By Martin Hutchinson
Contributing Editor
Money Morning
Could the massive Obama stimulus plan end up hurting the U.S. economy?
It's long been a worry, and now it's beginning to seem possible.
The latest housing reports suggest that the recent rapid run-up in 10-year Treasury bond yields may be having an unhealthy effect on the U.S. housing market. That tells me that - although home prices are back to their long-term average in terms of earnings - we may not yet be close to the price bottom.
If that's true, it's very bad news. A further substantial decline in housing prices would destabilize the U.S. banking system again, because of all the mortgage debt in it, which would cause a very nasty "second leg" economic downturn. That would have one very ironic further implication: U.S. President Barack Obama's $787 billion stimulus package - intended to help the U.S. economy push back the recession - would instead have succeeded in pushing it deeper into the mire.
A month ago, it appeared that the housing market might be in the process of bottoming out. The ratio of house prices to average incomes - which peaked at about 4.5 to 1 in 2006 - had fallen 33% from that apex, which brought the ratio close to its long-term average of 3.2 to 1, according to an S&P/Case-Shiller Index report. While interest rates remained low and government-backed home financing was readily available, it appeared the forces pushing up house prices (low interest rates and accessible financing) might soon come into balance and then dominate the forces that push home prices down (an inventory overage).
The jump in interest rates - from 2.07% on the 10-year Treasury bond in December to around 3.65% today - has weakened the case for a stabilization of housing prices. Mortgage rates, which were far below their levels of the last 30 years, have moved back above 5% -- even for "conforming" mortgages. Thus the Mortgage Bankers Association index of new mortgage applications was down 15% in the latest week. Meanwhile, new home sales have merely stabilized at very low levels of an annual rate around 350,000 - compared to more than 2.0 million at the peak of the market, while the latest price statistics suggest that price declines continued to be quite rapid in March, and possibly even accelerated slightly.
This interest-rate increase does not currently seem to be caused by expectations of inflation, which has remained around 2% annually, although oil, gold and other commodity prices have ticked up. Instead, it seems to have been caused by the exceptionally high demands being made on the government bond market by the U.S. federal deficit, which is expected to total about 13% of gross domestic product (GDP), or more than $1.8 trillion, this year.
It's not surprising that such a blip should have occurred this month; federal tax receipts are at their peak in April, as companies and individuals pay their taxes due, so the beginning of May saw a resumption of mammoth U.S. Treasury funding needs after a month's pause.
If interest rates continue to increase, the effect on the already-weak housing market could be severe, as housing "affordability" would be reduced in a period in which prices were declining and unemployment was rising. That, in turn, could have a self-reinforcing downward effect on prices, as home inventories bloat further, and buyers hold back.
Currently, according to the S&P/Case-Shiller 20-city house price index, prices are down 32% from their peak, but remain 40% above 2000 levels, while consumer prices are only 24% above those of 2000. However, 2000 was not a "bear-market" year; prices had already enjoyed several years of rapid recovery from their early-1990s low. Should rising interest rates cause prices to continue falling to 2000's level (another 28% decline), then on average every 80% mortgage undertaken since May 2002 (when the index first went above 125% of 2000's level) would be underwater, having an owed principal amount that exceeds the actual current market value of the house. That would cause a surge in mortgage defaults more severe than any yet seen, extending far into the prime mortgage category - and probably causing the U.S. banking system to implode once again.
The stimulus-package funds, which began flowing in April, may actually induce some GDP growth this quarter. At the very least, the Obama administration infusion should hold the economy to a very minimal decline in GDP.
However, if interest rates keep rising, the effect of further housing-sector weakness and the wobbling banking system would overwhelm any stimulus benefits, and would cause a second "dip" in this recession - one that's far worse than the first. The stimulus would, in that event, have proved counterproductive, killing the very economic recovery it was supposed to have stimulated.
Rising interest rates will have adverse effects on all countries with large budget deficits, the most notable of which are Britain and Japan. The effects would be harsh enough to actually prevent those countries from recovering from their own recessions.
For investors, the remedy is clear: Look to invest in countries that have produced only modest stimulus packages, and whose budget deficits are currently the smallest. In the invaluable statistical section of The Economist, a number of countries are projected to have budget deficits of less than 3% of GDP in 2009, in spite of their recessions.
At that level, deficits are easy to finance, and do not force up interest rates, so economic recovery should be relatively rapid.
Let's take a look at some of those countries in question:
- Canada: Budget deficit forecast of 2.5% of GDP. Americans are fond of sneering at Canada for its high public spending and sluggish growth. Well, Canada's public spending as a percentage of GDP peaked in the early 1990s and since 2000 the country has run budget surpluses. In 2009, Canada is forecast to have public spending lower than the United States, when provinces and states are taken into account, and to continue lower than its arch rival (the United States) for the foreseeable future. I wrote a few weeks ago about investment opportunities in the Canadian energy sector; those opportunities are even more compelling with the continued rise in the oil price to current prices of more than $62 a barrel.
- Denmark Finland and Switzerland: Wealthy European countries with healthy budget positions - deficits of 2.5%, 2.6% and 2.0% of GDP, respectively - will recover more quickly than their neighbors, because they have kept their economies in balance.
- Brazil: Probably the best of the lot, with a projected budget deficit of only 2% of GDP, inflation of 4.4% and bond yields of 11.8% -- meaning it can indulge in a little monetary expansion if it needs to. Brazil will also benefit if inflation returns (as I expect it to), because that will push up the prices of its commodities exports.
So there you have it. Maybe the U.S. bond market and housing market will stabilize, and the American economic recovery will proceed smoothly - nothing is certain. But investments in Canada and Brazil, in particular, will protect you against the possibility that the U.S. situation doesn't improve.
[Editor's Note:When the journalistic sleuths at Slate magazine recently set out to identify the stock-market guru who correctly predicted how far U.S. stocks would fall because of the global financial crisis, the respected "e-zine" concluded it was Martin Hutchinson who "called" the market bottom.
That discovery was no surprise to the readers of Money Morning - after all, Hutchinson has made a bevy of such savvy predictions since this publication was launched. Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives KO'd insurer American International Group Inc. He predicted the record run that gold made last year - back in 2007. Then, last fall - as Slate discovered - Hutchinson "called" the market bottom.
Now investors face an unpredictable stock market that's back-dropped by an uncertain economy. No matter. Hutchinson has developed a strategy that's tailor-made for such a directionless market, and that shows investors how to invest their way to "Permanent Wealth" using high-yielding dividend stocks, as well as gold. Just click here to find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor.]
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Since, as early as, March 26, 2009, I have been telling the rulers and policy makers through my various writings appeared in various sites about the hidden threats of the stimulus pacakges, based on heavy borrowing and deficit financing.
These stimulus pacakges would be catastrophic unless we strictly follow the fundamental principles of Economics and Banking, improve or increase the income and the purchasing power of the general public,make a reasonable saving and investment and innovation and above all become competative. Other wise, the stimulus pacakages would be counter-prodctive and make the crisis more severe and prolonged than predicted.
Unfortunatly, all these stimulus pacakges have been reduced into mere adhoc measure to clear the market of the unsold items without any measure for increasing the income, purchasing power, saving, invetament and innovation. Without making a drastic cut in cost of living and cost of production no economy can be competative and sustainable.
There is no doubt, oil price fall to the extent of $ 40 per barrle within three months, the time in which almost all stimulus pacakges are exhausted and nobody has any more fund to gnerate a minimum demand for oil or cars. The present trend of the rise of oil price without the backing of any economic reality is the greatest symptom of the Real Crisis more severe than the Hreaty Depression of 1929.
The greatest tragedy is that nobody has realized the seriousness and complexities of the Crisis and no concious and massive global action has been launched so far to deal with the Crisis. Both IMF and the World Bank too are confused without any solution in their hands. So also are the cases of our Gurues and Experts.
Credit or money supply is not the real problem, but the actual earning and purchasing power, the rate of saving and investment supported by innovation. According to the present trend, the Crisis will remain till the end of 2015 or 2017 becuase the wounds of the global economy are so deep.
A Global Summit on the Global Economic Crisis , that too with sound and sincere home works, must be convened and global actions must be launched to save the millions from prolonged harships, mental brakedowns, crimes and suicides. Let the UN, the world religions, various national and intgerantional agancies and governments come forward to save millions.
What would ever lead you to believe this "plan" would help anyone but Wall Street and the banksters? It is illegal and unconstitutional. Welcome to fascist Amerika.
I think you forgot, the perhaps strongest economy of all, Norway.
From NY Times May 14, 2009:
"in the midst of the worst global downturn since the Depression, Norway’s economy grew last year by just under 3 percent. The government enjoys a budget surplus of 11 percent…
Instead of spending its riches lavishly, it passed legislation ensuring that oil revenue went straight into its sovereign wealth fund, state money that is used to make investments around the world. Now its sovereign wealth fund is close to being the largest in the world, despite losing 23 percent last year because of investments that declined.
….there has been no real estate crash in Norway because there were few mortgage lending excesses. After a 15 percent correction, prices are again on the rise.
…Banks represent just 2 percent of the economy and tight public oversight over their lending practices have kept Norwegian banks from taking on the risk that brought down their Icelandic counterparts. But they certainly have not closed their doors to borrowers. "
Correction: May 22, 2009
An article on May 14 about Norway’s relative economic stability in the midst of a global downturn misstated its debt status. While the government enjoys a budget surplus and is a net creditor, it has liabilities related to social security and other programs equal to about 50 percent of its gross domestic product; its ledger is not “entirely free of debt.”
http://www.nytimes.com/2009/05/14/business/global/14frugal.html?_r=1