What strikes me first is demographics. Dubai's indigenous culture is small and practically invisible to the casual tourist. In Dubai, the ambient noise you hear is construction equipment. Almost no smells stand out. Everything is modern, new and arid.

In India, there are people everywhere...living everywhere...sidewalks, riverbanks, parks, monuments. There are shanties built on any available spot. You hear the sound of people...the murmur of voices, bicycles, car horns. Even today, when the weather is a beautiful 30 or so and the breeze steady, the air is tropical, dank and full of all manner of indescribable odors.

Soon after we arrived at the Taj, a sarapi-wrapped young lady delivered Chris and I personalized letters. Each informed us that due to state elections being held, it would be illegal for the hotel to serve us alcohol of any kind beginning at 5 PM on that day, ending 48 hours later. We found out later too that if our partners here in India were to keep the office open for work on Election Day, they risked being arrested, fined and possibly put in jail.

"Can a democracy be a dictatorship at the same time?" an op-ed asked in this morning's Times Of India in response to the draconian efforts the Maharashtra state had taken to boost voter turnout. The idea simply: if people weren't allowed to work and didn't have the option to spend the day drinking... they might turn out and vote. Right.

In Mumbai, voter turn out was just over 40% - respectable by some US standards - but down a bit from the last election in 2004. "Worth 2 days without the hooch?" might have been our op ed title, had we been asked to submit one.

When we asked one of our colleagues here if he voted or not, he said 'no' and laughed. "Maybe if there were a category that gave me the option to choose 'none of the above', I would do so. But there isn't."

Bureaucracy and corruption, are the two words we've heard most this week when asking what's holding India back. In one example, a national auction for oil and drilling rights held on Monday closed with only half of the contracts even receiving bids. A conflict between the Oil and Energy Minister and his brother have left many would be suitors for the rights contracts unsure who's calling the shots. This week, no one wants to put their own money down in fear of losing it unceremoniously.

Upon entering one of the security firms we visited we faced a door, but no walls. It looked every bit as if an architect had gotten carried away with "form" and completely forgotten "function"... Or a cubicle concept plan for "open space" office design gone horribly awry. Later we learned they'd planned to install glass walls several years ago during a renovation, but had never received permits to erect walls higher than 7 feet in their own office space. Huh?

"If we were willing to bribe the local building authority," our host suggested, "the walls could go up this afternoon."

Bribes, corruption and bureaucracy are part of the culture. But it's also part of what makes Mumbai work. "This is a 'make do' city," our travel compatriot Chris Mayer observed while we were driving around the city shooting video for a documentary short we hope to produce on the opportunities in the Indian market. We'd stopped in front of the state Police Headquarters for Maharashtra. It's a formidable colonial era building. But apparently they don't like you taking pictures... or stopping at all... in front of the building. An angry police officer began yelling at our driver in Hindi. Several officers carrying impressive weapons were standing behind him.

"Uh, maybe they don't like us shooting here?"

The driver got out and disappeared around the corner behind a truck followed by two of the police officers. One stood watching us in the back of the car. A few minutes later the driver returned.

"It's okay," he said and we carried on about our business.

Later we learned a quick 100-rupee note had saved us from a trip inside the police headquarters, rather than just gawking at its façade.

With 16 million residents here, many whom live below the poverty line, the roles defined over the millennia help ensure every mouth gets fed. The only part of the city that gets consistent electricity and water is Southern Bombay. The other parts of the city, and everywhere else in the country, go through regular interruptions in basic power.

Traffic is really a sight. Harsh, a twenty-two year old graduate of Northwestern in Chicago, explained that the population has been trained by years of scarcity to try to push their way to the front of the line. It used to be because they didn't have rice, bread or food; but now, they've been doing it for so long, it's a cultural thing. So, for example, when a train pulls up to the station everyone tries to get on at once. That's the way they drive, too.

"Harsh represents the future of India," his father Jayesh told us proudly. Jayesh and his family have been stockbrokers since 1954 when his grandfather founded KC equities "For years Indians have felt like second class citizens of the world. But not these guys. They grew up with the Internet. They're highly educated, motivated, confident. Rather than striving to stay in the United States after university, they're coming back to India to participate in the development of the economy, the markets here."

Having been to Dubai and meeting Moe, we were struck that a trend seems to be underway. In 1976, Richard Dawkins authored a book called The Selfish Gene, in which he identified a cultural unit - called a meme - that evolves and transforms as it gets passed from one human being to another.

Today, the "capitalist meme" is still actively cultivated here in the US. But because of access and speed of modern communications ... coupled with the crisis in markets and entitlement programs in the West... that meme is being carried by young, intelligent, educated, active and motivated youth to the far corners of the earth. Indeed, in today's Wall Street Journal's op ed pages, Susan Hockfield, the president of MIT, laments that the current immigration policy in the US is actively aiding and abetting the return of science and engineering students to their home countries.

But more so, opportunities in Dubai, Mumbai... Shanghai... are inviting students back home in droves as well. At dinner one night, Jayesh made this suggestion to his son: make a list of all the things you take for granted in the US and start businesses to provide them to the Indian market. Refrigeration, for example, or electricity and roads. India is the world's second largest producer of fruits and vegetables, but it loses 30-40% of them because lack of refrigeration.

Indeed, the small cap companies we looked at while working with our partners at Equitymaster.com included:

• India's largest financier of trucks and construction equipment
• The company leading the introduction of RFID and AIDC technology into retail purveyors
• The leading LED displays and light bulb maker in India
• The world's second largest steelmaker
• Largest producer of roses in the world

Foreign direct investment into the Indian stock market is still restricted and won't be available until the rupee and dollar become fully convertible. And that won't likely happen for several years. India is a net importer of grains etc. If the rupee were to float openly on the world's forex exchanges speculation alone could cause major disruptions in India's ability to feed itself.

For now, there are several companies available on the NYSE via ADR. And People of Indian Origin (PIOs) can invest in special accounts directly in the Indians markets. Likewise, Indians are now able to invest $250,000 a year outside the US. But progress in opening the flow of capital between India and the West remains a question for the future.

Bureaucracy, corruption and regulation are indeed impediments to short term growth. And reforms in a democratic society may come slowly... but the long-term opportunities are abundant. We intend to be there when they break.

Regards,

Addison Wiggin
for The Daily Reckoning Australia

P.S. We left the Taj at 2 AM to catch a flight at 5 AM. Our flight passed through Doha, Qtar and reached New York by 3 in the afternoon.

"We will know we're really making progress," our friend Ajit quipped as we enjoyed a final glass of wine on Friday evening, "when we can set the flight times of our own airlines heading to the West."

• Arab Wealth Pours Back into Dubai
• Qatar Relies on Natural Gas Reserves While Dubai Leans on Trade and Finance
• Unlike China, India is Not Willing to Learn from its Mistakes
• The Inflation Rate in India is Running About 12%
• India Has 36 Billionaires

The 4-lane Sheik Zayed road stretching between Dubai and Abu Dhabi is, at best, a competition for speed; at worst it's a death trap. Among the UAE's claim to world's largest shopping mall, world's tallest building and world's longest metro built in "one go", is this highways claim: to one of the world's biggest automobile pile-ups.

On March 12, 2008, 25 cars traveling along the route burst into flames after piling into one another as a band of fog rolled in from the Gulf. Nearly 60 cars were in the accident altogether... 347 people were injured in the crash, 6 lost their lives.

"The crash happened because everyone was speeding despite the severe weather conditions," an Abu Dhabi traffic police officer said at the crash site, as reported by the Gulf News. "Drivers weren't leaving a safe distance between cars and this resulted in everyone hitting each other after the first crash."

A documentary short posted on YouTube capturing the 911 calls placed from motorists describes 'Foggy Tuesday' as a morning devoid of "human caution." The film also heralds the obvious bravery of the men who arrived from the Abu Dhabi fire, police and rescue crews to save those who'd become entangled in the brouhaha.

We will not hold you in suspense any longer...the metaphor suggested by this fantastic auto accident is a perfect fit for those studying the Dubai property bust. And like the writer of a Hollywood script, we cannot help by bring it to your attention.

Yesterday, on the recommendation of our new friend Moe, we traveled the same stretch of Sheik Zayed highway where the accident had taken place. Mohammad "Moe" Fathi Al Abrozani a Bahrainian-Qtari whose mother was an Iranian-American. Moe was born in Abu Dhabi, educated in California, lived briefly in New York and Chicago, then spent seven years in Germany. (His German is so fluent our German friends, Andre and Vereena, here in Dubai did not expect him to be Arabic when they first met him in person.)

Moe had returned to the Middle East to take part in the expansive boom attracting so much attention around the globe. He's now an executive with TwoFour54 Media, a firm set up by the government in Abu Dhabi to woo Western firms into establishing their Middle East operations in the new Media City in the UAE's capitol city. The rulers of Abu Dhabi had witnessed the efforts, successes and failures of their fellow emirate, Dubai, and have since vowed to create a modern media communications hub greater than anything now in existence.

"Why mess with visas, permits and expatriate contracts down in Dubai?" Moe asked us at dinner the other night, "when you can come to Abu Dhabi and get them all from the government free...?" One foggy morning in the year 2008, the reckless speculation that spurned much of the outrageous development projects in Dubai began to pile up on each other. Now the motionless construction sites lay in wait for assistance. In a scene familiar across the West, Abu Dhabi, the company line suggests, has "come to the rescue" of Dubai; with low cost loans; paper money and the sincerity of an assassin.

When we met up with Moe and Andre at Shakespeare's a brand-new bar in the all-new Souk Al Bahar, they were quietly puffing from sisha - the traditional water pipes bubbling with aromatic smoke. Our mission in the region was and is simple. We want to establish a presence on the ground from which we can monitor the developments and assess investment opportunities in Dubai, the UAE and across the Middle East unfiltered by the mainstream press. But here we were being asked to consider moving the infrastructure of our publishing business, our families, our lives, half way around the world to the desert. Bloomberg, CNN, Forbes are all moving and or expanding their operations in either Dubai or Abu Dhabi.

Why shouldn't we? Our friends in Abu Dhabi are apparently ready and willing to help.

Dubai and Abu Dhabi, the two leading Emirates of the UAE are relatively new to the global finance and trade... but they want you to know they have arrived in high style. This weekend, Formula One racing makes its debut in Abu Dhabi. The government had to pull workers from several of its five star seaside resort project to complete the track and facilities on time. Ferrari World, a massive theme park dedicated to the sport sits nearby. Yesterday, the Emirates Palace Hotel - the world's first seven-star hotel - Demi Moore, Hilary Swank, and last year's Oscar winner, Freida Pinto (Slumdog Millionaire) graced the opening ceremonies of the Middle East Film Festival. The Abu Dhabi sovereign wealth fund has famously leveraged their way into both of the leading football franchises in the world - FC Barcelona and Manchester United.

Still, our friend Peter Cooper recalls a time in his own family history when Dubai was nothing but a backwater of the British Empire, a port full of smugglers, nomads and thieves. His great uncle had been stationed here during World War II. At the time, the strife caused by the war left the ragtag bunch group of 7,000 residents on the edge of starvation.

Sheik Rashid, the father of modern Dubai, dredged the Creek in the 1950s establishing Dubai as a free trade port. At the time, too, the Creek dredging project was roundly criticized, as it should have been. The project cost nearly 3 times Dubai's annual GDP. But it also established Dubai as the trading center for goods coming into the Middle East. If you go down by the creek today there are Iranian Dhows - the Middle East's answer to the Chinese Junk - bringing rice, rugs and refrigerators back and forth across the Persian Gulf. Iran's ports are about a two-day drift away for these wooden ships. Kuwait and Iraq a day or two more. Bahrain, Qtar, Oman closer still. Without the fantastic success of that initial dredging project, we wouldn't be writing to you from the desert today.

"Dubai the hot spot..." has been a center of trade, smuggling and the rougher trades ever since. As the back jacket copy on a 1970s novel about gold smugglers in Dubai written by the French Connection author Robin Moore indicates: "Dubai, where adventurers play the world's most dangerous games...gold, sex, oil and war. Cold- blooded adventurers in a blistering Mideast empire where life is cheap and no price too high for pleasure." The novel is still banned here because the sheiks don't like the image it portrays.

The promise of riches, however, is part of the region's allure and what has attracted those expatriates who chosen to ride out the bust and continue to live here to this day.

The most recent gold rush, the boom in Dubai property, came on the heels of the terrorist attacks on September 11, 2001 and the same policy response that spawned a housing and consumption bubble across the United States, London and much of the West. Arabs flush with energy and trading capital brought much of that money home to the Middle East fearing a Western clamp down. At the same time, investors in dirham backed assets - the local currency which has enjoyed a US-dollar peg since November 1997 - benefited from the same era of low interest rates that soccer moms in Montgomery County, Maryland or gamblers in Las Vegas, Nevada did.

And like all booms, the property in Dubai witnessed its excess and its pathos. An article in this week's Asian edition of Time Magazine laments the manmade island project meant to mimic all the countries on the planet. "The World is one of many architectural fantasies in Dubai that now appear to be shimmering mirages. The emirate boasts the 818m Burj Dubai, the world's tallest skyscraper; a manmade island shaped like a giant palm; a ski slope in a shopping mall; an 18-hole golf course in the middle of the desert that will slurp down 3.8 million liters of water a day. But the dozens of giant cranes that once littered the skyline are beginning to migrate elsewhere. Dubai today has the feel of a futuristic, five star ghost town blasted by sandstorms."

"The fools!" we can hear readers of Time Asia chuckle with superiority. Everyone likes to kick a gambler when he's down.

But the story remains. On our way to Abu Dhabi yesterday we passed by the free zone surrounding the new deepwater global trading port at Jebel Ali. Business Bay near Jebel Ali is the home to many of the Bubble Era development projects, 30-story towers standing side-by-side, dark windowed and tenantless.

We suspect many of these nutty projects - like the City of Arabia, which had boasted an amusement park full of life size animatronic dinosaurs as its calling card during the boom - will never find the funding to finish. More sober projects that are or are nearing completion will likely take years to find tenants. And those "investors" who bet big and large on Dubai property in 2003-08 are no doubt already wishing they never had.

But the free zone near Jebel Ali also the site of Dubai's real potential; banking and trade. Corporate tax rates in are effectively zero. You name a multinational and Moe can point to their local subsidiary. The Dubai Mall, for example, is reported to need 10,000 shoppers a day to break even but now only sports around 7,000. Why do the world's most famous brand names all have shops open and spiffy already, we couldn't help but wonder. It has to be for those fine tax rates, we couldn't help but conclude.

Among other racy themes we heard this week, Dubai is supposed to now be the world capitol of the flesh trade. And the gold price hit an all- time high early in the week after we arrived sparked by rumors the GCC would back a unified currency with gold and provide oil traders an alternative pricing unit than the US dollar...

We suspect this fantastic wreck in the desert is only one scene in a long, exhilarating drama. We're not "long" Dubai in any real investment sense. Not now anyway. But, like most onlookers to the spectacle, we struggle to avert our eyes. The story promises more exciting car chases, more steamy sex scenes and political intrigue to come...and we'd be lying if we didn't admit we're suckers for a good story. And, who knows, we may open an office of our own there.

Regards,

Addison Wiggin
for The Daily Reckoning Australia

• Qatar Relies on Natural Gas Reserves While Dubai Leans on Trade and Finance
• Arab Wealth Pours Back into Dubai
• Is Dubai the Bubble It’s Made Out to be?
• Equity Shareholders Are Wiped Out As Financial Shares Plummet
• DMCC and their Precious Metals Vault

When Social Security was founded, the typical US worker at age 65 could expect to live another 11.9 years. But if today's official projections are right, by the year 2040 the typical 65-year-old worker can expect to live at least another 19.2 years. If the normal retirement age had been indexed to longevity since 1935, today's worker would be waiting until age 73 to receive full benefits and tomorrow's workers even longer.

In a report called "Demographics and Capital Markets Returns," Robert Arnott and Anne Casscells argue that the crisis is not in Social Security, but in demographics. "When an entire society ages," suggest Arnott and Casscells, "...the thing that matters most is the ratio between the workers to retirees. Unfortunately, the aging of the baby boom generation, which is a significant bulge in population, will cause a dramatic increase in the ratio between workers to retirees, one that will put enormous strain on society and cause friction between generations."

In the United States, as in other developed countries, the unfunded benefit liability for public pensions amounts to 100 percent to 250 percent of GDP. It is a " hidden debt " far greater than official public debt. Unlike in the private sector, these debts are not amortized as expenses over 30 to 40 years. And it may be worth pointing out that under normal conditions economies do not run such crushing deficits. They only do so in crisis mode.

The annual cost of Social Security benefits represented 4.4 percent of GDP in 2008 and is projected to increase to 6.2 percent of GDP in 2034, and then decline to about 5.8 percent of GDP by 2050 and remain at about that level.

And to the retiring boomers' other doubts and insecurities, we might add that US health care costs are expected to rise by 7 percent of GDP over the next 40 years - a rate that is more than twice as fast as other developing nations. The "old old," - those aged 80 and over - are predicted to rise sharply through 2050 and will dramatically increase long - term care costs as well as disability, dependence, and health care expenses.

In fact, by official projections, in 2030, the US government will be spending more on nursing homes than it spends on Social Security today. "Although people justifiably worry about Social Security," says Victor Fuchs, an economist who studies the health care industry, "paying for old folks' health care is the real 800-pound gorilla facing the US economy." Adding projections for Medicare and Medicaid 's expenditures to those of Social Security could raise the total cost to more than 50 percent of payroll taxes.

The fiscal kickers of health cost inflation and political demand for more long-term care benefits threaten to raise public spending dramatically in the United States. Between 2005 and the fall of 2008, we spent two and a half years chronicling the efforts of David Walker, the former comptroller general of the United States, and Bob Bixby, executive director of the Concord Coalition, to reign in reform and shore up the Social Security and Medicare systems. The project yielded a feature length documentary film, which earned us a trip to the Sundance Film Festival in January of 2008 and another to the Critic's Choice Awards in Los Angeles a year later. We published a best-selling companion book of the same title in late 2008. You're encouraged to delve into the numbers we presented in the film and book. They're truly mindboggling. But in many ways the project was dated the moment we released it to the public.

The credit crisis that reached a fever pitch developed in 2008 pushed the date of insolvency of these programs ever closer. On May 13, 2009, the Medicare Trustees warned that the fund they tap to pay for beneficiaries' hospital care will be insolvent by 2017 - two years earlier than trustees had predicted the year before. The program has been paying out more than it collects in taxes and interest since last year, in part due to a recession well underway. Medicare would have to deposit $ 13.4 trillion - $ 1 trillion higher than last year's estimate - into an interest-earning account today in order for the hospital fund to pay its scheduled benefits over the next 75 years. The program's total unfunded obligation, which includes doctor and prescription drug benefits, is $37.8 trillion. The trustees estimated that in coming years, Medicare spending will rise faster than workers' earnings or the economy as a whole.

Trustees say that while the financial standing of Social Security decreased more sharply than Medicare last year, the health program remains at greater risk of insolvency. The financial difficulties facing Social Security and Medicare pose serious challenges, the report concluded.

For Social Security, the reform options are relatively well understood but the choices are difficult. Medicare is a bigger challenge. Its cost growth can be contained without sacrificing quality of care only if health care cost growth more generally is contained. But despite the difficulties - indeed, because of the difficulties - it is essential that action be taken soon, particularly to control health care costs.

After the revised Social Security and Medicare announcement the world began to wonder: Can the US hold onto its AAA credit rating?

"The US government has had a triple-A credit rating since 1917," David Walker, now president and CEO of the Peterson G. Peterson Foundation, commented in the Financial Time s following the release of the Trustees report, " but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.

"First, while comprehensive health care reform is needed, it must not further harm our nation ' s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country's future.

"Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us."

Of course, we must note that the whole credit rating biz is...well...corrupt. The agencies that are responsible for dishing out sovereign credit ratings (S&P, Fitch, and Moody's) are the same ones that left us all out to dry in 2007. (Of course, mortgage - backed securities get a AAA...housing prices never fall!) Rest assured, if Wall Street can buy its way into AAA, Uncle Sam surely can, too.

But even Moody's is starting to hedge their bets. They've since created three subdivisions within their AAA rating: resistant, resilient, and vulnerable...a corporate way of saying the good, the bad, and the ugly. While the United States isn't in the worst of the bunch, it's certainly not the best.

Regards,

Bill Bonner and Addison Wiggin
for The Daily Reckoning Australia

• Baby Boomers Are Ill-Prepared for Retirement
• Social Security a Bigger Scam Than What Bernard Madoff Schemed
• Austerity is Missing from the Financial Bailout Debate
• China’s Economy is Now Freer and More Competitive than the United States
• Obama Modifies His Views on Abortion and Child Rape

A.W. (a.k.a. Renter #1)

T.D. (Renter #2)

K.I. (Renter #3)

L.S. (Unwitting Speculator #1)

C.D. (Unwitting Speculator #2)

M.N. (Real Estate Investor)

A.P. (30-Year Fixed Rate New Homeowner)

Chorus: Café patrons and waitresses

TIME and SCENE: Mid spring 2005 A.D., our great nation is in the throes of a tenacious housing bubble. Whole cities have been tantalized, wooed and seduced by this Siren song of easy wealth; entire populations rendered giddy by profits... on paper. Nearly every conversation heard around the dinner table... across the bar... in a cab... is focused on one subject: the housing market.

The scene opens in Café Hon, a locally famous Baltimore eatery in the trendy suburb (sic) of Hampden, where big hair and gaudy make-up are curiously in vogue and admired. Seven colleagues from the Daily Reckoning's HQ are seated around a Formica-topped table.

Lacking an additional 30-yr fixed mortgage holder, the table less-than- fairly represents the breakdown of mortgages nationwide: roughly 60% fixed rate, 40% ARM... 25% of all new mortgage originations in 2004 were real estate investors.

LS (Unwitting Speculator #1) is closing on a house the following day. Mere hours stand between her and the single biggest financial transaction of her young life. Can those stalwart pessimists (Renters #1, #2 and #3) lash her to the mast in time to save her from the Siren's tantalizing tune? We shall see, dear reader... below...

ACT I - A MORTGAGE BROKER'S WET DREAM

Renter #1 : Hey, LS... I'm going to ask you one question. Your answer will determine how much I speak for the rest of this meal. Is your loan... an adjustable-rate mortgage?

Unwitting Speculator #1 : Not at all. It's interest only.

[A gasp is heard. Ominous Lon Chaney-style horror music rises from the background.]

Renter #1 (face wincing): Why... why?! [Screams of horror coming from the kitchen.]

Unwitting Speculator #1 : What?! I was tired of throwing away money on rent every month. I wanted to invest in something real... and build equity. Besides, we're going to sell in five years, anyway. So we're cool.

[Somebody snickers.]

Renter #2 : That doesn't make sense. You are still throwing away money. The only difference now is you pay a finance company instead of a landlord.

Renter #3 : And what if you can't sell in five years... doesn't that make you nervous?

Unwitting Speculator #1 : [muffled unintelligible remarks... something about the location of the house...a leafy street...children on bikes...speed humps... shiny happy people... yada, yada...]

Renter #3: Answer the question. What if you can't sell?

Unwitting Speculator #1: Well... I am a little nervous. [nervous laughter] We're risking a huge amount of money... more money than I've ever known. But hey, you only live once!

Unwitting Speculator #2: Oh come on LS, don't listen to them. I have an interest only mortgage, too. [More gasps of horror. Another burst of Lon Chaney music.] These guys are all gloom and doomers. Remember, they work for The Daily Reckoning.

[Renters' heads snap in unison to glare at Unwitting Speculator #2]

Renter #1: And...what about you, AREN'T YOU nervous?

Unwitting Speculator #2: Nope. I try to take life one day at a time. I don't look that far ahead. I'm doing okay right now... and besides, in 5 years, I hope to be married.

[Unwitting Speculator #2 holds up both hands with her fingers crossed. Smiles.]

All (in unison): Awwww.

Unwitting Speculator #1: Don't you know it's bad luck to cross your fingers with BOTH hands?

ACT II - UNSEEMLY PROFITS

Real Estate Investor: What about you Addison, why do you rent?

Renter #1 : Well, we live down by the water... in the neighborhood we want to live in... and to tell you the truth, I just don't understand the market anymore. Let me give you an example.

When we lived in the same neighborhood before moving to Paris back in 2000, the house across the street went on the market for $97,000. The price was so high, everyone thought the owners were nuts. It was a different time. A friend finally bought the place for $87k, gutted it and started renting to college students.

We moved to Paris for four years. Last year, when we were moving back, we looked for a place to buy in Fell's Point... low and behold, we saw the same property on the market. Guess how much?

All (in unison): How much... tell us!

Renter #1: $357,000. [Renter #1 moves his hands to his hips in disgust. Nods around the table.] A four-fold increase in just as many years!? Tell me, what market - any market - can sustain that kind of growth?

Real Estate Investor: Hey, a lot of people I know would say that's still cheap. Besides, it sounds like you were a damn fool to move to Paris. You should have held on for the ride. Still, I think you're right. The market is getting frothy... that's why I just sold my Baltimore properties.

[Puzzled looks of intrigue.]

Renter #1: Yeah, that's probably a good move. You bought in nice and early, and now you've sold near the top. Then you put the proceeds into a resort property in West Virginia... everyone knows that's an undervalued market.

[Fiddle-heavy blue grass music wafts from the kitchen. More nods of agreement around the table.]

Real Estate Investor: Yup. The price is up already. We only put ten percent down, but by the time of closing we had accumulated enough equity, the bank said they weren't going to require mortgage insurance. We'd already amassed an additional 10% of equity!

30-Year Fixed: Hell yeah! We made over $30,000 on our house before we'd even slept there!

Unwitting Speculator #2: Yeah... same here... my house is way up already, so I have a good margin of safety. And when I get married...

All (in unison): Awwww.

Renter #1: Hey, 30-year fixed, I know you've already made money on your house, but what do you see in the future?

30-Year Fixed: I have a response, but first I'd like to make a comment...

There are some neighborhoods that will always hold value. [muffled remarks... something about the location of the house...a leafy street...children on bikes...speed humps... shiny happy people... yada, yada...]

Renter #1 (with much enthusiasm): Au Contraire! (after all, that is THE motto of The Daily Reckoning...)

Baltimore is a case study of good neighborhoods gone bad. Look at Druid Hill... beautiful row homes. Back in the '20s F. Scott Fitzgerald and Gertrude Stein held garden parties and entertained European royalty up there. Now look at it. Hell might offer better refuge for a family of four.

On the other hand, in the '70s respectable folk wouldn't let their children go down to Fell's Point unchaperoned. It was a haven to bikers, ne'er-do-wells and urchins of the night. Today, they're building spec homes on the water that start at a million plus...

Renter #3: Too bad the harbor smells so bad...

All (sighing): Yeah...

[Pregnant pause. A moment of quiet reflection.]

Chorus: At this point, it's not clear what conclusion, if any, can be drawn from the play.

When will the housing bubble burst?

Is it a bubble at all?

Or... will prices keep rising for five years, handing the interest- onlys the last laugh; leaving the renters, humbled once again with egg on their faces... and feeling like chumps? Well, dear reader, this is what makes a market.

Still, the renters bumble on...

ACT III - THE INTERVENTION

Unwitting Speculator #1 (jolted with excitement turning to Renter #1): Oh, that reminds me, can I have the day off tomorrow? I'm closing on my house. [Turns to the table.] Should I wear a suit?

30-year Fixed: Nah...you don't have to wear a suit for those yahoos.

[Snickers]

Renter #1: Sure, you can have a day off. But I forbid you to use one of these.

[Renter #1 holds up a pen. Renter #2 and Renter #3 smile at each other.]

Renter #3 (smugly): Ahhh... No pens, no signing.

Renter #2 (smug and grinning): Yeah... no pens.

30-year Fixed (Gesticulating expansively, raises his voice): Ah, don't listen to THEM... (mutters to himself) for crissakes.

[Check arrives. Curtain falls.]

Regards,

Addison Wiggin
for The Daily Reckoning Australia

DISCLAIMER: Any and all events in this dramatic reenactment are purely non-fictional. Any resemblance to real life is intentional; not at all coincidental. Some liberty may have been taken with the facts, but we swear it was in good faith. We may have been embellished a tad for dramatic effect.

AUTEUR'S NOTE: It goes without saying, if this reality play had been written in 1999, the object of desire would have been tech stocks instead of houses.

A lot has changed since 2005. (Addison fell prey to the Siren song of real estate and now owns a home). And, unbeknownst to the cast of characters, the real estate bubble was about to find its pin...starting with the subprime market. As the subprime loans began to reset at higher rates, borrowers found themselves in over their heads, not able to make their mortgage payments. The subsequent defaults shook the lenders to their cores, causing a ripple effect over the rest of the economy...the effects of which, we are still feeling.

We aren't out of the woods yet, unfortunately. Another wave of defaults will soon be upon us when the "Alt-A" and "Option ARMs" reset at higher rates.

• Negative Equity Becoming the Norm in U.S.A.
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• Bye Bye General Motors
• Investors Think Things Will Return to the Way They Were in the Bubble Epoque
• A Bull Market That’s Missing Parts

How do all of those surplus countries play into this falling dollar picture? Remember, former Fed chairman Alan Greenspan observed that in economics, the sum of all surpluses equals the sum of all deficits.

So when a surplus country stops investing that surplus in U.S. dollars, its currency will increase against the dollar. This realization has profound implications. Not only does the dollar continue to fall against other currencies; as it does so, it accelerates the undesirability of pegging currencies to U.S. currency or investing in Treasury bonds and other debt. In other words, it becomes less and less viable for foreign investors and central banks to fund ever – growing U.S. debt.

This is not just a problem of U.S. consumer debt trends. We may be the addicts, but we have codependents and enablers around the world. Just as the U.S. consumer is addicted to spending excesses, foreign exporters have become addicted to selling goods to Americans. The problem is with sellers, as well as buyers. The governments in those other markets are as concerned about the U.S. dollar’s fall as Americans are (or should be). Why? The fall of a dollar is the same thing as a rise in other currencies. So the competitiveness of the foreign export economy is damaged more and more as their own currencies increase in value. Just as a falling dollar hurts the buyer (Americans), a rising currency hurts the seller (foreign economies) in the same degree.

The United States is only one side of the problem. As the consumer, our dollars have tremendous influence throughout the world, if only because so many central banks (e.g., China’s) have pegged their currency to the dollar – and at the same time many exporting nations are seeing their currencies going up in value, making it untenable to continue exporting at the same rates as in the past. So we have, through trillions of dollars of debt accumulation, created a de facto dollar standard in much of the world economy.

The debt is based, however, on a worldwide bubble economy, perhaps the biggest bubble in world history. The whole theory behind this comprehensive “bubblization” (a new word for you, referring to the combination of federal deficit, trade, mortgage, housing, dollar, and credit bubbles all working together) has grown out of the economic theories of the Fed. Although Mr. Greenspan was the chief culprit behind the theory that spending is good, more spending is better, and the most spending is best, we can’t pin the whole thing on him. Like the U.S. consumer, he had enablers and codependents everywhere. His helpers include an array of bankers, corporate executives, and investors – all buying into the Greenspan version of the U.S. economy and how it just might work.

Now Mr. Bernanke, who happily puts himself out there as the leading economic forecaster and wise man, also contends that bubbles can’t be recognized until they burst. That’s like saying you can’t tell that your house is on fire just because smoke is billowing from the windows; you have to wait until it bursts into flame. The truth is, bubbles are easily recognizable well in advance of bursting, but we cannot know when they will burst. The dollar bubble is going to burst, and that is inevitable. The effects on the economy of that burst are going to be serious. As long as investors, consumers, and business managers continue to base our financial decisions on assets of inflated and unrealistic value, we are denying this inevitable outcome. The more we depend on those inflated values, the more damage we will suffer when the bubble bursts.

In the case of Japan in the recent past, its pattern was somewhat different from the U.S pattern of today. Japan’s deficit budget spending went into business investment, which in turn expands productivity and trade profits. Spending on business equipment and plans, commercial buildings, and other production – based infrastructure had a specific effect: When Japan’s economy slowed down, it merely came to a halt and has remained chronically slow ever since. In comparison, U.S. deficit spending is overwhelmingly going into consumer spending with very little business investment or consumer savings to offset that trend. Thus, the U.S. trend in GDP is led by consumption and not by investment. So the use of deficit spending has everything to do with the consequences of deficits, and ultimately with the effect of a dollar crash. Unlike Japan’s economy, which merely flattened out as a consequence of deficit spending, the U.S. economy is likely to see a more devastating change in the entire economic landscape – with the accompanying price inflation we have to expect as an outcome.

Addison Wiggin
for The Daily Reckoning Australia

• 4 Ways to Protect Against a Falling Dollar
• US Dollar Declining as China’s Currency Rises
• The Greenback Dollar Decline
• What Happens to Gold When High Inflation, Excess Cash, and Falling Dollar Jolts Economy?
• Inflation: Ron Paul Explains How We Got Into This Mess

Pretty faces, angry rappers, desperate U.S. retailers, happy shopaholic tourists, and Canadians who have finally turned the tables on us...we wondered what on earth is happening, as 2007 drew to a close and this new edition of The Demise of the Dollar goes to press.

Although Gisele has denied making any such claim about her payment currency of preference (and has stated that she is happy to earn salaries in a variety of currencies), the fact that this story spread like wildfire through media outlets from Bloomberg and CNBC to E! News and People speaks volumes. The dollar has little credibility on the streets of New York - or pretty much on any street around the world. The twilight of the Great Dollar Standard Era is upon us. The euro is now worth almost 50 percent more than the U.S. dollar, and in Great Britain, you can get two U.S. dollars for every British pound.

In 2007, the famous refrain in the poem by Emma Lazarus describing the flood of foreigners streaming to U.S. shores needs to be updated to "Give me your tired, your rich, your huddled masses yearning to shop free." Seven out of every $10 that fuels our gross domestic product (GDP), the measure of a nation's productivity and hence security, comes - not from goods and services that we produce and sell - but from shopping. We're addicted to cheap credit.

American consumers face the spectre of losing value in their retirement savings, finding out they cannot live on a fixed income, and suffering from chronic hyperinflation. These changes are unavoidable. Today, the problem is compounded because the U.S. dollar's value is falling. It all involves productivity changes in the United States. We have not competed with the manufacturing economies in other countries, and that is why our credit (i.e., our dollar) is suffering.

Any number of things could create a sudden, wrenching drop in the dollar's value. Consider the following three possibilities:

1. Foreign countries drop their U.S. dollar reserves. We depend on foreign investment in our currency to bolster its value or, at least, to slow down its fall. When that thinly held balance changes, our dollar loses its spending power.

At a November 2007 meeting of the Organization of Petroleum Exporting Countries (OPEC)'s 13-member cartel, Iranian President Mahmoud Ahmadinejad, whose country already receives payment for 85 percent of its oil exports in nondollar currencies, urged other countries to follow suit and "designate a single hard currency aside from the U.S. dollar...to form the basis of our oil trade." "The empire of the dollar has to end," chimed in Venezuela's Hugo Chavez; his state oil company changed its dollar investments to euros at his order - er, request.

Rumors are circulating that the Bank of Korea, after selling off $ 100 million worth of U.S. bonds in August 2007, is getting ready to sell $1 billion more, and if Washington forces trade sanctions, China, which threatened recently to cash in $900 billion of U.S. bonds, will probably follow suit.

In Russia, Vladimir Putin's dream of a stock market to trade the country's natural resources in rubles is not so far-fetched; in 2005, Russia, the world's second-largest exporter of oil, followed South Korea's lead and ended the dollar peg. And once again, Sudan is hinting that it will impose trade or financial sanctions against companies that do business with the United States - only this time, the words just might have teeth. As other countries follow suit, the dollar - and your spending power - drops. What does this mean? You will need more dollars to buy things than it takes today.

2. Oil prices increase catastrophically. We - and our real inflation rate - are at the mercy of Middle East oil. In 2005, we couldn't imagine what would happen if the price of oil were to double - or triple; but that's exactly what has happened in 2007 as oil kept flirting with $100-a-barrel prices. Our vulnerability is not imaginary. For example, if terrorists were to contaminate large reserves with nuclear radiation, the supply of oil would drop and prices would rise. We are all aware of our vulnerability and dependence on oil, but we don't like to think about it. Rising oil prices affect not only what you pay at the pump, but many other prices as well: nonautomotive modes of travel, the cost of utilities, and local tax rates, for example. It all adds up to unquestioned "pain at the pump" for American consumers. By September 2007, gasoline averaged $ 2.78 a gallon - double 2002's price. "Pain at the pump" leads to "pain in the pocketbook," as consumers know. You're not seeing double in the checkout line at the grocery store - costs really are double. There was a 5.6 percent increase in 2007, compared with 2.1 percent for all of 2006.

3. The double whammy of trade and budget deficits. We're living beyond our means. It's as simple as that, and something is going to give. The federal budget deficit - annual government spending that is higher than tax revenues - adds to the national debt at a dizzying rate, making our future interest burden higher and higher every day. Our trade deficit - bringing more things in from foreign countries than we sell to the same countries - has turned us into a nation of spendaholics.

We've given up making things to sell elsewhere, closed the store, and gone shopping. But we're not spending money we have; we're borrowing money to spend it. In 2006, the trade and budget deficits doubled the deficits of 2001. Any head of a family knows that this cannot go on forever without the whole thing falling apart - and yet, that is precisely what we are doing on a national scale.

Even as our economy burns, our political leaders fiddle. They point to economic indicators to prove that our economy is strong and getting stronger. This information would be valuable...if only it were true.

Politicians like to measure the economy with esoteric indicators. For example, we are told that consumer confidence is up. Well, confidence is all well and good, but what if it isn't accurate? Yankee optimism has achieved a lot in the past 200 years, but it alone is not going to prevent the current dollar crisis from getting worse and worse.

Does this mean that the United States is finished? No, but it does mean that our long history of economic power and wealth is being eroded from within. For most people, the real state of our economy is measured in one way: jobs. Sure, the number of jobs rises every month, but the complete truth is not as reassuring. We are losing high-paying jobs in manufacturing and replacing them with low - paying jobs in health care, retail, and other menial job markets. Our mantra of "Yankee ingenuity can accomplish anything" is gradually being replaced with a new mantra: "Would you like fries with that?"

Regards,

Addison Wiggin
The Daily Reckoning Australia

• Will Synchronized Rate Cuts Solve International Financial System Problems?
• Dollar’s Demise Has Started a Chain Reaction in Currency and Commodity Markets
• U.S. Dollar Strength or Oil Weakness?
• Greatest Economic Disaster in Recorded History
• US Dollar Declining as China’s Currency Rises

The trade deficit—the excess of imports over exports—has a direct and serious effect on the value of U.S. dollars. As long as we continue having big trade deficits, it means we’re spending more money overseas than we’re making at home. Our manufacturing profits are lower than our consumption. If your family’s budget has a “trade deficit” of sorts, you’ll soon be in trouble. If your spouse spends $4,000 for every $2,000 you bring home, something eventually gives way. This is what is going on with the trade deficit.

In fact, the trade deficit is one of the most important trends in the economy, and the one most likely to affect the value of the dollar. Combined with our government’s big budget deficit, the trade deficit only accelerates the speed of decline in our dollar’s value. Speaking in terms of spending power of the dollar, the trade deficit is the third rail of the economy. Here is what has been going on: The United States used to produce goods and sell them not only here at home, but throughout the world. We led the way, but not anymore. The shift away from dominance in the production of things people need has allowed other countries (most notably, China and India) to pass us up, and now the U.S. consumer has become a buyer instead of a seller.

This international version of conspicuous consumption is financed not from the profits of commerce, but from debt. Let’s think about this for a minute. If we were buying from domestic profits, the trade deficit wouldn’t be such a bad thing. It would mean we were spending money earned from domestic productivity. But this is not what is going on. We are going further and further into debt to buy goods from other countries.

American wealth is being transferred overseas and, at the same time, Americans are sinking deeper into debt. This is taking place individually as well as nationally. Consumer debt (you know: credit cards, mortgages, lines of credit) is growing to record levels, and the federal current account deficit is moving our multi trillion-dollar national debt into new high territory.

Sure, we should be concerned about retirement income from savings, investments, pension plans, and Social Security. But a bigger danger is that, even with a comfortable retirement nest egg by today’s standards, what if those dollars are worthless when we retire? What then?

The big question today is, how long can this debt-driven economy continue? If you quit your job and refinance your home, you could live for a while on the money. The higher your equity, the longer you would be able to spend, spend, spend. But then what?

This is precisely what is going on in the U.S. economy and, at some point very soon, we are going to have to face up to it and change our ways. The trade deficit is the best way to track what’s going on. Returning to the analogy of quitting your job and living off of your home equity, you may stay home all day and order an endless array of electronics, furniture, toys, computers . . . in other words, you could consume goods in place of working. But remember, you didn’t win the lottery; you are financing this “new plan” with borrowed money. The lender will want that repaid. So this individual version of a trade deficit (the deficit between generating income and spending money) is what is happening on a national level in the United States.

This is the problem that is directly affecting the value of the dollar; and the situation is getting worse. We know that the dollar is in trouble because we see it depreciating against the floating currencies of other countries. America has a lot of wealth, but that wealth is being consumed very quickly. History shows that no matter how rich you are, you can lose that wealth if you’re not productive. Meanwhile, the dollar’s value falls and - in spite of the Fed’s view that this is a good thing - it means our savings are worth less. Your spending power falls when the dollar falls, and as this continues, the consequences will be sobering.

The dollar’s plunge has taken many people, currency experts of banks included, by surprise. For many of them, it is still impossible to grasp. Some talking head on CNBC said that he was at a complete loss to understand how such weak economies as those seen in the European Union could have a strong currency. For America’s policy makers and most economists, the huge trade deficit is no problem. They find it natural that fast-growing countries import money while slow-growing economies export money. At least, that is the recurring theme.

So Americans traveling abroad may continue to complain that “it has become so expensive to travel in Europe” as though the problem were somehow the fault of the Europeans. But in fact, it is the declining spending power of the dollar that is to blame, and not just the French, the Italians, and the residents of the so-called “chocolate making” countries.

This problem is pegged not to some speculative or fuzzy economic cause, even though the concept of currency exchange rates continues to mystify. A historically large trade deficit is at the core of the declining dollar. Somebody needs to get over the notion that our economy is strong and other economies are weak, merely because this is America. In the United States, the reason for the trade deficit is not a high rate of investment as we see in some other countries, but an abysmally low level of national savings. We are spending, not producing.

A second argument offered by some is that “capital flows from high-saving countries to low-saving countries, wanting to grow faster.” Under this reasoning, a deficit country, looking at both consumption and investment, is absorbing more than its own production. But whether this is good or bad for the economy depends on the source and use of foreign funds. Do those funds pay for the financing of consumption in excess of production (as in the United States) or for investment in excess of saving? That is the key question that ought to be asked in the first place about the huge U.S. capital imports.

To quote Joan Robinson, a well-known economist in the 1920–1930s close to John Maynard Keynes: “If the capital inflows merely permit an excess of consumption over production, the economy is on the road to ruin. If they permit an excess of investment over home saving, the result depends on the nature of the investment.”

The huge U.S. capital inflows (economic jargon for money coming into the country), accounting now for more than 5 percent of gross domestic product (GDP), have not financed productive investment. America’s net investments are among the lowest in the world, meaning we prefer spending and borrowing over actual production and growth. The huge capital inflows have not helped finance a higher rate of investment. America has been selling its factories and financial assets to pay for consumption.

It’s helpful to use a real means for measuring economic strength. Money coming here from overseas finances higher personal consumption. The steep decline in personal saving is a symptom of our spending, and along with that habit we have lower capital investment and a growing federal budget deficit. The U.S. economy has for years been the strongest in the world, leading the rest of the countries. Our Daily Reckoning newsletter routinely gets reader responses saying, in effect, “How dare you impugn the superiority of the American economy! How dare you!”

We’re rather thick-skinned so the insults bounce off rather easily. But “facts are stubborn things.” The fact that the U.S. economy has outperformed the rest of the world in the past several years is easily explained. Our credit machine has been operating in overdrive nonstop.

It is geared to accommodate unlimited credit for two purposes— consumption and financial speculation. Let’s look at these two things a little more deeply. Credit is not the same thing as production, despite the fuzzy logic you get from the financial media. There is a severe imbalance between the huge amount of credit that goes into the economy and the minimal amount that goes into productive investment. Instead of moving to rein in these excesses and imbalances, the Greenspan Fed has clearly opted to sustain and even to encourage them. Today it is customary to measure economic strength by simply comparing recent real GDP growth rates. It is pointed to as proof and applauded by U.S. economists when U.S. economic growth outscores Europe— like some kind of dysfunctional futbol match.

Financial speculation is equally unproductive. An investor puts up capital to generate a sustained and long-term growth plan. For example, buying and holding stocks is a form of investment and a sign that the investor has faith in the management of that company. peculators don’t care about long-term growth. They want to get in and out of positions as quickly as possible, make a profit, and repeat the process. So speculative profits—especially those paid for with borrowed money—tend to be churned over and over in further speculation and increased spending. None of that money goes into investment in the long-term sense. The speculator is invested in short-term profits, nothing more. Even so, the speculator is today’s cowboy, the risk-taking, living-on-the-edge market hero willing to take big chances. He is seen as a guy with big stones because he’s staring the prospect of loss right in the eye.

Regards,

Addison Wiggin
The Daily Reckoning Australia

• None Found

The Industrial Revolution moved economic power in ways that continue to affect economic balances to this day. And now we face another great shift, away from US dominance of world markets and toward new leaders - China and India.

The economic reality - a type of geography - is changing. As a consequence, real estate speculation in New York, Chicago, and Los Angeles may be replaced with more global interest in the new real estate markets - in Beijing, Shanghai, and Bombay. Who knows? We can only anticipate how changes will occur based on what we observe today. Does this mean the age of America is ending? No, it simply means that economic muscle will be flexed by someone else in the future. This is a trend. And like all trends, they are more easily viewed in historical perspective but harder to judge from their midst.

When we look at trends in dollar values, we can observe that incomes have not declined. That's great. But we also see that prices have risen faster than incomes. So with decreased buying power (caused by this disparity) we have seen a decline in income in terms of what really counts. It takes more dollars to buy the same thing (in other words, prices are higher) but incomes have not risen to meet that price inflation. That's what happens when the value of the dollar declines.

Economic history is a history of bubbles - and of bursts. The great disservice being done to United States citizens by the financial media is that they are not being offered the opportunity to learn from what is going on. They are losing buying power, but apart from a few painful spikes at the gas pumps, it's invisible.

In the Great Dollar Standard Era, the problem is global. While there is, of course, more to it than just the value of the US dollar, here is how it works:

1. The dollar's value falls due to Fed policy, liberal credit, and artificially low interest rates.

2. Eventually, we cannot afford to buy as many foreign goods.

3. Foreign manufacturers, unable to sell at previous levels, have excess inventory, which causes an inflationary outcome.

4. Foreign governments, in an effort to counteract this inflation, blame the fallen dollar for the problem and begin moving out of US instruments.

5. As debt returns to the United States, our system is unable to absorb it. This creates more severe recession in America.

The whole thing is connected. This is similar to what happened worldwide at the end of the 1920s.The worldwide depression had numerous aspects, but most notable among them were two things: a huge transfer of funds from World War I reparations, and far too much credit that went beyond the borrowers' ability to repay. All of that credit - essentially, funny money - also creates a fake demand.

We see the effects of this policy in housing as severely as anywhere. The whole housing bubble mess is traced back to the origin - a Fed policy encouraging debt spending as a means to artificially create the appearance of productivity. This Fed policy has included four aspects:

1. The Fed has lent money below inflation. Fed lending rates have been far below inflation (even as measured by the consumer price index, not to mention any real inflationary measurements). In a very real sense, the Fed has lost money on these loans. When inflation is higher than the lending rate, it is a loss. Just as a business cannot stay open when it sells goods below cost, the Fed cannot continue to hold the view that it isn't real money. The point is, the money lent out at bargain rates is real credit, and that is corrupted when it is given away cheaply.

2. The low interest rates have created the housing bubble without any corresponding investment. It is basic: if you borrow money to invest in productivity (new plants and equipment, for example) it is a profitable use of money. But those low interest rates have gone, instead, into cheap long-term mortgages. Current homeowners have refinanced, and many first- time buyers have gotten into the market because low rates make housing affordable.

3. The mortgage bubble has inflated the housing market in an exaggerated fashion, creating the illusion of equity. All of that cheap money has created two troubling changes in housing. First is higher demand for owner-occupied housing based on the low cost of borrowed money rather than on any real market forces. Second is the resulting equity buildup from rapid expansion of market value in residential property. But it is as fake as the low interest rates. Like all pyramid schemes, the whole thing will eventually crumble under its own weight. We do not have an endless supply of new home ownership demand; quite the contrary. The baby boomers mostly own homes already, and a smaller population of people coming into home ownership age will ultimately result in an oversupply of housing stock. Once the mortgage bubble bursts, we can expect to see several consequences:

• Defaults on existing loans. As rates on variable mortgages begin to rise right up to their cap rates, we'll see many of those marginal loans go into default. Many Americans are barely able to afford the mortgage payments they are making based on low interest qualification. But as the Fed finally faces reality and allows interest rates to rise, those variable increases will kick in as well. Many existing loans will be defaulted as a result.
• Reduced market value from oversupply of housing. The oversupply in building will become suddenly obvious. At some point, when the bubble bursts, everyone will realise that too many homes were built too quickly, and the anticipated demand simply isn't there. The result: those skyrocketing market values will disappear.
• Abandonment of no-equity properties. The reduced market value in homes is not going to be limited to a simple supply and demand cyclical change. For investors, reduced demand and flat or falling prices may be viewed as a cyclical and natural effect. But when the supply-and-demand cycle has been manipulated through interest rate policy, we have to expect a more wrenching effect. For those who enter into the housing market when prices are inflated, the day arrives when they realise that real equity is below zero.

There remains no incentive to continue making payments, notably when lenders are raising rates and when the dollar's buying power is tumbling. In such a severe condition, marginal buyers are going to simply walk away from their properties. Why stay when there is no equity - or worse, minus equity?

• Secondary market fallout from these changes. Where does all of that mortgage debt end up? It isn't held by your local bank or savings and loan. It all gets sold to Ginnie Mae, Freddie Mac, and other mortgage pools, who then package it up and sell it on to investors, many of them from Europe and Asia. Imagine how those pools will perform when the foreclosure rate rises and when - at the same time - market values fall. A high rate of foreclosures in an overbuilt market spells disaster in the housing sector.

While a normal supply and demand cycle may last three to five years on average, this downturn could be severe, going much longer into the future. The actual length of the housing recession would depend on how decisively the Fed will be willing to act and to fix the problem.

4. The lack of investment and a flat manufacturing trend are damaging the US competitive position in the world market. Imagine an economic situation in which enterprising homeowners refinanced their homes when rates fell, invested the money in small business expansion, and created an internationally competitive economic climate.

Well, this is the rosy picture the Fed hopes will eventually emerge from its monetary policies. By artificially lowering interest rates and enabling homeowners to get at their equity, the idea is that on a broad range of economic trends (housing, business investment, savings, etc.) there will be a strong growth spurt, an economic recovery that will return the United States to its leading position. But the lack of investment is doing great damage. The whole thing is credit-based, starting with the Fed losing on below-inflation loans and ending up with credit based spending but no real productivity.

It appears that Federal Reserve policy has been premised on the idea that lower interest rates bring down inflation. Yet there is no evidence of that in economic history. It has always been an effective policy to raise rates to slow down inflation, just as lead rods are moved into the radioactive core of a reactor to cool down the chain reaction.

Higher rates put a damper on spending. This has been recognised widely, so the Fed policy - based on the idea that lower rates are "good for the economy" - is baseless. In fact, it is damaging. The housing market and its mortgage bubble will most likely be the first and most visible victims of this policy.

Regards,

Addison Wiggin
The Daily Reckoning Australia

• None Found

And Cerberus — the three-headed dog who guards the gates of Hades — gets to keep the car company. Cerberus now owns the Chrysler, Dodge and Jeep makes, and Chrysler Financial. They just bought GMAC financing, the only part of GMC worth a spit. And they’re looking at the 2005 bankruptcy Oscar winner, Delphi.

Look for Cerberus to come out strong next year with a new and improved debt-free global automaker for sale… and a fistful of performance fees stuffed into its own pockets.

Addison Wiggin

• None Found

What kinds of events could do the same thing to the U.S. dollar, and what can you do today to position yourself strategically? The potential fall of the U.S. dollar is good news if you know what steps to take today. We're not as insulated as many Americans believe. In the 1930s, 20 percent of all U.S. banks went broke and 15 percent of life savings went up in smoke. After the emergency measures put into effect by President Franklin D. Roosevelt through the Emergency Banking Relief Act of 1933, confidence was restored with another piece of legislation: the 1933 Glass-Steagall Act. This bill created the Federal Deposit Insurance Corporation (FDIC), insuring all U.S. bank deposits against loss.

The severity of the growing situation had been seen well in advance. The financial newspaper Barron's, established in 1921, editorialized in 1933 that: "Since early December, Washington had known that a major banking and financial crisis was probably inevitable. It was merely a question of where the first break would come and the manner of its coming."

Two weeks earlier, the same column cautioned its readers that when the dollar begins to lose value, this leads to a series of "flights" - from property into bank deposits, then from deposits into currency, and finally from currency into gold.

We can apply these astute observations from 1933 to today's currency situation. The government, anticipating a flight from currency into gold, had already made hoarding gold or even owning it illegal. The second step - insuring accounts in federal banks - helped to calm down the mood. By preventing the panic, currency stabilized. But in those times, we were still on the gold standard. The currency in circulation was, in fact, backed by something. Remember, that riverboat gambler who keeps asking for ever-higher markers will eventually run out of credit. At some point the casino boss realizes that his ability to repay is questionable. Maybe those markers are just a heap of IOUs that can never be cashed in.

In the 1930s, the causes of the Great Depression were complex but related to a series of obvious abuses in monetary, financial, and banking policies. History has simplified the issue by blaming the Depression on the stock market crash (which takes us back to the explanation that "wet sidewalks cause rain"). The stock market crash, one of many symptoms of policies run amok, has lessons for modern times. The unbridled printing of money - expansion of the "IOU economy" - is good news for those who recognize the potential for gold.

We hear experts on TV and in the print media shrugging off the deficit problems. "Our economy is strong and getting stronger" is the mantra of those with a vested interest in keeping dollars flowing: Wall Street brokers and analysts, for example. But we cannot ignore the facts. The federal deficit is growing by more than $40 billion per month. It is not realistic to point to this economy and say it's doing just fine.

Gold is the beneficiary of reckless monetary policies and the War on Terror. Check the average value of an ounce of gold over the past decade. It has been rising steadily since the end of 2001. The cause of this change in gold's price may be attributed at least partly to the attack on the World Trade Center. But it reflects equally on the Fed's monetary policies and spiraling debt-based economic recovery. During the same period that gold prices have begun to rise, we should also take a look at the trend in money in circulation.

This is troubling for the dollar but - again - great news for gold. Remember what the world economic and political situation was like in the early 1970s: a weakening dollar, easy money, and international unrest. Sound familiar? We're back in the same combination of circumstances that were present when gold prices went from $35 to over $800 per ounce.

The numbers prove that gold is going to be the investment of the future. World mining in gold averages 80 million ounces per year, but demand has been running at 110 million ounces. So if central banks want to hold the value of gold steady, at least 30 million ounces per year must be sold into the market. This creates a squeeze. As the dollar weakens, central banks will want to increase their holdings in gold bullion, not sell it off.

This is why gold's price has started to rise and must continue to rise into the future. As long as that demand grows - and it will rise as the dollar's value continues falling - the price of gold simply has to reflect the forces of supply and demand.

But, you might ask, why do central banks want to hold down the value of gold? We have to recognize how this whole money game works. Most world currencies are off the gold standard, following the U.S. example. So as gold's value rises, it competes with each country's currency. Of course, the trend toward weakening currencies and the continuing demand for gold mean that the growth in gold's value could continue strongly for many years to come.

When the United States removed its currency from the gold standard, it seemed to make economic sense at the time. President Nixon saw this as the solution to a range of economic problems and, combined with wage and price freezes, printing as much money as desired looked like a good idea. Unfortunately, most of the world's currencies followed suit. The world economy now runs primarily on a fiat money system.

Fiat money is so-called because it is not backed by any tangible asset such as gold, silver, or even seashells. The issuing government has decreed by fiat that "this money is a legal exchange medium, and it is worth what we say." So lacking a gold backing or backing of some other precious metal, what gives the currency value? Is there a special reserve somewhere? No. Some economists have tried to explain away the problems of fiat money by pointing to the vast wealth of the United States in terms of productivity, natural resources, and land. But even if those assets are counted, they're not liquid. They're not part of the system of exchange. We have to deal with the fact that fiat money holds its value only as long as the people using that money continue to believe it has value - and as long as they continue to find people who will accept the currency in exchange for goods and services. The value of fiat money relies on confidence and expectation. So as we continue to increase twin deficit bubbles and as long as consumer debt keeps rising, our fiat money will eventually lose value. Gold, in comparison, has tangible value based on real market forces of supply and demand.

The short-term effect of converting from the gold standard to fiat money has been widespread prosperity. So the overall impression is that U.S. monetary policy has created and sustained this prosperity.

Why abandon the dollar when times are so good? This is where the great monetary trap is found. If we study the many economic bubbles in effect today, we know we eventually have to face up to the excesses, and that a big correction will occur. That means the dollar will fall and gold's value will rise as a direct result.

The sad lesson of economic history will be that when the gold standard is abandoned, and when governments can print too much money, they will. That tendency is a disaster for any economic system, because excess money in circulation (too much debt, in other words) only encourages consumer behavior mirroring that policy.

Thus, we find ourselves in record-high levels of credit card debt, refinanced mortgages, and personal bankruptcies - all connected to that supposed prosperity based on printing far too much currency: the fiat system.

We can see where this overprinting will lead. As debt grows relative to gross domestic product (GDP), we would expect to see positive signs elsewhere, such as a growth in new jobs. But like a Tiananmen Square Rolex watch deal, the value simply isn't there. Job growth is slow but, in reality, there is a decline in earnings. High paying manufacturing jobs have been replaced and exceeded by low-paying retail and health care sector jobs, so even if more people are at work, real earnings are down. Instead of simply measuring the number of jobs, an honest tracking system would also compare average wages and salaries in those jobs. Then we would be able to see what is really going on - more low-paying jobs being created, replacing high-paying jobs being lost.

Addison Wiggin
The Daily Reckoning

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