ANSWER: The carry trade in the US dollar. The Federal Reserve's quantitative easing* and zero interest rate policy (ZIRP) has flooded the world with cheap dollars and driven up the stock market and prices of commodities like wheat and oil. Banks are borrowing at near zero percent interest and investing in these asset markets, sending prices through the roof. It is creating hunger and social discord in the Third World, but also ludicrous highs in the stock market. Those fully invested in the stock market, riding on the coattails of the big banks, are flush with paper wealth and are driving up real estate values in New York and in some spillover towns like Northampton, which is attracting increasing numbers of hip young urban professionals who prefer the quality of life and cheaper real estate here.

Realtors are grinning from ear to ear, but this is not sustainable. The condo market here has already collapsed and folks who bought after 2005 are now selling at a steep loss, not to speak of money lost to property taxes, mortgage interest, private mortgage insurance, and home improvements. But single-family homes have held their value and may even be rising now, with this new influx of Wall Street money.

A word to the wise: this will end badly. Hard to say when, but the movement of this hot money into food and oil and other commodities threatens not only to cripple the countries we are exporting inflation to (virtually every country on earth, since all these commodities are priced in US dollars), but also to damage the real economy here (with high oil and food prices and general inflation). What's more, hot money flows (using US dollars to buy the local currency) into emerging economies like Brazil and China and India are hyperinflating their asset markets and driving up their exchanges rates, seriously damaging their balance of trade (see several incisive articles on this by Michael Hudson, www.michael-hudson.com). And all this global turmoil (not to speak of food riots and trucker strikes over the cost of petrol) to keep real estate values in this country from falling to their natural levels!

Charles Hugh Smith and others think this may be the endgame for quantitative easing and ultralow interest rates. If it is, and Bernanke would be loathe to let this happen, real estate values here could revisit 1998 levels.

Folks buying today in Northampton will suffer huge losses if they sell into such a bust, and even if they don't, they may regret that they did not rent, as prices fall hard around them and their equity vanishes into thin air.

 

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    * Quantitative easing:  Essentially, when a central bank expands ("eases") the money supply ("quantity" of money) by creating money and directly purchasing stocks, Treasuries, toxic mortgage-backed securities, you name it. It would be printing money in another era, but most money today is credit money.

        Lowering interest rates is another form of "easing" or expanding the money supply (encouraging the creation of credit money), but once you get close to zero percent (for central bank to bank lending), you have no more magic potion in your bottle. Quantitative easing (QE) was first used in Japan and has continued to be used there since the collapse of their real estate market (and banking system in effect) in 1989. When interest rates were close to zero and the money supply was still contracting (= deflation), the Japanese central bank began creating money electronically and directly purchasing assets (both to support those markets and to expand the money supply). Bernanke turned to QE in 2008 after the collapse of the mortgage-backed security market.

      Carry trade: borrowing in one currency at near zero interest and investing in another currency (or asset) with a much higher rate of return. The yen carry trade was responsible for much of the asset inflation (real estate and stocks) in the US from 1985 on. Unlike the yen carry trade, the US dollar carry trade is wreaking havoc in global commodity markets (priced in US dollars) as well as in asset markets and currency exchange rates in the BRIC (Brazil, Russia, India, and China) countries. By using cheap dollars to buy the local currency and buy local assets, we are strengthening their currencies against the dollar and making their manufacturers less competitive in world trade. For the BRIC countries, it is an intolerable situation and they are, slowly but surely, trading with each other and with other countries not in US dollars but in the currencies of the two trading partners. It won't happen overnight, but the US is digging its own grave here. We'll see how long the Fed can continue to kick this can down the road.