Near-term home sales fell in August to a record low, according to the Associated Press. Buyers are having difficulty getting mortgages.

This is thanks to the rising cost of credit and to tighter lending procedures that now appear to be in place — a decision we feel is shutting the stable door after the horse has bolted!

In the same article, the AP wrote, some economists don't see things improving soon.

Everyone is now aware of the subprime mortgage problem and that great thought is being given to sort out the mess — a mess that still has our credit markets largely clogged.

Indeed, as my colleague David Frazier reported yesterday, in an item headlined "Greenspan Agrees with Us," former Federal Reserve Chairman Alan Greenspan says the global credit crunch in not yet over. "We're not by any means out of the woods," he said.

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In addition, as Christopher Ruddy pointed out in the September edition of our sister publication, the Financial Intelligence Report (FIR). "The dominoes continue to tumble in the CDO crisis."

In the same Publisher's Corner article, Ruddy included a chart, published by Credit Suisse Fixed Income U.S. Mortgage Strategy. It shows that the adjustable rate mortgage (ARM) reset schedule. (See chart 1 below)

The chart illustrates the monthly volume of ARM resets due to take place over the next six years from January 2007, the date of its publication.

It is a shocking picture, which we believe has serious implications for our economy.

First, it shows the ARM reset problem as a major headache for at least the first five of the next six years.

Second, it illustrates clearly that the bulk of resets are still to come, peaking over the next two years.

In other words, the subprime problem has only just started. Indeed it looks as if it could get a lot worse.

[Editor's Note:Special: Sir John Templeton Was Right. Get His Latest Insight on Housing and Markets.]

Millions of American mortgage-holders will be affected by ARM resets — all of them consumers. And we know that the confidence and continued spending by U.S. consumers — accounting for 72 percent of GDP — is vital to our avoiding a deep recession or even a depression.

Of course, if our interest rates could be brought down further, it might alleviate the problem to some extent.

But a fall in U.S. interest rates, unmatched by cuts in the interest rates of competing currencies, like the euro, could lead to still further falls in our dollar.

A weaker dollar will unleash further inflation and lead us straight into the "stagflation trap" we have long warned against.

Far more seriously, however, a weaker dollar could also erode the prestige of the vital "reserve status" of the U.S. dollar, the world's most relied upon reserve currency.

A collapse of confidence in the world's main reserve currency would, we feel, unleash a vicious and highly deflationary round of international competitive devaluations as each group fights desperately for exports.

As the recently exposed phone call between Fed chief Ben Bernanke and Citigroup Chairman Robert Rubin appears to illustrate, pressures were most probably brought upon the Fed to give us a rate cut in mid August.

Notably, Bernanke appears to have resisted, yielding only to a cut in the discount rate to ensure liquidity in the shocked, but vital, credit markets.

However, On Sept. 18, Bernanke and his FOMC appeared to "capitulate". They gave us a further 50 basis point cut in both the discount rate and in the vital "high profile" target Fed funds rate — it was a "morphine shot", which will likely trigger a run on our vulnerable dollar.

So much for the "independent" Fed!

We believe that Ben Bernanke, a student of the great crash, will be all too aware of the deeply deflationary effects of an international currency war.

We also believe that, above all, Bernanke will want to avoid a repetition of the 1931 depression.

Therefore, with the looming threat of recession or worse, we feel that even Democrat politicians may well take fright and push for the excruciatingly painful domestic discipline of a stable dollar.

[Editor's Note:Will the Liquidity Crisis Sink Your Stocks? 12 Ways to Profit.]

For this reason, we believe the chances of further Fed rate cuts in 2007 are less than most experts and the capital markets appear to think.

In light of all this, we continue in our long-held view that our more conservative readers should consider lightening their equity and long bond weightings — taking cash off the table at near-record highs — in favor of accumulating more cash, near-cash Treasuries, agricultural commodities, and gold.

Finally, we notice that the price-to-earnings (P/E) ratio discount in favor of (risky!) overseas stocks has now been bid up to parity with the similar U.S. average P/E. This indicates that the rush to diversify abroad, that we have long recommended, is now more expensive and requires yet more caution.

Editor's note:
Will the Liquidity Crisis Sink Your Stocks? 12 Ways to Profit.
Buffett Says This Book Made Him Billions
Special: Sir John Templeton Was Right. Get His Latest Insight on Housing and Markets.