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Here is a typical story about the ECB rate hike this week of .25% and the rationale for it. It is my view that the emerging economic strength in Japan, the US and Europe are only late manifestations of the final stage of the great world liquidity bubble Japan started in the early 1990’s. This latest round of rate hikes is going to severely harm the US and world consumer economy. They (central banks) are late. LONDON (MarketWatch) -- The European Central Bank raised interest rates Thursday for the second time in four months, moving to quell inflation as Europe's economy begins to improve. The ECB, as expected, lifted its key interest rate by a quarter of a percentage point to 2.5%. Since about 1990, the world has had an incredible boost of cheap money. It started with Japan after their stock and real estate busts in the early 90’s. Since then, there was a huge US and world stock bubble, a tech crash here, worldwide housing bubbles which are really speculation finance bubbles. We in the US are now seeing our own housing bubble weaken significantly. This week statistics are out that the US housing bubble is cooling significantly, and there is speculation that this is only the beginning of a coming collapse in consumer spending here. The fact that the US consumer statistics still show strong gains recently does not mean that the downside of a housing collapse will not result in a severe drop in US consumer habits. I foresee that about fall of this year, the published consumer statistics will begin to show significant drops of consumer sentiment and spending. This is the pattern that emerged about the housing bubble. IE, the statistics of a slowdown were 3 months behind the real event. I believe we are right at the crux of the drop of US consumer spending, and the statistics will show this convincingly in about 3 months. Now, back to world interest rates. There are enough inflationary forces worldwide that, Europe, Japan and the US are now raising rates simultaneously. Japan is growing decently and the BOJ has stated it intends to raise rates in the coming months. That is a huge change from their ten years of zero cost money. I said before that Japan had started the world liquidity bubble, and they are going to now raise rates in a major change of policy. The fact that this is happening now in conjunction with US continued interest rate hikes, and now the ECB is raising rates, having done a baby step .25% increase. What is emerging is a final chapter of a world liquidity bubble that began in Japan in the early 1990’s. So much money has now gone into real estate, bonds, securities, derivatives, and so on, that this world liquidity bubble will burst with a great crash. The central banks are going to try to use baby steps, i.e. .25% increases, but that will only just allow the asset bubbles to reach there very pinnacle before they implode. The now simultaneous interest rate increases in much of the world is going to really start to hamstring liquidity at some point. Already, real estate markets in Shanghai, China, Britain, Australia, the US and other nations are cooling and are going to really break hard. This should occur, in my estimation, by the fall of this year. At that point, I will be looking for major drops in world stock markets, and for some recovery in good sovereign bond markets. Take a look at the inverted US yield curve below and we will talk a little about it and what it means:
Here we see that the six month US treasury (UST) is well above the 2, 3, 5 and 10 year in yield. Typically, this is a harbinger of a recession. The lag time is about 6 months. Now here in the US, we have pretty strong public statistics for the US economy and employment growth. However, the yield curve indicates that in 6 months we are going to turn down into recession. This would dovetail nicely with the unwinding of the YEN carry trade, where super cheap YEN are borrowed from Japan, and are reinvested in UST’s and markets worldwide, in real estate and stocks, to just about everything. I have stated that Japan is a virtual central bank of the world, and has caused huge liquidity bubbles to emerge. The US got well into this game by lowering interest rates here to historical lows after 911, and that, combined with Japan, China, and Europe having super low rates, has created a very unstable economic recovery world wide. Much of the growth in Japan, China, and the US is really due to the incredible amounts of new debt for the consumers, and speculation related positions for investors. This whole speculation mountain is about to quickly erode. The first cause will be simultaneous rising interest rates worldwide, followed by consumer pullbacks here and elsewhere. This is all aligned to occur/begin in the fall of 06. © 2006
Christopher Laird The PrudentSquirrel Newsletter tracks trends such as this every week. Stop by and have a look at the testimonials and subscribe. There are 44 issues a year. CONTACT
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