The Impending Destruction of the U.S. Economy: Part 1

We U.S. citizens enjoy a magnificent and prosperous economy the rest of the world can only envy. Employment is humming along, inflation is tame, and the lines inside Starbucks (Nasdaq: SBUX  ) everywhere remain annoyingly long. Despite a number of hiccups this year, the stock market is still just a rock's throw from another all-time high. 

But we're coming up on a bend in the yellow brick road, and going 'round it could cause the party lights to go dark quickly. That could change everything about the way we and future Americans live. Sound scary? It is.

A nation built on debt?
Let's go back to the 1990s. It wasn't a bad time to be an American. Ace of Base was topping the charts, the economy was parading freely, and the stock market could make a Chihuahua look smart. With newfound wealth came newfound toys and spending habits, and a drive to leverage up to your eyeballs to fund the cars, boats, and multiple TVs for your second or third home. Since 1990, non-mortgage household debt has gone up more than threefold, outstripping economic growth and inflation.

But, heck, the amount of debt we had was not a problem! The economy kept buzzing at a pace that allowed consumers to fund their debt-laden habits. And with reasonable interest rates throughout the '90s, layering on consumption outside your earnings means wasn't that big a deal. The indulgences in spending kept going, and going ...

The music stopped. But the party's still kicking ...
It wasn't until 2000 when the Nasdaq parade came to an end that the party looked like it truly might be over. With trillions of dollars of wealth purged from consumers' wallets, the economy was startled into a justified panic.

Then as the dust around the tech bubble cleared, Sept. 11 knocked us off our feet. An uncertainty we as a nation had never experienced before loomed over our heads. Federal Reserve Chairman Alan Greenspan prescribed a quick and drastic resuscitation in the form of a massive cut in interest rates to help revive the economy. And it worked, perhaps too well.

Since 2001, the U.S. has had the benefit of laughably low interest rates. Investors, still shell-shocked from the stock market turmoil, began salivating over another asset class they could exploit with those low rates -- real estate.

Savvy businessmen finessed ways to market exotic mortgage products to consumers most of us wouldn't lend a cup of sugar. Thus the birth of the subprime-mortgage calamity that propelled companies such as Countrywide (NYSE: CFC  ) into the stratosphere and allowed homebuilders such as Beazer (NYSE: BZH  ) and D.R. Horton (NYSE: DHI  ) to crank out as many subdivisions as they could dream of.

I'll save you the ending of this real estate saga -- we know how much of a mess we're in now. And it's probably worse than any of us could have dreamed, with massive write-downs from respected financial institutions, such as Citigroup (NYSE: C  ) and Merrill Lynch (NYSE: MER  ) .

What now? Many of us would like to believe Uncle Bernanke will bail us out by slashing interest rates and bringing back the good old days. Right?

Kind of -- and that's where the massive economic debacle begins, my friends. Those same spend-happy consumers raised in the go-go 1990s -- they're still alive and kicking, and you better believe they still love to spend.

Dollar, schmollar ... I'm gonna spend!
The massive account deficit we currently hold with the rest of the world totals some $800 billion per year. Where the heck is all that money coming from? From foreign investors in China, Japan, the Middle East, and nearly every other conceivable corner of the globe. They have no problem lending us the difference, because while we as a country spend more than we make -- we're still incredibly wealthy and good on our word.

But like a massive Ponzi scheme, the fun will certainly end. In the past six years, the value of the dollar has taken a serious beating. The euro, worth $0.85 a few years ago, is now worth $1.47. Yikes. But because the average American shops mostly within the borders, this probably isn't too pressing an issue, and so the greenback's plummet doesn't show its full effects.

How about the foreign investors funding our perilous spending party? You'd better believe they're keeping a close eye on the dollar's precipitous plunge. As a foreign investor holding assets denominated in dollars, every drop in the dollar erodes the value their investments will be worth when they choose to convert them back to their native currency, whether yuan, yen, euros, or pounds.

How do we keep our foreign investors happy? With a rapidly depreciating currency, there is but one way to keep them enticed: higher interest rates. You heard it: higher interest rates. With the housing and credit markets swimming in turmoil, the idea of higher interest rates sends shivers down the backs of homeowners facing foreclosure, and rightly so.

I think you can see the predicament we face: One part of our economy demands lower interest rates to bail out the housing debacle, and foreign investors who finance our massive spending habits demand higher interest rates to forestall the dollar's demise.

My goodness, this is looking scary. What will happen next? More importantly, what's a Fool to do?

Check back later this week for part 2 of the "Impending Destruction of the U.S. Economy."

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