Volcker

In the words of Paul Volcker

The United States is importing 7 percent more goods than it exports, personal debt is soaring and the national debt Ð while "not terribly large" compared with the total economy Ð is mostly financed by investors in Japan, China and other countries.

"You can't expect this great country to live forever off other people's money," said Volcker..

The Daily Bear could not agree more with this statement. At some point, the f/x investment will slow and interest rates must rise.

Foreign investment now represents over 50% of us debt holdings up from 20% in 1994.

What does this mean to the Bear and you?

Given our weakened ability to service our debt, foreign countries are going to be less apt to buy our debt (mainly China and Japan). This will soon cause the long bond to drop and interest rates to rise. Of course the dollar will likely fall as a result. Couple this with excess demand for commodities such as oil and oil and oil, and you get a nice recipe for inflation. Last time the Bear checked high interest rates, inflation and a weak dollar will likely add extra risk premium in long term bonds

If foreign countries stop buying (or lessen demand) our debt, long-term bond prices will drop, interest rates will rise and the dollar will fall. Excess demand for energy and natural resources from China and India will likely spur a rise in U.S. inflation rates. Higher interest rates and inflation coupled with a weak dollar make long-term bonds a risky investment with very little upside. And again more pressure on rates to rise. As shown so brilliantly in the chart below, a drop off in foreign purchase or US debt since 2004 has led to a gradual rise in long term rates. What makes us believe this will turn around, our massive budget deficit, healthy dollar or out of control current account deficit.














And to those of you who think the global economy is strong enough to brush off a serious recession and fall in the US dollar, think again. A 10%-20% decline in the dollar will lay a severe blow to European imports. For example, over the past 3 years the average dollar cost to buy a European made car costs the US consumer $6500 extra. To say this will not impact demand and the Euro economy will be uninformed. Similar effects likely in Latin America and Africa. While fixed rate cheaters in Asia will likely escape the immediate impacts of the falling dollar, the America's and Euro region makes up greater than 50% of all imports from the APAC region. US GDP alone represents on order of 33% of the world output.

Did we mention the effect of higher interest rates on housing. commerical real estate and corporate profit? 100 times before..

The average 30 year fixed rate mortgage has risen to 6.75 from 6.18 in January.. ouch. In the spirit of Jerry Marks, "It's Freeee" the ride is coming to a halt sometime in 2007.

See you at the bottom of the correction.

DB