The European Union took a great
fall. All the king’s horses and all the king’s
men couldn’t put the European Union together again.
France voted emphatically to reject the European Union Constitution,
and the Dutch were even more emphatic in their rejection.
England may not even bother to vote, and Italy wants to drop
the Euro and go back to the Lira. Is it any wonder that the
US dollar is getting stronger and that long term US Treasury
rates (10 years and out) are declining.
The unemployment rate in France is 10.2%, and in Germany
it is 11.8% versus 5.1% here. The US economy is still the
strongest in the world. China’s economy may be growing
faster, but their financial structure is on a very shaky foundation.
So if you are a foreign country and hold lots of dollars,
where are you going to put those dollars? Longer term US Treasury
securities naturally. It is this demand for the safety of
our treasury securities that is holding up the price of the
securities while holding yields down. Look for yields on longer
term treasuries to tread water between 4.0% to 4.5% for some
time.
Richard Fisher, Chief of the Dallas Fed, recently hinted
that rising rates may be in the 8th inning (8 consecutive
increases). We may however go into extra innings. The Fed
meets again at the end of this month and will probably raise
rates another 25 basis points. The Fed will face a real conundrum
as short rates approach long rates. They will not want to
risk an inverted yield curve with short rates higher than
long rates as this almost always is a precursor to a recession.
Interest rate cycles can and do stretch out for long periods
of time (40 years or more). Interest rates reached lows in
the late 1930s and did not peak until 1981. Long rates have
been declining since, and although we expect these rates to
rise, it will probably be a long term gradual rise.
Low rates of course have caused money to stampede into real
estate. Remember, money goes where it is treated best. This
has caused much concern about a bubble similar to the stock
market in the late 1990s. Not likely in our opinion. The stock
market bubble affected the entire country, whereas rampant
real estate speculation has been confined to smaller areas
of the country. How appropriate that Las Vegas is one of those
areas. Eventually real estate prices in these “hot”
areas will decline but not with epic proportions, and most
of the country will not be severely impacted. Only if mortgage
rates were to rise to double digits would there be problems,
and we do not see that happening.
The economy continues to chug along, and in spite of the
release of mixed economic data, we still see continued growth.
The conundrum here is that while employment numbers are erratic
month to month, and that only 78,000 new jobs were created
last month, the unemployment number dropped from 5.2% to 5.1%.
More and more Americans are going into business for themselves,
thus are not being reported in the unemployment numbers. Small
businesses create over 90% of new jobs, and we would expect
this trend to continue. In addition, however, foreign companies
are building plants here to take advantage of our highly skilled
labor force and to be closer to our consumers. Both of these
events are setting the table for the next great economic boom
in this country.
Get your wallet out. The next bailout facing taxpayers will
be large corporate pension funds. United Airlines has already
defaulted, and the Pension Benefit Guaranty Corporation will
have to make good on payments to pensioners. Most of these
retirement funds are defined benefit plans, and in the high
flying stock market of the 1990s, these corporations were
guaranteeing benefits based on 10% or better returns in the
stock market. After three years of negative returns beginning
in 2000, these pension plans are grossly under-funded. The
airlines in particular are crying bankruptcy unless the government
(taxpayers) bails them out. Look for other corporations to
follow suit. An ancient philosopher once said, “There
are no guarantees in life, only opportunities.” One
has to wonder.
Random thought for June 2005:
“Government is the great fiction, through which
everybody endeavors to live at the expense of everybody else.”
- Frederic Bastiat
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