There has been lots of bad news coming out of the US of late. And top of the bad news pile is the US housing market. Recent analysis on Moodys.com has predicted that 20 metro areas, out of 379 across the US, could see property prices crash, or at least fall by more than 10 percent. Furthermore, the report estimates that around 100 areas face the significant probability of experiencing declines within a year.

The typical US citizen is far more indebted than the overstretched Brits, and it is felt that a US housing market slowdown poses a much greater threat to Uncle Sam’s economy than a similar slow down in the UK.

And yet, markets celebrated the last couple of months of 2006 by spending, with the Dow hitting new highs with almost tedious regularity.

There seem to be two reasons for the good performance. Firstly there is oil. The latter half of 2006 saw sharp falls, at one point dropping to $20 lower than the level hit in July.

oil

Then there is, perhaps, a deeper reason. Company valuations relative to forward profit projections are at a ratio of just 15, compared to typical ‘PEs’ of 25 back in 2000.

The falling price of oil is causing celebration for two reasons. Firstly, cheaper oil means we are better off – of course it does. Secondly, cheaper oil should means lower inflation, meaning lower interest rates, meaning the housing market could be off the hook. But here, we could be seeing the biggest economic fallacy of the last few years. Maybe, the link between oil and inflation, not to mention the link between cheap imported goods and low inflation, is a false link – at least in the long run – and economic policy has been flawed.

And to find out why, read below

Article first written by Michael Baxter on 4 October 2006

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