U.S. economy poised for nose dive*

Major recession feared when 'liquidity bubble' bursts

Posted: April 21, 2007

As the dollar sinks to near-record lows against the euro and the British
pound, the stock market has returned to record highs, but investors are
being advised to anticipate a worldwide downturn and the U.S. economy
may have already entered a recession.

An explanation may be found in a private investment letter published by
the Carlyle Group to its "professional investors."

A copy of a Jan. 31 letter by the Carlyle Group's founding partner and
managing director, William E. Conway, Jr., to the firm's investment
professionals worldwide.

In the letter, Conway attributes the continued rise of world stock
markets to a glut of liquidity in the world financial system, which he
describes as "the availability of enormous amounts of cheap debt."

Conway writes, "This cheap debt has been available for almost all
maturities, most industries, infrastructure, real estate and at all
levels of the capital structure."

He says there is so much liquidity in world financial systems that
"lenders (even 'our' lenders) are making very risky credit decisions."

Previously reported concern that the decision of the Federal Reserve to
quit publishing a traditional index, "M3," a broad measure of the money
supply, signaled a decision to pump the economy with excess liquidity.

Since the Fed quit publishing M3 data, economists who have attempted to
re-create the index from other available data have estimated M3 data
would today be reporting upwards of a 10-percent increase in the money
supply, a high level by historical standards.

"Liquidity" is defined by economists as money available in all forms to
be given out as debt, ranging from credit card debt to mortgage debt to
large quantities of institutional debt typically used in complex
financial transactions such as highly leveraged corporate acquisitions.

Excess liquidity, as reflected in the rise of highly leveraged hedge
fund accounts, has been widely seen as a major factor in the rise of the
stock market in the recovery since 9/11.

Conway cautions that "this liquidity environment cannot go on forever."
He warns that "the longer it lasts, the worse it will be when it ends."

Looking on the bright side of what could be a major recession when the
liquidity bubble bursts, Conway advises, "And of course when [the
liquidity bubble] ends the buying opportunity will be once in a lifetime."

He adds, "But I do not know when it will end."

Bob Chapman, who publishes a bi-weekly Internet newsletter, The
International Forecaster, has issued his reconstructed M3 estimate
to100,000 subscribers.

"The world is awash in money and credit," Chapman said. "My numbers show
M3 increasing at about a 10-percent rate right now."

Chapman has spent 45 years in the finance and investment business,
including 28 years as a stockbroker specializing in gold and silver
shares. He publishes his newsletter from an undisclosed address outside
the U.S.

In his April 14 newsletter, Chapman wrote, "The effort to save the
American economy, which began in 2001, has finally come full circle and
the Ponzi scheme is coming unraveled. The overextension of credit,
outrageously low interest rates and loans to the totally unqualified
have finally come home to roost."

For months, Chapman has been warning that the U.S. economy entered a
downturn in February 2006. Chapman expects it will develop into a
prolonged recession caused largely by the bursting of the housing bubble
and the weakness in the dollar attributable to the United States' large
federal budget deficit and international trade imbalance.

At the same time, Chapman has been predicting for months that the dollar
will challenge the technical support point of $USD 80 on the world
currency markets.

On Thursday, the dollar index closed at $USD 81.64 in a steady decline
that began at the end of February.

The euro late last week was trading as high as $1.3576, near its
December 2004 record of $1.3539. At the same time, the pound rose to
$1.9938, its highest point since September 1992. The pound last reached
the $2 mark 14 years ago, when the UK was ousted from the European
Exchange Rate Mechanism.

Chapman has argued the U.S. Treasury and Federal Reserve have been
trying to manage a gradual devaluation of the U.S. dollar.

Chapman expects the dollar could lose as much as an additional 20
percent of its value this year alone. In the last five years, the dollar
has lost 35 percent of its value against the euro.

Still, until debt defaults force a crisis in the world debt markets,
Chapman agrees with the Carlyle Group that excess liquidity will
continue to buoy the world stock markets, including the New York Stock
Exchange, to new highs.

Chapman also agrees with Conway that when the liquidity bubble bursts,
the decline in world stock markets could be sharp and severe, possibly
even reaching crash magnitudes on the downside.

"Tens of billions of dollars have already been lost in the U.S.
sub-prime lending market and the contagion is spreading as the media
tries to cover-up what is really going on," Chapmen wrote in his March
28 newsletter. "We are watching the disintegration to an extent of the
entire mortgage market, which encompasses 25 percent of all outstanding
credit."

Chapman continued: "We predicted this three years ago and those who
believe they are savvy discovered the problem a couple of months ago.
This is a general meltdown and do not think it isn't, and it has several
years to go until the real estate sector is purged."

The Carlyle Group, a large Washington, D.C., private equity firm
headquartered founded in 1987, has close ties to the administration of
President George H.W. Bush.

The Carlyle Group has established a new team to invest in Mexico. The
team includes Mark McLarty, president of Kissinger McLarty Associates
and former chief of staff and special envoy to the Americas for
President Bill Clinton.