and said in Illinois Friday night: "It's Government that causes inflation, and Government can make it go away by cutting out deficits and stopping the printing of money."

Credit controls. They will be imposed. Said Carter: "Inflation is fed by credit-financed spending. Consumers have gone into debt too heavily. Businesses and other borrowers are tempted to use credit to finance speculative ventures."

So what happened after this?

Massive spending cuts were instituted and many government benefits were slashed. More importantly numerous steps were taken by the Federal Reserve to choke off the lending of money by banks. Raising interest rates was only part of it. A significant campaign was launched to choke off credit lending itself.

This was March, 1980.

The interest rate was 18%.

One year later, the problems still existed and the Fed interest rate was jacked up to 21.5%. You couldn't get a mortgage for less than 22%.

The lesson learned from people like then-Fed Chairman Volcker (who is now Chairman of U.S. President Barack Obama’s Economic Recovery Advisory Board)?

Next time act faster to combat inflation by raising interest rates to similar levels and don't give the economy, lenders and borrowers time to adjust.

Ominous, don't you think?

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Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

How US Treasury Sales Immediately Impacted Canada This Week

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It has been another banner week for the US Federal Treasury and Treasury sales. This week alone the Fed had to convince “investors” to buy up $150 billion worth of debt! This follows three weeks where the US auctioned off $87 Billion, $127 Billion and $138 Billion. This is an astonishing amount of debt for investors to absorb (and there's lots more to come).

This insatiable demand for debt sales has now created a historic crash of the bond market with TLT (the 20 year bond fund) losing almost 30% of its value. The ten year rose to 4% and that will take 30 year mortgages well over 6% in the United States.

This last statistic is particularly important for us because as US mortgage rates go, so do Canada's mortgage rates.

As such three of Canada's major banks decided to push mortgage rates higher yesterday despite the fact the Bank of Canada did not change it's rate and the BOC govenor wishes lending rates to stay where they are.

Nothwithstanding, the Royal Bank of Canada, the Bank of Montreal and Bank of Nova Scotia all announced they had increased the rates charged for money for homebuyers. Five year mortgages at these institutions will now cost a borrower 5.85%, four-tenths of a percentage point higher than the previous rate. Likewise, the rate for a three-year term rose 0.40 of a percentage point for the trio of banks, reaching 4.55%.

And why did they do this even when the Bank of Canada had not changed the lending rate?

CBC reported the news this way, "Analysts have noted that the cost of borrowing for longer periods of time more likely reflects the prevailing view of inflation in the next couple of years rather than the current short-term collapse in economic activity. Governments have responded to the ongoing recession by running deficits and printing money, factors that can boost short-term activity but hold out the threat of longer-run price increases. Thus, lenders will be reluctant to extend cash for longer periods without a commensurately higher interest rate."

But the Bank of Canada lending rate is still 0.25%. What gives?

The article goes on to note, "More ominously, the U.S. government got the cold shoulder from debt buyers Wednesday when Washington sold off $14 billion US in long-term bonds. Traders said Washington has been forced to flood debt markets in order to cover its stimulus spending. In bond economics, falling prices equal higher interest rates. Thus, industry experts now expect interest rates on longer-term borrowing to start rising again."

You see? It's all about US Treasury and Bond sales, which is why we follow the topic so closely.

Interestingly... Global News covered the rate increase on their 11:30pm newscast Wednesday night. The last interview of the piece was with a CMHC rep who pointed out that Vancouver prices are still falling and are expected to fall further over the next year, suggesting that future lower prices might more-than-offset future rate increases.

In other words rising interest rates are going to beat down house prices so that anyone buying at the higher interest rate will still be able to afford roughly the same size house because the lower selling prices (and thus mortgage size) will produce a similar monthly payment despite the higher interest rate.

Gee... and on what blog did you hear that prediction first?

And it's an important point, because it will happen.

When rates do skyrocket to 1981 levels (22%), anyone trying to sell their $650,000 home is screwed. They would need a buyer to assume a mortgage that will equate to a monthly payment of $11,700 per month... and that's simply not going to happen.

The only way that house is going to sell is if the price falls to $220,000.

The CMHC rep knows what all of us who were old enough to live through those times in 1981 know... that high interest rates will crush our bubble inflated Vancouver Real Estate market like a flimsy tin can.

So I ask you, what would you rather have?

(1) A $600,000 mortgage at last weeks low 2.99% variable interest rate, or
(2) A $220,000 mortgage at 1981's 22% interest rate?

Both will run you about $2,500 per month in monthly payments.

The difference? If interest rates skyrocket, you won't be able to renew your mortgage if you choose option (1). You will lose your home.

If interest rates skyrocket, as so many analysts now predict, a seller will never be able to sell a $650,000 property unless he slashes the price to $220,000 because no one can afford a $600,000 mortgage at 22%.

And when you consider how many local homeowners, who have bought in the last five years, will have to surrender their homes to banks under foreclosure when owners can't pay the monthly payments required when they have to renew under these rates... the downward pressure of forced bank sales will easily push prices down to $220,000, if not lower.

Remember banks don't keep foreclosed properties, they move them off their books ASAP.

If you buy under option (2), you still have the same monthly payment as option (1) BUT when rates go down again, you'll be laughing.

So why would anyone buy in today's market when virtually all economists are predicting a return to late 1970s style inflation and interest rates?

Why indeed.

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The First Tremors

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Last week we talked about the looming possibility of inflation and even hyper-inflation with the 'quantatitive easing' policies (ie. printing money) of many Western goverments, particularly the United States.

The danger this represents to Vancouver Real Estate, of course, is we could see a return of the high interest rates of the early 1980s. With the inflated bubble real estate prices of the Lower Mainland, homeowners with with large outstanding mortgages face potential ruin.

[For example: the monthly payment on a $650,000 mortgage at today's five year monthly variable rate of 3.30% would be $2,603.28. If the rates spiked to 11%, the montly payment would be $6,090.22. If rates spiked to the 1981 level of 22%, your monthly payment would be $11,922.46.]

The greatest concern outlined by Peter Schiff was the massive dependance by the United States on foreign countries to continue purchasing US Treasuries. Schiff speculated that if China stops financing US debt, the value of the US dollar will plummet, triggering a hyper-inflationary spiral in the US.

Last week, for a few horrifying moments we saw the possibility of this scenario playing out.

The tremors began in Beijing, where a essay from the governor of the People’s Bank of China favoured the creation of an IMF currency to replace the U.S. dollar as the world’s reserve currency.

Delegates of China’s legislative advisory body suggested that the biggest foreign holder of U.S. debt diversify away from Treasuries into more risky assets. Jesse Wang, executive vice president of China Investment Corp., said that his $200 billion sovereign wealth fund may invest in “undervalued” commodity assets. Zhang Guobao, head of the National Energy Administration, said China should invest more in commodities instead of hoarding the U.S. dollar.


Almost simultaneously, in Europe, the rotating president of the European Union, outgoing Czech Prime Minister Mirek Topolanek, characterized America’s plan to combat the widening global recession as the “road to hell.”

Meanwhile, British Member of the European Parliament Daniel Hannan made headlines with his stinging rebuke of the inflationary and debt-focused policies of the current UK government.

In response to these events, the U.S. dollar suffered a dramatic drubbing on money markets.

Immediatly Treasury secretary Geithner and his ministerial counterparts in Berlin, Paris and London did their best to convince everyone that the world is pulling together as one to combat the economic crisis.

The charm offensive was effective, calm was restored and the dollar leveled... for the time being.

Given the size and scope of the remedies that the Obama Administration is cajoling the world to adopt, it is likely that the unease will grow. Germany and France are now openly refusing to continue with America’s stimulus plans.

Washington insists that North America's economic problems result from a lack of consumer spending. Therefore, the solution is for government spending to pick up the slack. However, if Americans are too broke to spend, then how can government spend for the people? The only money they have is taken from the American people through taxation. To postpone immediate tax hikes (adding interest for good measure), Washington plans to borrow more from abroad.

The US Administration continues to argue that more debt will restore growth which will then allow the repayment of borrowed money.

But the rest of the world is starting to vocally condemn that approach. This week, at the G20 conference, the United States and Canada will hear that to solve our problems we must first come to terms with their source. We borrowed and spent ourselves to the brink of bankruptcy, and now we must save and produce ourselves back to prosperity.

The voices from abroad are insisting that there is simply no way to sustain an economy based on consumer credit.

Nothwithstanding, the Obama Administration will go to London to cajole the world to adopt its stimulus initiatives. Given the size and scope of the remedies they want implimented, it is likely that worldwide unease will grow until many countries emerge in open revolt to America’s plans.

Meanwhile we continue to splash about on the shores of the Village on the Edge of the Rainforest blissfully unaware of it all.

As greater Vancouver home sales continue at a pace of 100 sales per day, I wonder how many real estate agents - supposedly representing the best interests of their clients - have offer a single, cautionary word to their clients making those purchases?

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Email: village_whisperer@live.ca

Inflation or Deflation?: A firestorm of debate erupts

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Last Monday I wrote about the possibility that the US Federal Reserve was opening Pandora's box and unleashing a destructive wave of monetary inflation with their policy moves to deal with the financial crisis.

Through programs known as quantitative easing, the Fed was basically printing money in an attempt to buy up toxic assets.

On Wednesday March 18th, Fed Chairman Ben Bernanke raised the ante with a move that has shocked the financial community. In announcing that they were printing an additional $1 Trillion dollars, the Fed embarked on a course that has NEVER been utilized... they began buying their own treasury bills.

This has touched off a firestorm of debate around the world as to whether it is deflation or inflation that looms on the horizon.

But who is right?

In the Vancouver Sun the debate is hi-lighted in an article titled "Will it be inflation or deflation? Observers are split: U.S. government's injection of new money could overheat the world's biggest economy".

"That's one of the great debates right now," said Douglas Porter, deputy chief economist at BMO Capital Markets. "What is the greater medium-term risk to the global economy -- deflation or an outbreak of inflation?"

Yesterday I wrote that Garth Turner had come out decidedly against the inflation scenario. Today he has somewhat tempered his outlook. In the latest post on his blog, Turner concedes the point I have been trying to make - that the policies of today will lead to an inflationary spiral that contains a poison pill for anyone buying real estate in today's markets.

While Turner envisions a longer time-line, the end result is the same. Dramatically higher interest rates are on the horizon. Anyone buying now and financing at today's incredibly low mortgages rates face a devestating prospect.

The normal fixed-rate mortgage term here is five years, and increasingly borrowers have opted for shorter periods of time, gambling that interest rates will be lower when the loan comes due.

But as Turner notes, "Rates can only move in one direction. Up. Over the course of the next five years, possibly way up. In fact, I’d say it’s a certainty. Central banks around the world have been printing a flood of money to try and stall deflation and revive economic growth. Public debt has exploded, governments have plunged headlong into deficit spending, countries are buying back their own bonds with tax money and banks have been nationalized while the money supply increases. In this are sown the seeds of inflation, once economic expansion continues."

Turner then summarizes the looming catastrophe, "So, if 3% mortgages in 2009 become 11% mortgages in 2014 (that is the historic norm over the last few decades), just imagine the consequences for someone buying a house today. After all, a $400,000 mortgage at 3% costs less than $1,900 a month to carry. But the same loan at 11% has double the payments - $3,850 a month."

The inflation vs deflation debate rages on right now. But even staunch inflation discounters like Garth Turner now concede that dark storm clouds loom on the horizon, storm clouds that could bring economic ruin to anyone holding a large mortgage or who jumps into the market with a large home purchase.

Check out this CNBC roundtable debate on the issue featuring Peter Schiff. Its a complex issue but it is imperative that everyone understand what is going on.

Tomorrow I will try to post a summary outlining Schiff's position.


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Email: village_whisperer@live.ca

The Great Gamble

Laurel Magri explains her 'other' profession, click to hear.

Yesterday, at Sunday Brunch, the topic of this blog came up, specifically my contention about the coming onslaught of inflation.

Close friends question my 'alarmist claims' that the central banks of so many nations are actually 'printing money' in an effort to deal with the financial crisis.

Fortuitously Fed Chairman Ben Bernanke provided an unprecedented media interview on Sunday night with the CBS newsmagazine '60 Minutes'.

From the interview...

• "In the crisis, Bernanke had freedom to act immediately - he doesn't need permission from Congress or the president. While they debated on Capitol Hill, Bernanke cut interest rates nearly to zero; then he used Depression-era emergency powers to launch a dozen rescue programs of his own. There was support for money market funds, mortgages, short term lending to small business, and support for auto loans, student loans and small business loans - commitments of a trillion dollars, doubling the size of the Fed's balance sheet.
  
  Asked if it's tax money the Fed is spending, Bernanke said, 'It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It's much more akin to printing money than it is to borrowing.'
  
  'You've been printing money?' Pelley asked.
  
  'Well, effectively,' Bernanke said. 'And we need to do that, because our economy is very weak and inflation is very low. When the economy begins to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation.'
  
  He's not kidding about printing money: the Fed issues U.S. currency, which is why it says 'Federal Reserve Note' on all the bills in your wallet. The Treasury Department's Bureau of Engraving and Printing is just a few blocks from Bernanke's office. It prints the money at the Fed's request.
  
  The Fed's mandate from Congress is to put enough money in the system for maximum employment, but not so much that it sets off inflation."
  

The reason Bernanke has embarked on this course is clear. As he told 60 Minutes, we were close to a second Depression and addressing it required emergency measures.

In a sense, Bernanke has been preparing for this emergency his whole professional life. He got a PhD in economics from MIT. He chaired the economics department at Princeton, where his specialty was the Great Depression.

He's among many economists who now believe it was the Federal Reserve itself that helped turn the recession in 1929 into a global calamity.

• "They made two mistakes, basically. One was they let the money supply contract very sharply. Prices fell. Deflation. So monetary policy was, in fact, very contractionary. Very tight during that period. And then the second mistake they made was they let the banks fail. They didn't make any strong effort to prevent the failure of thousands of banks. And that failure had terrible effects on credit and on the ability of the economy to right itself," Bernanke explained.
  

So there you have it, right from the horses mouth. The Fed's intention is to print more and more money knowing that it will trigger inflation and stave off the deflationary cycle we were plunging headlong into.

So is Bernanke worried about unleashing the inflation genie?

No. As Bernanke says in the interview, he believes he can control it. When the economy begins to recover, the Fed will wrestle inflation to the ground by unwinding those programs, raising interest rates, and reducing the money supply.

It's a huge gamble because despite Bernanke's confidence, the inflation genie is an economic Pandora's box.

According to greek myth, Pandora had been given a large jar and instruction by Zeus to keep it closed. But Pandora ultimately opened it. When she opened it, all of the evils, ills, diseases, and burdensome labor that mankind had not known previously, escaped from the jar, but it is said, that at the very bottom of her box, there lay hope.

In their desperation to find that hope, the central banks of the United States, Canada, Britain, Japan, China and Switzerland have opened that box.

We have been down this road before. In the late 1970s the inflation genie was unleashed and it ravaged the economy by inflating consumer prices at an annual rate of 13.5%.

While the circumstances and causes were different from today, the fact is that when when the Fed finally took decisive action... interest rates rose dramatically.

The US Federal Reserve Chairman of the day, Paul Volcker, is widely credited with ending that inflation crisis of by employing the proposed measures Bernake is now talking about - particularly by raising the federal funds rate.

The federal funds rate shot up to an average 11.2% in 1979, was raised by Volcker to a peak of 20% in June 1981. That year the prime rate for banks shot to 21.5%.

Paul Volcker is now Chair of the President's Economic Recovery Advisory Board.

It doesn't take a rocket scientist to see what advice Bernanke is receiving on this crisis. Bernanke believes he can quickly shut off the tap and reign it in before it becomes a problem.

Beware the law of unintended consequences.

Even in a perfect world, when inflation takes off, you will see a dramatic hike in the interest rate in an attempt to immediately wrestle it to the ground.

And if the genie doesn't go back into the bottle right away, that rate could well shoot up higher than it did in 1981.

That's what is scaring the pants off of savvy investors right now.

Oh btw... if you were to renew your $650,000 mortgage at an inflation period rate of 22%... your monthly payment would be $11,412.24.

Like the Real Estate Industry says, "It's a great time to buy", isn't it?

They best pray Bernanke doesn't burn all of us as he plays with fire.

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Email: village_whisperer@live.ca