MARKET MADE SHOCK WAVE
by Bill Bonner
Editor, The Daily Reckoning
July 6, 2007

"When money and credit are free and easy, people become free and easy with them.
They begin spending more than they should…and investing recklessly.
Eventually, there is a shock… a tipping point…a moment of desperate reality…"

Look up, dear reader. There, over The Daily Reckoning headquarters in London - in the building with the golden balls on the roof - is our Crash Alert flag…flying proudly.

Why bother? The stock market looks healthy. The problem in the housing market is "contained" in the subprime sector. And M3 is growing at 13% per annum - the fastest rate in 30 years. With all that new money coming into the system, how can prices do anything other than float higher?

But the risk of loss is always at its highest on the precise moment that most people judge it of least concern. Most likely, there will be no crash tomorrow…nor the day after. But there are some things you are better off preparing for, even though they may not happen for a while.

When money and credit are free and easy, people become free and easy with them. They begin spending more than they should…and investing recklessly. Eventually, there is a shock…a tipping point…a moment of desperate reality, in which people feel the ground give way beneath their feet. They look down and panic.

What kind of a shock? It could be almost anything. Sometimes it is a war…sometimes a bankruptcy…sometimes a market shock - such as a sudden increase in the price of oil…or the collapse of a stock market. Then investors, as if they shared a single mind, begin to worry not about the return ON their money; they are concerned about the return OF their money.

What could cause a shock today? Any number of things.

1) The Chinese stock market is getting hit hard. Its CSI 300 Index is down 17% in the last three weeks. Brokerage account openings have dropped by two-thirds. Could global hot money…and local cold cash…turn bearish on Chinese shares? Could Chinese officials say something particularly stupid? Could the market fall another 20%…50%? Could this trigger a worldwide equity sell-off? Yes to all those questions.

2) The dollar is in trouble. On Wednesday, it hit its lowest level against the pound (GBP) in 26-years. It is now near its lowest level ever against the euro (EUR). Trillions worth of dollars now sit in foreign vaults - while reserve managers openly talk of diversifying away from greenbacks. Foreigners don't have to abandon the dollar en masse to knock it down…all they have to do is to let up on their purchases of dollar-denominated assets - such as U.S. Treasuries. Could it happen? Could the shock cause a crash in major financial markets? Why…yes…again.

3) All paper currencies are dangerous. The dollar is not the only paper currency in the world whose supply is growing rapidly. Practically every central bank is printing up its own money in vast quantities - trying to keep up with the U.S. brand. This is why the world has so much "liquidity." It's why so many assets are rising in price so steeply. But could investors suddenly become fearful of so much monetary inflation? Could consumer prices shoot up…as asset prices already have? Could the world's people want to get rid of their paper currencies in favor of other stores of value - notably gold, as The Wall Street Journal warns in an article entitled "Money Meltdown"? And could this lead to a worldwide crash? Yes…yes…yes.

4) A Milan-based bank, Italease, has just seen its derivative portfolio blow up. So has Bear Stearns (NYSE:BSC). Large lenders are getting skittish of complex debt instruments…just as more deals than ever before come to market. So far this year $1 trillion in deals have been done in the North America - a rate of deal-making nearly 50% higher than the year before. What happens if the wheeler-dealers don't find the credit they're looking for? What would investors think if even one of these mega-deals blew up badly?

Reports Bloomberg: "The world's biggest bondholders have had their fill of leveraged buyouts…

"TIAA-CREF, which oversees $414 billion in retirement funds for teachers and college professors, is boycotting some debt offerings used to finance LBOs. Fidelity International, a unit of the world's largest mutual fund company, and Lehman Brothers Asset Management LLC, the money-management arm of the third- biggest bond underwriter, say they're avoiding debt from buyouts.

"You cannot do fundamental analysis and believe that those are creditworthy companies," says an analyst.

"More securities than ever have the lowest rankings, with CCC ratings assigned to 26.5 percent of the new debt, according to New York-based Fitch Ratings. That compares with 15 percent in 2006 for debt that Fitch says has a 'high default risk.'

"Traders demand 3 percentage points in extra interest to own U.S. junk bonds rather than government debt, compared with a record low of 2.41 percentage points on June 5, Merrill Lynch & Co. index data show. That's the fastest increase in spreads since April 2005, just before General Motors Corp. and Ford Motor Co. lost their investment-grade credit ratings."

Meanwhile, the Bank of England raised its key interest rate on Thursday by twenty-five basis points to 5.75 percent - another six-year high. This is the fifth time this year. The ECB's Trichet held steady this month but hints that rates will go up in the future. Elsewhere, banks are likely to hike rates too. And watch out if the Chinese decide to do some serious tightening.

Could there be even bigger blow ups waiting to happen? And could they cause a stampede for the exits? Anthony Bolton, Britain's most successful fund manager, worries about it. So does the Bank of International Settlements. And so do central bankers in Madrid, London and who knows where else. And if the pros stop lending so freely, mightn't it trigger a credit crunch…and a crash? Why, yes…now that you mention it.

5) The great millstone of housing debt continues to grind America's middle and lower classes.

The LA TIMES: "Slow job growth and declining home prices are causing financial problems for more Americans, who are falling behind on consumer debt, including home equity loans, at the highest rate since 2001, the American Bankers Assn. said Tuesday.

"Credit counselors said consumers were paying the price for reckless attitudes about debt fostered by years of easy credit, particularly in the mortgage market.

"'It's a monster we all created,' said Todd Emerson, president of Springboard, a nonprofit consumer credit management organization in Riverside."

Let's see, Chinese companies depend on consumer buying from America…which depends on U.S. consumer spending…which depends on consumer credit…which depends on mortgage lending…which depends on a secondary market in mortgage backed securities…which depends on rising housing prices! But housing prices aren't rising; they're falling.

Could housing prices go lower? Could lower housing prices cause consumers to stop spending so much? It seems so. The sale of light motor vehicles in the United States dropped 3.4% month-to-month in June to a seasonally adjusted rate of 15.6 million units, according to Northern Trust's Paul Kasriel. A number of retailers have lowered sales guidance as buyers tighten their belts.

Could an attack of consumer thrift one day swarm over financial markets like Japanese bombers over Pearl Harbor? Your guess is as good as ours, dear reader.

Will there be a crash on Wall Street today? Will the Chinese economic bubble find its pin? Probably not quite yet. But we will keep our eyes open anyway…and keep our ear to the ground for you, dear reader.

So the great debate continues… shall we carry on as we have been, waving our Crash Alert flag…or are we 'full of malarkey'?

© 2007 Bill Bonner
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Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons). In Bonner and Wiggin's follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is - an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount - just click on the link below: "Now Perhaps Someone Will Listen!" http://www.isecureonline.com/Reports/RCKN/E_O_D/ You can sign up for a free subscription to the Daily Reckoning here: http://www.dailyreckoning.com. This essay was originally published in The Daily Reckoning.