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Us Can't Avoid House Crash Or Recession

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Global stock markets seem to have calmed down a little since the rollercoaster ride of May and June - but investors are still jittery.

There are plenty of good reasons to be nervous. The global liquidity cycle is turning - in other words, interest rates are rising across the world.

The lax monetary policy of recent years has left consumers across the Western world mortgaged up to their eyeballs with wallets full of debt-laden credit cards. That means they're vulnerable to higher interest rates.

At the same time, rising inflation means central banks have no choice but to jack up rates if they want to prevent rising costs from taking hold.

These problems are affecting every country, from Australia to the UK. But the one that the markets are focusing on, of course, is the US. So what does Federal Reserve chief Ben Bernanke have in store for the global economy?

Ben Bernanke hasn't had an easy time of it in his first few months as Federal Reserve chairman. That's by no means unusual however - his predecessor Alan Greenspan had to contend with the 1987 stock market crash just two months after his appointment, while Paul Volcker faced a bond market crisis shortly after he took the Fed chairmanship in 1979.

Mr Bernanke hasn't had to face anything quite so challenging yet. In fact, you could argue that most of his problems have been of his own making. Having a casual 'off the record' chat in May with a famous female journalist about US monetary policy isn't the kind of mistake you'd expect a senior policy-maker to make - particularly when the details contradicted everything he'd told the markets just a couple of days earlier.

That gaffe sent stocks tumbling in May, and since then, the fear that the Fed would tighten 'too much' and send the US economy into recession has seen stock markets dive at the faintest hint of inflationary pressures.

But Mr Bernanke seemed to pull it together with last week’s testimony before Congress at which he suggested that the slowing economy should keep a lid on inflation. That suggested there would be no more rate rises - which cheered markets up for a while.

But now it looks as though Wall Street is starting to worry that the slowdown has already arrived. Data from the Fed's 'Beige Book’ survey yesterday suggested that inflationary pressures were moderate. But the market didn’t leap in reaction, as it might have done a fortnight ago - instead stocks were muted, with the Dow Jones ending a point lower at 11,102.

The signs are not good. The US housing market continues to cool rapidly - mortgage applications fell for the second week in a row last week, while homebuilders' confidence hit a 14-year low this month. Retail sales fell 0.1% in June, compared to May. And second quarter corporate earnings have so far been mixed, with the latest batch of disappointing results coming from internet retailer Amazon and aerospace giant Boeing.

So what can be done about it? The clamour is already building for an interest rate cut. Tom Kilgore on MarketWatch says: "Basically, unless Bernanke changes the current course of interest rates, a recession is on the horizon."

There's every possibility that Mr Bernanke will be unable to resist dropping interest rates - emulating Alan Greenspan’s trick of clearing up the fall-out from one asset bubble bursting by attempting to inflate another.

But that would leave the dollar looking very vulnerable indeed. The suggestion that US rates may not rise next month was enough to push the greenback down sharply against both the yen and the euro yesterday.

A falling dollar means imported inflation. It also means that all those foreign investors who have been lending the US money will become less keen to do so as they realise that the US has no intention of protecting their investment from inflation. That would drive up bond yields, which would in turn push up mortgage costs - so the housing market is doomed either way.

What people can't seem to accept is that it's sometimes the Fed's job to trigger a recession. You can't have a boom without a bust - it's nature's way. If we simply allowed the markets to set interest rates, then the cycle would probably be smoother - people would take fewer risks if they didn't expect an all-seeing Fed to bail them out at the first hint of trouble.

But if we will insist on having central banks, then sometimes their task is to spoil the party - to take the punchbowl away just when everyone is starting to loosen up and have fun. Unfortunately for Ben Bernanke, his predecessor Alan Greenspan preferred to spike the punch with the cheap whisky of negative real interest rates. Everyone has partied harder, and sung Mr Greenspan's praises, but now the resultant hangover will be far far worse.

And if Mr Bernanke decides to simply follow the Greenspan method of central banking and slash rates again - well we all know what happens when someone drinks far too much. They collapse - which is the most likely fate of the dollar under that scenario.

That's bad news for most investments - but to find out how to protect yourself and your portfolio from a falling dollar, click here: How to survive the dollar collapse (http://www.moneyweek.com/file/12676/how-to-survive-the-dollar-collapse.html)

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Guest Bart of Darkness

If the US enters a recession, is there any way at all that the UK could avoid the fallout?

(I'm thinking not, but the bulls on here will tell you that the UK "party" will never end, hence no hangover)

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  • 302 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?

      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%

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