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The Dawn of a Lengthy Economic Decline

By: Steve Johnson

7/14/2008 - 13 Comments

The importance of whether or not America is in an official recession is not as important as understanding what's really happening.

The sub-prime housing market collapse that was suppose to be “contained” is now threatening the entire economy – by taking out Freddie Mae and Fannie Mac – which together hold nearly 50% of the US mortgage market.  The global economy is also at risk as many nations have billions investing in Freddie/Fannie bonds.  This two-fold problem has forced the US Treasure into a position of bailing out Freddie/Fannie.

But the government doesn’t have any money, so where will they get it from?  They have three choices. They can increase tax, print more or borrow.  All three options have already exceeded their effectiveness to the point where any more will further damage the economy. The amount of money needed to bailout Freddie/Fannie is likely to be over a trillion dollars, which means the government will likely need to use all three methods to raise the money.

Housing Prices to Cave

No matter how they do it, housing prices will need to drop another 20-50% as borrowing money will become more difficult and more costly. The high risk of borrowing money to Freddie/Fannie will force them to raise their interest rates, which will put up the interest rates of home owners that need to borrow money for their mortgage. This increase in interest rates will push down on housing prices.  The national housing price decline over the past year has already been the steepest drop since the great depression. The sudden change in prices is very dangerous for the entire economy, yet the effects of Freddie/Fannie will likely further accelerate the rate of declining prices.

Global Inflation Rates Increase

Almost half the world is already suffering from double-digit inflation rates do to the sudden increase in food and energy prices. 

The rapid increase in inflation is eliminating the rewards of owning stocks. This has caused many stock markets to drop by 20-50% this year.  Dropping stock prices will pressure companies to increase their profits to again attract investors. But increasing profits in a recession is very difficult.  Many businesses will fail and the one’s that survive will raise prices and rely on necessity products like food and energy.

The End of the Goldilocks Economy

The Wall-Street cheerleaders and the Bush administration and many Americas that are not paying attention or have bought into what the cheerleaders are saying - still don’t get it. They believe we are in a short recession that will only last a few months and then the economy will return to its bubble state.

The goldilocks economy is gone forever and we are at the dawn of a lengthy economic decline.

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