Four big stories topped this week's economic news: Fannie and Freddie, oil finally dropping, high inflation, and banking turbulence. None of them are too comforting to discuss, especially when so many people's well-being relies on them.
I'm reminded of a quote from Berkshire Hathaway (NYSE: BRK-B ) co-chairman Charlie Munger, from a speech he gave while discussing what he calls his multidisciplinary approach. When you drill down to the basics of subjects, Munger said, you "realize everything is so damn interconnected."
Fair enough. Let's see how this week's four major economic news events are all interconnected.
Fannie and Freddie might become your business
I hate to drown in hypotheticals, but let's go out on a limb and assume that government-chartered mortgage behemoths Freddie Mac (NYSE: FRE ) and Fannie Mae (NYSE: FNM ) need some sort of bailout involving widespread government intervention. If -- and again, I said if -- the government had to take control of these organizations, the $5 trillion in mortgages they own and guarantee would presumably be transferred onto the books of the U.S. of A. That's an awful lot of potential liability -- more than $15,000 for every citizen -- and if a lot of that paper turns out to be bad, it could cause the budget deficit to balloon, putting substantial downward pressure on an already beaten-down U.S. dollar.
More oil, please
In case you haven't noticed over the past several years, let's remember what happens when the value of the dollar plummets. First, it makes you feel like a peasant when traveling abroad. Second, it increases the price of worldwide commodities priced in dollars -- particularly oil.
On its website ExxonMobil (NYSE: XOM ) states, "From January 2002 to March 2008, the price of Brent crude increased in nominal dollar terms by about 430%, compared to about 200% in euros." Behind the argument over who's to blame for oil prices -- Big Oil, speculators, consumers, whomever you choose to blame -- lies an inconvenient fact: The value of the dollar has a huge impact on the price of oil, and the dollar is worth a lot less than it was in the past. Give it a good catalyst to fall even more, and, well, I'll let you ponder the consequences.
The inflation nation
Moreover, oil isn't the only burgeoning nightmare. Wednesday brought news that inflation at the retail level grew at the fastest pace in 26 years, with food prices joining energy as major contributors to the rise. Meanwhile, wholesale prices surged 9.2% in the past year -- 1.8% in the last month alone. I don't need to remind you that inflation is threatening the economy in ways we haven't seen in years, if not decades.
No worries there, though. As anyone who believes what they learned in Econ 101 will tell you, there's an easy tool to zap the chains of inflation: Just raise interest rates. As rates rise, lending becomes more expensive, which puts the brakes on consumers and businesses who had access to as much cheap money as they could get their hands on.
Phew! So that whole inflation thing isn't a big deal. Just raise rates and the economy returns to bliss … right?
Don't bank on it
The other big news of the week involves the ongoing turmoil in the banking sector. IndyMac went belly-up last weekend. WashingtonMutual (NYSE: WM ) and Bank of America (NYSE: BAC ) saw enough volatility to give an astronaut vertigo. Meanwhile, the Federal Reserve reported that its emergency bank lending window, which gives investment banks like Goldman Sachs (NYSE: GS ) and Morgan Stanley the ability to draw funds at 2.25%, has regained popularity.
Despite some good news from Wells Fargo this week, many banks are already struggling to tread water as it is. With banks' profits reliant on the difference between the low short-term rates they pay for capital and the higher long-term rates they earn on loans, jacking up interest rates could well be the last straw that sends some struggling banks into a black hole, some mediocre banks into bankruptcy, and even some strong banks into disorder.
Connect the dots
There are four problems hanging over the economy like the sword of Damocles. Each might seem detached from the others, but when it comes down to it, they're all connected in one way or another. To solve any of them for good, we'll eventually have to solve them all.
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