Last month, Paul Volcker wrote an article for the Washington Post entitled "An Economy on Thin Ice." You may remember him as the Federal Reserve Chairman right before Alan Greenspan. Volcker is concerned that Americans are spending too much, saving too little, and increasing their debt to the world. He believes that the U.S. government will only decide to change its policies after a crisis occurs.
While I agree there's no political will to make substantial financial reforms, I don't think it's possible to avoid a crisis. The U.S. economy is so interconnected, and balanced so precariously that an unexpected event in any sector will ripple across the economy.
Price inflation has moved into the news spotlight as it's taken a larger bite out of consumers' paychecks. The Producer Price Index released Tuesday showed a 0.6% increase in April, which is a pace of 7.2% yearly.
The Consumer Price Index jumped 0.5%, despite easing oil and gas prices.
Americans haven't seen costs surge like this in two decades.
The Federal Reserve has vowed to combat inflation, but they are contributing to the problem. Inflation is caused by an increase of money and credit in the economy, or too much money chasing too few goods. Alan Greenspan's policies have injected excessive numbers of dollars into the system at an astonishing rate. Prices are rising on everything from houses to food because each dollar is worth less.
In an attempt to curb price inflation, the Federal Reserve has raised its federal funds rate six straight times, and is expected to add another quarter point next month. Greenspan has stated he will gradually increase rates until he reaches "neutral." Unfortunately since 1950, the Federal Reserve has triggered a recession every time it embarks on a rate raising cycle.
Businesses have already been affected by the increase in short-term credit costs. Capital expenditures may be priced out of reach. Higher rates and spiraling costs for raw materials have eroded profit margins.
Stiff competition has prevented companies from passing on many of the increased costs to consumers. In order to boost profits, many corporations are merging and downsizing.
Although the unemployment rate held steady at 5.2% in April, job creation continues to be much lower than expected for an economic expansion. Almost 500,000 workers have given up hope of finding work.
Challenger, Gray & Christmas reported over 57,000 job cuts last month, while wage growth has stagnated far below the rate of inflation. Even businesses that are not laying off workers are trying to squeeze more productivity out of their existing employees.
Corporate earnings have dropped this year along with stocks. The S&P 500 is down 3.15%, the Dow is off 3.65%, and the Nasdaq is down 6.67% in 2005. These market declines have been led by America's largest companies, such as GM, JP Morgan Chase, and AIG. Lower consumer confidence numbers have translated to falling retail sales at Wal-Mart and Target. Fannie Mae and Freddie Mac have seen their share prices slump as these government sponsored mortgage enterprises have been rocked by accounting scandals.
Congress is debating regulating this industry more rigorously due to the threat to the economy. Fannie Mae and Freddie Mac hold nearly $1.5 trillion of debt. These companies were created by the government to ease the process of home buying. Failure of either enterprise would sharply reduce the amount of mortgage credit available, and crush the real estate market.
Although housing is still strong on the East and West Coasts, there are signs this bubble is starting to deflate. Inventory is building in the heartland, with cities like Indianapolis, Denver, and St. Paul reporting a buyer's market. According to Reuters, "The Commerce Department report showed housing starts plunged 17.6 percent in March, marking their steepest drop in more than 14 years, as groundbreaking for both single-family and multifamily homes tumbled."
Due to high real estate prices far outstripping increases in wages, many homeowners have resorted to creative financing. A growing number of consumers have adjustable rate mortgages (ARMs), or even negative amortization loans where the monthly payments are less than the cost of interest. When the federal funds rate increases finally trickle into the housing market, budgets stretched tight at today's costs will snap.
Consumers will have to sell quickly and suffer losses in a lackluster market, or face foreclosure.
Many homeowners in financial trouble have taken out home equity loans to maintain their standard of living. These consumers are left with little equity in their houses. If the real estate market falls and leaves these homeowners "upside down" on their houses, many will simply walk away. If a glut of foreclosures hit the market, prices will sink quickly. Banks who have invested heavily in subprime mortgages may fail.
With the U.S. economy walking a tightrope over the abyss of stagflation, how can you keep your balance? You need a safety net of hard assets, especially the precious metals. As Alf Field points out, in uncertain times, investors move from risky speculation to more secure asset classes. Silver and gold are the safest long-term investments of all.
Plan for your financial future. Get some precious metal insurance before the panicking herd causes the price to soar.
Copyright © 2005 Jennifer Barry
