Suppose that you want to buy a house, but you are waiting for the bubble to pop. You are hoping that prices will go down 20% and then you'll jump in and buy. But suppose when home values do go down 20% you find that no one, not one single bank, will lend you anything. Suppose several banks have already gone under and there are not that many to choose from anyway. Suppose that all the surviving banks can do the math: that they will most likely lose tens of thousands on any loan they write, on top of the huge portfolio of bad loans they already have. This scenario is not so unlikely. It happened in Japan not too long ago after a very similar real estate bubble to ours. I am not talking about some vauge possible future event. I am predicting banks to be in serious trouble, and a near complete halt in lending in 2006. The real estate bonanza is over and gone!
And why would this dreadful scenario come to pass? Because interest rates are inverted. They are unlikely to come back. A continued inverted yield curve will completely wreck the home mortgage business, making virtually all lending unprofitable. This inversion has been building for a long time, and seems to be a long cycle trend. It is very likely to invert more deeply. The reason that the mortgage business will end is that banks borrow short term to get the cash to lend to buy houses. The mortgage itself is a long term loan. To be profitable, there has to be a good spread between the long and short lending rates.
Now think what will happen to Americans when they not only can't get mortgages, but they can't get LOCs on the houses they do own, and they can't even get a lousy 20% interest rate credit card. Americans may be addicted to oil, but they are heavily addicted to credit. Commerce comes to a halt. Businesses close up. Plywood on the storefronts.
This is depression, folks. Very few houses get bought or sold (very little of anything gets bought or sold). When houses do sell, they go for all cash to the real estate barons who are just waiting for the chance. Or maybe a seller will accept a monthly payment plan from you. A few ounces of gold will make a useful down payment.
Friday, March 03, 2006
Thursday, March 02, 2006
“Suppose oil is traded only in Mongolian tugriks. So, you take your currency to the forex, exchange it for some tugriks and buy all the oil you need – and then the seller immediately converts tugriks to euros or yuans or whatever. Net benefit for Mongolia? Exactly zero. What difference does it make? It seems to me that as oil exchange currency the US dollar is no more more significant than a subway token.” —abb1, writing a comment on blog Crooked Timber
This post brings up the very good question: what difference does it make what currency oil trades in, anyway? So, lets follow the admittedly absurd proposition that oil may only be traded in tugriks. A single crude oil contract (one thousand barrels) is worth almost 62 thousand bucks today. That converts to 73.5 million tugriks. Given a week or two, a banker might be able to come up with that sum. Don't forget that currencies are commodities, subject to supply and demand equations like any other. Some have a vary large, liquid market with small spreads between buy and sell quotes, others, like tugriks, don't. Maybe a Canadian mining and exploration company would want a lot of tugriks now and then. But overall, it is not a huge market.
How many oil contracts can the tugrik support? Total supply is not that large: M2 in 2004 is 847 billion tugriks (stats here). That will buy only 11 thousand oil contracts. Clearly, if the world traded oil only in tugriks, the Mongolian central bank would have to get busy issuing bonds. Bankers all over the world could buy these bonds and lend out the cash to those who want to buy oil. Mongolia would have to issue a lot of bonds. This amount of cash would completely change Mongolia as a nation, because many of those petro-tugriks would come back to Mongolia. What would the Saudi princes do with their tugriks? They would probably buy beautiful ranches in Mongolia and breed racehorses (they probably already do that). Canadian oil-sand barons, Venezuelan oil rich bureaucrats, Russian KGB tycoons, all would have mountains of tugriks. Eventually that Mongolian cash would come home to roost like loyal hunting falcons on the high steppes of Asia. Because if the oil sellers don't buy Mongolian property with the tugriks, then they will have to sell them - the principal buyer would be the Mongolian central bank.
Mongolia would be flooded with their own cash. Real estate values would soar, stock market values in Ulan Bator would skyrocket. Domestic industries such as mining, farming and manufacturing, would produce so little money in comparison to the huge currency trade that they would be declared unprofitable and irrelevant. Because the money would come in through international banks instead of broad based domestic industry, it would be an extremely unequal distribution of wealth. This is not unlike what has happened to the United States in recent decades. But the US economy, being the world's largest, can absorb such huge quantities of money much better than the tiny economy of Mongolia.
The real question in my mind is why does oil have to be traded in a single currency? It was Henry Kissenger who formalized an agreement with OPEC, that in return for military protection, OPEC would agree to trade oil only in dollars. Kissenger foresaw the long term structural benefits to this arrangement. It need not be so. A sensible system would be to peg oil to gold. Oil exporters could ask for bullion, or, for countries that have stable currencies, could accept any national money at the rate gold trades for in that currency. Since every nation needs oil, it makes sense to trade it in a way that is internationally equitable.