April 5, 2005


Rate hikes may create 'perfect storm': How oil, housing, and China could all crash (Joe Duarte, April 5, 2005 , CBS MarketWatch)

As Europe flounders in its self-inflicted bowl of economic soup, and Japan muddles along, China continues to outpace them all, fed by still relatively low interest rates, and international capital searching for growth.

But, even that, will come to an end, at some point, especially if the Federal Reserve raises interest rates further. It's difficult to predict when that magic rate will be hit. But, for those who believe that China's economy addicted to cheap money, the withdrawal syndrome will be painful when it happens.

According to Intelligence service Stratfor.com: Chinese "debt is extremely vulnerable to interest rate hikes. As rates rise, that debt will become impossible to maintain, and China will face the beginnings of a financial crisis. Given the makeup of the Chinese financial system, such a development is unavoidable. The only questions regarding the crisis to come are time frame and severity."

After 9/11 the Fed flooded the world with dollars. Much of that money went to China, driven by the growth rates of the Chinese economy, and escaping what some thought would be a major Depression scenario in the United States.

That dramatic change in the flow of capital is responsible for China's seemingly endless expansion.

The net effect is that the world economy is now used to cheap credit, and is booming, especially in emerging markets like India, and China.

In the United States, million dollar homes are being financed with adjustable rates and low interest only mortgage payments.

But the Federal Reserve, and more recently, the European Central Bank are concerned about possible inflation.

Furthermore, with global levels of debt at dangerous levels, maintained only by liquidity, the market is likely to be more sensitive to smaller rate hikes, and that the whole system could come apart faster, if the Fed reaches a critical point in its interest rate hikes.

According to BankRate.com, 5-year adjustable rate mortgages in the U.S. have risen from 4.2 to 4.8%, over the last six months, while the Fed Funds (www.federalreserve.gov) rate climbed from 1.6% to 2.5%.

If, the Fed raises the fed funds rate at one-quarter point from now until September, at each of its upcoming four meetings, rates would be at 3.5%. If there is one surprise half-point rate hike, the Fed Funds could be at 4%.

Five-year adjustable rates could theoretically rise to 6% or above, creating a significant increase in the monthly payments for those who can't or won't lock in lower rates.

So China implodes and takes oil with it. America still has to house 500 million people by 2050. The housing market dips, it doesn't go down.

Posted by Orrin Judd at April 5, 2005 1:00 PM

According to Intelligence service Stratfor.com:

That's where they lost me. Stratfor is living proof of OJ's theorem that the conventional wisdom is always wrong: they're conventional in their wisdom, and they're nearly always wrong.

Posted by: Mike Morley at April 5, 2005 1:10 PM

Help me here. The story talks of "...the Chinese financial system..." Where is this and when did they get it?

Posted by: Luciferous at April 5, 2005 1:15 PM

Housing markets can have crunches. The early 90s in the US and Japan is a good example. Prices in Hawaii, especially Oahu, still haven't exceeded those of the late 80s, when the Japanese pushed the market into the stratosphere. People buy a house based upon how large a mortgage payment they can carry, not the sticker price. My guess is we'll see a fairly long period of relative stagnation with some really nasty looking regional and temporary shakeouts of the bad loans, followed by another boom in the 2010s.

I'm confused here. Isn't it supposed to be the money the Chinese are lending us that's keeping interest rates low here, not vice versa? A long-term depression in the PRC would hurt oil stocks badly and would not be good for the home team's currently energy-heavy portfolio.

Posted by: bart at April 5, 2005 1:37 PM

Yes, Japan's housing market stayed down because they don't need it.

Posted by: at April 5, 2005 1:47 PM

China's oil usage has been dropping in recent months, while they've been refining enough gasoline to be a net exporter as of late. Which means their economy is either already on the downslide, or wasn't as heated as much as most of the reports indicated, and that oil right now has no reason to continue its rise, unless there's some sudden cutoff of supply or India somehow rides to the rescue to buy the $59 per barrel oil that China's supposed to be purchasing by the tankerful, but isn't.

Posted by: John at April 5, 2005 2:42 PM

Of course, all bets are off if this happens:

"China is apparently planning an “out-of-the-blue” (OOTB) attack on Taiwan, that will initially consist mainly of missiles, warplanes, paratroopers and troops out on "training exercises"."


Posted by: Rick T. at April 5, 2005 3:33 PM


Oil will drop to $5 a barrel once China is a post-nuclear landscape.

Posted by: oj at April 5, 2005 3:41 PM


Bombs away!!

Posted by: Rick T. at April 5, 2005 4:01 PM

Where the heck is Robert Duquette when you need him?

Posted by: joe shropshire at April 5, 2005 4:11 PM

Trying to dig up all the Krugerands he has squirreled away in the shelter.

Posted by: oj at April 5, 2005 4:19 PM

Oh, great, and we're buying a new house.

And we can afford it, I think. Even under the old rules, 28-33%.

Posted by: Sandy P at April 5, 2005 5:37 PM

Don't tell anyone in D.C. that Chinese oil consumption is down - their heads will explode.

If that is true, then a lot of people in the cities are going to start eating less. One more pressure point.

Posted by: jim hamlen at April 5, 2005 11:48 PM


Bravo! Don't ever place a bet (i.e. invest) based on ChiCom financial 'numbers'.


I am likewise confused. Fortunately, I pay no attention to most 'reporting' on economic matters from China.


I've stated my views herein before on Chinese debt, and won't repeat. Isn't it about time you chanelled 'X'.

Posted by: Fred Jacobsen (San Fran) at April 6, 2005 1:39 AM

I wish I could get X to send me his e-mail address. He's invaluable.

Posted by: oj at April 6, 2005 1:42 AM