Why I Believe We are Headed for Harder Times Ahead

Dear Profit Confidential Reader:

Here are a simple few paragraphs as to why I see the U.S. economy unraveling. Please print this issue out and keep it in your desk. Refer to it whenever you make an investment or major purchase so you can gauge how either will fair under the coming economic scenario:

After 9/11, former Fed Chairman started lowering interest rates aggressively. By the summer of 2004, U.S. rates had fallen to their lowest level in 46 years.

Low rates led consumers to borrow more. Consumers used their credit cards, personal lines of credit and an ever increasing variety of interest-only mortgages to borrow money to make major purchases such as homes. A consumer buying frenzy developed and the U.S. personal savings rate fell to one of the lowest rates on record.

Seeing aggressively lower rates had caused speculation in the housing market, the Fed then raised rates 17 times in a row. The U.S. Federal Funds Rate has gone from 1% in the summer of 2004 to 5.25% today–a 425% increase.

With the higher rates of today causing financial stress for American consumers (the loans they took out several years ago are costing more to carry), consumers have started to cut back on spending, especially for big ticket items. New home builders are seeing demand drop, so are automakers. (Have you seen Ford’s share price lately? Try $7)

Because consumer demand is soft, prices are falling for most goods except the commodities. Soon, rather than later, the Fed will have to lower rates so deflation does not set in. My concern is that U.S. consumers are too overextended–lower interest rates this time might not spur consumer spending.

The above scenario will likely cause a recession to develop in the U.S. And this time, I see the coming recession being deep and difficult because U.S. consumers do not have the savings to spend their way out of a recession. The same thing happened in Japan and it took them over a decade to get out of recession and deflation even when their central bank lowered rates to zero. The Japan example proved that when consumer confidence is shattered, even zero percent interest won’t spur consumer spending. The same thing could happen here.

NEWSFLASH–Toll Brothers, one of the largest U.S. home builders reported a 19% drop in third quarter profit yesterday. Robert Toll, the company’s CEO, was quoted saying “this overhang in (housing) supply and the aggressive discounting of many builders is undermining consumer confidence and keeping buyers on the sidelines.” Robert, don’t expect homes buyers to come back soon. It will take years for the inventory of speculators and home builders to be absorbed.