by Asim Jalis
Here are some possible outcomes of a weak dollar. Forbes points
out the first few.
Here is the article.
1. Companies with non-US suppliers will experience higher costs
and lower margins.
2. Companies with non-US buyers will experience higher dollar
revenues and higher margins.
3. Companies with both non-US suppliers and buyers might have the
two effects cancel each other.
4. The perception that the Bush administration will not rescue
the dollar will make it dollar denominated assets unattractive
for foreign investors. This will cause it to drop further.
5. The lower interest rates also make it unattractive, again
causing it to drop further. In fact this whole dynamic started
because the feds reduced interest rates as a way to reduce the
price of capital to spur the economy.
6. The net effect of 4 and 5 is that US assets will be
unattractive to investors (both US investors as well as foreign).
7. 6 will cause the prices of stocks to drop as supply exceeds
demand. The stock market will experience a decline.
8. The lower interest rates have created a bubble in real estate.
There is a professor at UCLA called Didier Sornette who claims we
are in the middle of a real estate bubble.
9. He reports that real estate borrowing is at an all time high.
10. Lower interest rates have made it easier for people to borrow
money for mortgages. With the same down payment and the same
monthly payments, the lowered interest rate allow people to
borrow about twice as much as before the rates dropped.
11. People who could not afford houses are moving out of rental
properties into houses.
12. Money withdrawn from the stock market after its crash is also
being invested into real estate.
13. These pressures are causing the real estate prices to
increase.
14. Banks are taking the higher prices at face value and lending
money freely expecting the underlying real estate to act as safe
collateral.
15. However, the banks' reasoning is circular. If the real estate
market collapses their loans will become unsecured.
16. The lower interest rates allow people to afford more, which
causes higher valuations. The higher valuations cause the banks
to lend more money under the assumption that the valuations are
real and that the money is secure.
17. People are leveraging over valued real estate to get large
loans and causing real estate prices to go up further.
18. This is a recipe for an exponential, unstable bubble. in real
estate prices. 17 describes the feedback loop.
19. Any disruption in the feedback loop will cause the market to
collapse. Disruptions could include:
(a) An interest rate hike by the feds to save the dollar.
(b) Saturation of the real estate borrowing market -- any
hesitation by real estate investors to borrow more.
(c) Saturation of the lending market -- any hesitation by the
banks to lend more.
(d) News of an economic recovery that causes interest rates to go
up.
20. Another source of disruption could be a shake-up in a major
financial institution that deals with mortgages or loans. For
example, a shake-up at Freddie Mac.
Reuters:
"The dollar fell broadly, with the euro climbing to session highs
around $1.1788 from the $1.1700 area after Freddie Mac, the
second largest source of U.S. home financing, said it fired
president and chief operating officer David Glenn."
Miami Herald:
"The federal agency that oversees Freddie Mac, the Office of
Federal Housing Enterprise Oversight, is investigating the
company's accounting. In a letter to the company over the
weekend, agency Director Armando Falcon said he has "become
increasingly concerned about evidence that has come to light of
weakness in controls and personnel expertise in accounting areas
and the disclosure of misconduct on the part of Freddie Mac
employees."
Also: "Earlier this year, Federal Reserve Chairman Alan Greenspan
expressed concern that Freddie Mac and its larger sister in the
home mortgage market, Fannie Mae, may not have adequate capital
and that many investors have the misperception that they are
backed by the government."
21. If Freddie and Fannie are inadequately capitalized, this
could be the pin that pops the bubble.
