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Fed policy indicates belief that the real estate bubble is "too big to burst."

Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
Peter Schiff
Friday, June 13, 2003
In its effort to keep inflating the housing bubble, which is now the sole support for the "borrow and consume" U.S. economy, the Fed has set America on a course that can only lead to hyper-inflation. Americans are able to spend more money on imported products (and with the domestic manufacturing sector nearly non-existent, almost all products are imported) because they are continuously able to "extract" equity from their appreciating homes. In addition, jobs related to the housing bubble, such as construction, remodeling, and mortgage finance, are the only segments of the economy generating significant employment growth. It cannot be denied that retail sales, particularly for big-ticket items like autos, are increasingly financed by home equity extractions. In fact, in today's America, owning a home is more important than having a job. Let's assume an individual owns a typical $500,000 house (financed with a 3.5% adjustable rate interest-only mortgage leveraged 90%) which is appreciating at a modest 20% per year. After mortgage payments and taxes, that home is generating about $80,000 dollars per year of spendable after-tax income. To have the same annual after-tax income from a job, one would have to earn at least $125,000. This helps explain why, with so many layoffs, the unemployment rate is still only 6%. An unemployed homeowner is not necessarily in immediate need of a job. In fact, there are many expenses related to having a job (commuting, dining out, dry cleaning, etc.) that one avoids by not working and living off of equity extractions. To keep the bubble inflating, and the housing economy humming, Greenspan must do all in his power to keep interest rates falling and bond prices rising. At some point, the radical money supply expansion necessary to accomplish this will result in a collapsing dollar (the U.S. dollar index closed today at a 7 year low) and rapidly rising consumer prices. Not wanting to prick the housing bubble, Greenspan will be unable to raise interest rates to combat rising consumer prices. As bondholders finally realize that the Fed is powerless to stop inflation from spiraling out of control, they will dump all dollar-denominated debt. Again, the Fed will be forced to monetize this by buying the bonds that private citizens are no longer foolish enough to hold. Further, as consumers witness rapidly increasing prices, they will rush to spend dollars as quickly as possible. The result will be a hyper-inflationary spiral that basically wipes out most of the real value of all dollar denominated financial assets and liabilities. Perhaps the Fed sees this as more politically acceptable than busting the housing bubble, which will immediately result in millions of voters losing their homes and their jobs. Since most voters are net debtors, with their home mortgage exceeding all other financial assets, the Fed would apparently rather punish creditors, many of whom are foreign citizens who can't vote. However, in the final analysis, the destruction of the dollar will ultimately lead to more economic hardship for average Americans than had the Fed opted to prick the housing bubble in the first place. No longer able to pay for imports with a printing press, Americans will suffer a sharp reduction in their living standards, the retirement dreams of several generations will have been completely destroyed, and America's savings pool, vital to future economic growth, will have been wiped out.

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Our investment strategies are based partially on Peter Schiff's personal economic forecasts which may not occur. His views are outside of the mainstream of current economic thought. Investors should carefully consider these facts before implementing our strategy.