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, but 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 US 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 US 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 favour 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 (BIT:BIL), 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 US$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 US 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 organisation in Riverside."
Let's see, Chinese companies depend on consumer buying from America...which depends on US 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.
Bill Bonner
The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
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About the Author
Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Comment by MR Smith on 26 December 2007:
What is money
Yes sure people all think they know what it is and may even understand the effects of inflation and can understand why down the road this often leads to the devaluation of a currency but few will know or understand how the money from the BoE printing press gets distributed without someone dumping it from a helicopter.
School history lessons will have taught you that the American revolution was all about freeing the slaves and therefore will not know what script money was or why it placed brother against brother or more precise the bank of England against other new banks.
Some here may had come across the words gold standard but how many know that it was illegal for an American citizen to hold gold and they were all forced to sell it to the government at a fixed rate that was below market value and that was not that long ago.
Wild west gold miners that didn’t starve to death used banks to store their gold and the gold was weighed and a hand written receipt was given out but soon people discovered that these hand written receipts for gold could be forged and hence the need for a official receipt that became known as the American dollar.
Later this gold was lent out but soon that gave way to cheques and before too long the value of the paper money was far in excess of the value of the gold held by the banks and when the miners discovered this discrepancy they were offered something new at the time called interest payments to keep them all happy.
What the miners soon became unhappy about was another new invention called inflation where a ten dollar bill was suddenly worth only nine grams of gold and not the ten they had originally deposited with the bank.
Fast forward to today and we have shorts, longs , stop losses , petrodollars, futures , derivatives , CDO’s, and something you may had come across on the news called the sub prime crisis that gave you all a 0.25% cut in interest rates but also lead to the GBP buying you 1.5% less from abroad.
Now hands up all those people that have a pension fund with XYZ who I just so happen to be working for just now who can honestly say they know what money really is.
Bring yourself up to speed by watching
Money as debt
http://video.google.com/videoplay?docid=-9050474362583451279
The money masters
http://video.google.com/videoplay?docid=-515319560256183936
Monopoly men
http://video.google.com/videoplay?docid=-7065177340464808778
Now lets talk small figures like the £1800 it has just cost every UK tax payer to bail out northern rock http://www.telegraph.co.uk/news/main.jhtml?xml=/news/2007/12/19/nrock119.xml and that’s just looking at the official figures.
Lets move on to the real deal and that the $500tr plus derivatives market that is starting to unwind and that alone weighs in at a staggering $90,000 for every man woman and child on the earth.
Please don’t take my word for it and look around the internet and you will soon find many people agreeing the figure is anywhere between $451tr and $600tr with others showing calculations that put it as high as $2200tr and shown below. http://www.financialsense.com/fsu/editorials/laird/2006/0624.html
Hopefully those still reading this article can make the link back to pension funds and by now will understand the personal impact this will have on them directly and maybe tempted to stop being too greedy and to reduce there exposure to the banks and the markets but what we have left is Gold that I believe is now over priced or bricks and mortar that has already peaked in most parts of the world and is now on it’s way down again.
I was stopped at Heathrow the other day after clearing customs when I was stopped and asked if I had any money on me to which I replied about 200 quid and then the gentleman asked if that was all in sterling or was some in Euros’ sir ! kinda makes you ask yourself what the hell is going on as I am sure many Americans are asking themselves after the offices of the liberty dollar were raided a few weeks ago.
http://www.courierpress.com/news/2007/nov/15/liberty-dollar-office-raided/
Banks can try to hyper inflate their way out of trouble to some degree much like Germany did in the 1930’s and Zimbabwe is trying today but it’s likely to fail and that’s why I think we are facing a situation just like Germany and Zimbabwe where food and water becomes much more important than bit’s of paper and ownership of a few meters of mud and if I am wrong then you can always eat your stack of food or go and do your bit for charity before the sell by date is reached.