It Will All Hit the Fan in 2007, Part 3

In Part 1, I described a change in bankruptcy laws and implied that it will have a negative effect on the U.S. economy.

In Part 2, I showed how, in 2005, the savings rate in the U.S. was negative for the first time since the Great Depression.

I will now describe several other things that recently occurred and bode ill for our economy:

1) On January 1, 2006, a change in federal law took effect that requires minimum credit card payments to double from 2% to 4% of the outstanding balance.

All of those people who could barely make the minimum payments on their credit cards before the change are going to be in deep trouble.

2) The yield curve inverted.

What the heck does that mean?

An inverted yield curve means that short-term interest rates are greater than long-term interest rates. It usually presages an economic recession. The last time we had an inverted yield curve was 2000 and we all know what happened then.

3) Our federal trade deficit exceeded $700 billion.

It’s hard to envision exactly how much $700 billion is.

Maybe this will put it in perspective:

Iowa and Kansas have the most productive farmland in the world. The combined value of all the farmland in those two states is around $210 billion.

Last year, our trade deficit was more than 3 times the total value of all the farmland in Iowa and Kansas.

We are trading away the core of our wealth for Chinese-made electronic gadgets and trinkets.

Using a similar theme, Warren Buffet, arguably the greatest investor of all time, has equated the trade deficit to a family who owns a lot of land. They consume more than they produce and pay for the difference by selling land from the outermost borders of their holdings.

There isn’t a happy ending. Eventually, they’re going to run out of land to sell.

A direct consequence of our huge trade deficit is foreign economies accumulate massive amounts of dollars. They use those dollars to buy dollar-denominated U.S. assets, such as U.S. companies.

An example is the recent $18.5 billion offer to buy Unocal by Chinese-government-owned oil company CNOOC.

CNOOC didn’t succeed, but its bid is a precursor of future Chinese acquisitions of U.S. assets.

We are consuming more than we produce and selling our "land" to pay the difference. The problem is, the difference is now so large, we are seeing and feeling its effects.

And it’s only getting worse.

Coming soon: Part 4 – Bad News on the Horizon