Tags: Experts: | Real | Estate | Bubble | Could | 'Sink | Economy'

Experts: Real Estate Bubble Could 'Sink Economy'

Tuesday, 02 August 2005 12:00 AM

The Federal Reserve acted "irresponsibly" by setting interest rates too low, say two prominent economists – and that contributed to a housing bubble that threatens to burst and sink the entire economy.

The experts say the Fed must act to adjust interest rates because the United States has become so dependent on real estate and construction to fuel growth that "an eventual, wrenching correction has the potential to sink the economy," according to the financial news service Bloomberg.com.

"Act now and cut off the pinky, or wait till later and risk slicing off the entire hand," says David Rosenberg of Merrill Lynch.

While Fed Chairman Alan Greenspan has acknowledged that home prices may be "unsustainable" in some regions, he has decided not to use interest rates to address the problem.

But according to various experts:

"There's enough of a risk that the Fed should be preemptive," Maury Harris, chief economist at UBS Securities LLC in Connecticut, told Bloomberg. He said the Fed should keep raising its short-term interest rate until market forces lift mortgage rates three-quarters of a percentage point.

Stephen Roach of Morgan Stanley agrees that the Fed should act.

"We're in a dangerous place," he says.

The Fed contributed to the housing boom by lowering the target for its overnight lending rate to a 45-year low of 1% in 2003 to fuel the economy after the recession, Bloomberg reports.

"The Fed acted irresponsibly by overstimulating housing," says Edward Leamer, director of the Anderson Forecast Center at UCLA.

The lending rate has been raised several times since then, but mortgage rates have remained near four-decade lows. Greenspan believes that markets -- and not the Fed -- should determine the correct price of housing.

But eventually policymakers will have to act, according to Lyle Gramley, senior economic adviser at Stanford Washington Research Group.

"If they can engineer a monetary policy now that brings a nice smooth end to this run-up in home prices," he said, "they're less likely to have economic instability down the road."

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2. Unusual: Dollar and Commodity Prices Both Increase

The Wall Street Journal reminded us on Monday that, "in each of the past three years, commodities have climbed and the dollar has weakened."

Their article exposes the major plot twist this year: both the dollar and commodity prices have increased. That's an unusual development since commodities are priced in dollars.

Investors treat commodites as asset alternatives, which generally increase when investors lose faith in dollar-denominated assets. Gold is the classic example. Its price generally increases as the dollar falls, when investors lose faith in a government's ability to maintain a store of value.

As commodity prices rise, they are often offset by a falling dollar. Traders often grumble that despite large commodity moves, it takes more dollars to buy the same amount of a raw material.

However, the 2005 experience has proved commodity investors can have their cake and eat it too.

Their commodity-related gains compare to a rising dollar. It takes them less dollars to buy the same thing and they come up winning on both fronts.

The last time this dual bull environment existed was in 2000, when the economic picture buckled.

The Journal goes on to suggest that should this picture continue, it opens the doors to escalating fears of inflationary pressures. After all, the main squeeze on prices is due to global supply constraints at a time when demand remains solid – especially in the energy sector.

Higher prices for raw materials often end up pushing producers into nudging up the prices of final goods for the consumer.The Reuters Jefferies CRB index, which measures a basket of commodity prices, is up 11% this year. The J.P. Morgan Dollar index is up 4% at the same time.

Crude oil futures, already up 17% in 2005, hit new record highs following the recent death of Saudi Arabia's King Fahd.

Heating oil and gas have also been spurred on by the delicate balance between the 80 million barrels of global oil capacity and the surging industrial demand for energy.

The recent Chinese revaluation of the yuan makes it less expensive for the world's fastest-growing nation to buy fuel and other commodities.

A stronger yuan also makes Chinese goods more expensive to importers, but this small 2.8% revaluation will hardly serve to dent the ambitions of Chinese companies expanding abroad.

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3. CNOOC Bid For Unocal Fails

Chinese ambitions to take control of Unocal failed this week.

CNOOC probably readied itself for political grief along the way as they attempted to upstage mighty Chevron's initial attempt to snag the oil producer. 

That's how it seemed on the surface, and word from insiders was that we would soon know whether or not the Chinese would seek oil producers elsewhere and abandon the Unocal venture.

Well, they were quite right. CNOOC officially dropped its bid today. Even a $2.7 billion premium just wasn't enough to push the company into Chinese hands.

 It wasn't so much the money that was at issue.

Analysts say that it would have been futile for CNOOC to raise its $18.5 billion bid to $20 billion. The political opposition in Washington had become so grizzly that there was no point.

In order for the deal to succeed, CNOOC Chairman Fu Chengyu would have to have been convinced that he could persuade Unocal's board that his latest offer brought value to the table, so they would champion the deal on Capitol Hill.

It was too tall an order.

Clearly Chengyu and his team felt that Unocal would not push for political acceptance for the deal.

So it seems the deal is dead and that Chevron will walk away with Unocal.

For Chevron, it must have been infuriating to surmount the CNOOC challenge. They needlessly boosted their bid by $700 million, when the political opposition to CNOOC may have made that costly step unnecessary.

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The Federal Reserve acted "irresponsibly" by setting interest rates too low, say two prominent economists - and that contributed to a housing bubble that threatens to burst and sink the entire economy. The experts say the Fed must act to adjust interest rates because the...
Tuesday, 02 August 2005 12:00 AM
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