Debt Views

Concerned investors are, shall we say, paying close attention to 2008 scenarios and the domino effect the home mortgage mess may have on stocks, toppling real estate, gold and the economy in general.

Sweating bullets may be more like it. Many in-the-know investors are now sweating bullets about what 2008 holds.

And rightfully so. The order of magnitude of the housing-ignited financial crisis-and its potential to widen and deepen-is far greater than the typical TV news-watching man and woman in America ever suspects. If they suspect anything at all.

So what could happen? How bad could it get? Are we in for a mere shake? Or a severe shake and bake?

Or could it, as with countless “paper dangers” in the past, somehow pass us by?

Ever see one of those domino-toppling exhibitions? Someone pushes a domino over, just one mind you, and it leads to a fascinating chain reaction that eventually topples each and every domino in the complex design. Well, if we can get away with comparing our complicated economy to one of those neat designs, here’s one domino effect that (as plausible as it may turn out to be) we hope never happens.

The Trigger Domino

Could consumer spending be the trigger domino, the one that knocks all the others over? Yes, and for good reason. American consumer spending is the engine that drives the world economy. Our enthusiastic buying of cheap imports keeps China happy, and our tanking up with ridiculously high priced gas keeps Saudi sheiks in silk.

Which may, surprisingly enough, be a very good thing since both nations (plus other Gulf States), have nearly $3 trillion in cash reserves and are, needless to say, pretty disgruntled over the direction those dollars have been heading these last few years. Threats have even been made of the nuclear option, of China and the Middle East dumping their dollars in favor of the euro and a basket of other currencies.

So far, the great antidote for that nuclear option has been the American consumer-as long as Americans are eagerly spending, China and Saudi don’t seem particularly trigger-happy. They show little interest in burying the very people who are buying their stuff.

But if that spending grinds to a halt, all bets are off.

The Fed’s Hail Mary Pass

So…what is the 2008 outlook for the American consumer? Here’s the one-word answer: Housing. With housing in historic trouble, America’s home-based “ATMs” are effectively shut down. There will be no more borrowing against the formerly lofty appraised values of our homes, not when, in some areas in Florida for example, houses are already selling for half their 2005 values.

This is serious business. The president of Wells Fargo, John Stumpf, certainly didn’t mince any words: “We have not seen a nationwide decline in housing like this since the Great Depression.” Stumpf is by no means a lone voice in the wilderness. “I’ve never seen the market as bad as this. And it could get worse,” said veteran Wall Street analyst, Ivy Zelman. Similar dire quotes could fill up this article.

The Fed’s answer to this cataclysm in the making is arguably its answer for everything else these days: cut and print. Cut rates and print more dollars. The thinking here is that cut and print will lead to even weaker dollars, subsequently cheaper looking stocks to foreigners and-the Fed earnestly hopes-an eventual rising stock market. And that would include the average Joe’s and Jill’s 401ks.

Will this Hail Mary pass work? Will stocks go up and, even with housing crashing all around us, will we be encouraged enough to keep spending until the crisis is effectively over?

Question: Do most Hail Mary passes work?

The Dreaded Domino Effect

Okay, just so we cover the bases here, let’s look at, worst case, what could happen in 2008.

In the third quarter 2007, foreclosures rose to their highest level since the Mortgage Bankers Association began keeping records back in 1972. Just as ominously, homeowners behind in their payments rose to a 21-year high. That frightening trend continues well into 2008.

With so many people either losing their homes or working at second or third jobs at McDonald’s just to make their payments, buying the latest big screen HDTV not only isn’t a priority, it isn’t even a consideration. Neither is a new dining room set, fishing boat, next-generation computer or digital sound system. These are all discretionary purchases, luxuries hard-pressed folks can do without.

Consumer spending tanks.

The Fed keeps up with its cut and print strategy but, like drugs given to an addict, it seems to have less and less effect on the markets. Maybe that’s because a credit crunch is now going on-nobody’s borrowing and nobody’s lending-not to mention the fact that banks are in terrible shape. Some estimates put their coming sub-prime losses at up to half a trillion dollars. Some estimates put it even higher than that. It’s hard to throw a party for the latest rate cut when the house is burning down.

As hoped for by the Fed, with the dollar setting record lows virtually every week, foreign money is now moving into America’s “cheap” stocks. But it’s not happening fast enough and, burdened by negative consumer sentiment, the market isn’t rising high enough. People aren’t exactly thrilled over their meager 401ks.

Meanwhile, China and the Gulf States are now getting hit with a double whammy: their $2.7 trillion in cash reserves is losing value almost by the minute, thanks to the Fed’s excessive rate cutting, AND their revenue from American consumer spending is plummeting.

Frighteningly enough, the nuclear option is now back on the table.

What happens if China and Saudi play that option? That’s another story for another day. Suffice it to say, with a floundering economy and a decimated dollar, people are desperately searching for another means of savings and exchange. Something universally accepted by both sellers and buyers, that, unlike paper money, has never, ever been worth nothing, no matter what banks or governments throughout history have tried to do.

Gold.

By that time, an ounce of the shiny stuff could be worth well over $1,000. Maybe even over $2,000 or more. Who knows? What you should know, whether the domino’s topple like this admittedly dark scenario or there’s just the chance that this could happen to you, your family, your stocks or your home, is that gold still serves as both the ultimate money and the ultimate diversification… particularly if your portfolio only contains, well, paper.