Economic Predictions About the Year 2000

Beware economic predictions! Here is a fun one from 1999. 

The Effect of Interest Rates on Housing Prices

Most people do not buy a house--in reality they buy a payment. Buying the house comes later, because they begin with no equity, and most of their monthly payment for a long, long time goes not to create equity, but just to pay the interest on their loan. Let's say you borrow $200,000 and your payment is $954 at 4% interest. As most people tend to max out what they can borrow and get a bigger house if they can, the payment amount that they can afford will not change. So if interest rates go up to 6%, then this payment would be $1199. That is out of the budget restraints for the potential new home owner. A $160,000 loan at 6% will be $959. (For a handy amortization calculator, click here. All figures are from this calculator.)

Think about what this means. When, not if, interest rates go up, house prices will have to go down. Under this scenario they will decline 20% making a huge number of home "owners" owing more on their home than it is worth. (Remember that it will be years, many years, before a home owner has much equity.) The market would have already been affected by the modest increase for the last 6 months except that investors are buying 50% of all homes and they are paying "cash." A lot of these investors are using very low interest rates to buy the houses. It is a gigantic gamble

So the "rule" is that as interest rates go up, house prices go down. 

Get Ready

Interest Rates Headed Up

This looks like fun, but it won't be.Rather than reinvent the wheel, I have decided to repeat a blog post about Interest rates and the budget from Jan, 2013. I think that the low rates will continue for some time, but as Herb Stein famously said, "What can't continue, won't continue." 

I have been warning for some time that the US was facing a crisis because of debt service. The "buzz" on this is starting to reach the mainstream. I read an article on interest paid by the US government on Investor's Business Daily recommended by a Texas congressman. Right now the percentage of the budget spent on interest is under the danger point—18 %. The non-partisan (as you are always supposed to say) Congressional Budget Office, has estimated that it will be 20% in 2020. This assumes the US will have revenue growth due to economic growth, and that interest rates will remain low for the foreseeable future.

I have already predicted low interest rates and modest growth for a few years, a little breathing space. This is why I am guardedly pessimistic. We still have time to get our house in order. But based on the latest rhetoric from Obama this is almost a forlorn hope. The unwillingness of Republicans to cut their own sacred cows is part of the problem as well. 

Interest rates are not just low; interest rates are not just as low as they have been in recent memory; interest rates are as low as they have ever been in recorded history. Look at this list of interest ratesto see what I mean. 

I am not out on a limb when I say that these rates cannot last. They were over ten times higher in the 80's. That would mean that interest rates would consume 200% of the budget in a few years if rates get that high. 

Let’s say interest rates are double the projections, not at all out of the question. This would mean that interest on the US debt would consume 40% of the budget in 2020. Based on the fact the budget borrows 30% of every dollar it spends, this would mean that paying interest on the debt would consume 2/3 of all tax revenues. 

Do I have to point out that this cannot happen? 

So look for more of the same from the educated idiots in power. Things will continue on as they are. It will look fine on the surface, until the dry rot causes the structure to collapse. I do not expect the whole building to fall over, but the US will have to live with a rotten floor for some time. But the floor can be repaired. 

Are you ready for the great stagflation of the next decade? If not, get ready. You have some time as the sucker's rally takes place over the next few years.

A China Century?

When I listed all the positive and negative trends for the medium-term US economic future, you might have been surprised by my insistence that things are not going well in China. This is not the standard view. Sure this might end up being a China century, but there are a huge number of negative factors that will delay this. 

Anytime that the government dominates economic planning, investments will be made in the wrong places. So with a lot of credit floating around in the Chinese system, cities were built that are still mostly empty. Here is a news report on this. 

This leads to the next Chinese problem. As is common, the banks do not have enough capital for even a modest amount of defaults. The government of China does have capital to take care of this issue, but it will not be pretty. 

What does China's elite think abut the future? 

It's one of the largest and most rapid wealth migrations of our time: hundreds of billions of dollars, and waves of millionaires flowing out of China to overseas destinations.

According to WealthInsight, the Chinese wealthy now have about $658 billion stashed in offshore assets. Boston Consulting Group puts the number lower, at around $450 billion, but says offshore investments are expected to double in the next three years.

A popular pastime for the elites is giving birth in America in order to give the child an American passport. Canada is also a popular destination. The wealthy in China are voting with their feet and their bank accounts. Since China has capital controls, various tricks are used to move money overseas. Jewelry is purchased in China, then a trip is taken to another country and the jewelry is sold. Since the markup in jewelry is notoriously high, this is very inefficient. Recently the Bitcoin phenomenon is used as a way to launder money. One third of all bitcoin transactions take place in china. This is a major factor in the Bitcoin bubble.

In any event some sort of crisis in China is brewing and this, as with Japan, will take pressure off the various American bubbles and issues. These various foreign issues give the US a chance to make some changes. I hope the time is not wasted.

Budget Crisis

While the budget crisis is not as severe as it once was, it is still pretty bad. Now instead of a one trillion dollar deficit we only have a 700 billion dollar deficit. While this is a cause for celebration, we are "not out of the woods yet."

The main negative factor is that most of the congress does not seem concerned about the issue. It is just politics as usual. The stereotype is that Republicans are evil, poor-hating bastards and the Democrats are spending money like there is no tomorrow. Maybe the Republicans do hate the poor, but in reality both sides spend money in prodigious amounts. I could say that the government is spending "like a drunken sailor," but that would be insulting to drunken sailors.

As long as about half the population receives more from the government than they pay in taxes we will continue to head down the wrong path. While Romney was criticized when he pointed out that 47% of the population receives more money from the government than they pay, and that this was a difficult hurdle for Republicans to jump, Romney was obviously right on this. (Even my agreement with Romney on this was not enough for me to vote for him.)

A budget freeze until the government is in balance seems an obvious step, but I must hate the poor. Even the hateful Republicans are not actually proposing any cuts in spending, they are only proposing a reduction in the rate of spending increase.

This is not enough. We have limited time and time is running out.

This caller to a talk show illustrates the problem, even if it is a "performance piece." I am assuming that this was a real caller, but it may just play into my prejudices. Talk shows are plagued with fake callers all the time. But make of this what you will.

I am pessimistic that these problems can be solved, but I hope I am wrong. Either way a trying time is coming.

Get ready