It seems as if we're entering a calmer period in the market place and will most likely be in that period for the foreseeable future. The Fed and treasury have effectively taken the financial system collapse off the table with their recent actions of nationalizing every bank and now looking to continue purchase trillions of dollars in toxic debt.
The underlying debt that they are purchasing will continue to lose value as home prices fall, credit card, student loan, and auto delinquencies rise, and corporate debt defaults. With the "no one fails" system in place, it will take trillions more to cover the continuous losses that will pour in over the next year. The money needed for the continued bail outs will come from printed money from the Fed and borrowed money from foreigners.
This will continue until the United States as a nation collapses under its own debt and declares bankruptcy. How long will this take? Probably at least another 12-18 months. During that period we will continue under the same macroeconomic paradigm that we have for the previous 20 years. That is the rest of the world living below their means, saving, and producing goods that they send to us. We then purchase those good with borrowed money from them and now printed money from the Federal Reserve.
Most economists feel this will continue on for many years into the future because our debt to GDP ratio is still very low compared to most other countries. What they fail to realize is that 72% of our GDP is consumption which is going to vanish without the ability to borrow. This is happening as we speak with home equity lines being pulled across the board, and news this morning of credit card companies pulling back $2 Trillion in credit lines.
When Americans are no longer able to borrow and spend the system will begin to break down. Our GDP will then collapse and be seen for what it really is which is just smoke and mirrors. Foreign countries will then see our debt levels at their true horrific values, and proceed to slowly cut off our credit lines. This will leave only the Fed as the money source of last resort. At this point the Fed will be buying treasuries, mortgage securities, credit card debt, student loans, and auto loans. Trillions and trillions and trillions will continue to enter the system.
Somewhere during the year 2010 the house of cards will begin to topple and we'll begin to experience a hyperinflationary depression. In the near term, however, I expect to see the recent trillions of dollars entering the system to continue to have a calming effect on the markets.
Under the surface, however, the losses will be real and continue to grow. They will just be temporarily covered with printed and borrowed money, but as the great Warren Buffet has said, "once the tide goes out you'll be able to see who was swimming naked."