-- Posted Thursday, 13 October 2005 | Digg This Article
Rick’s Picks
Thursday, October 13, 2005
For investors who’d rather be smart than lucky
I’ve covered the markets and specific securities on the paid-subscriber pages, providing some key supports for crude oil as well as guidance for the short positions we hold in Citi and the Diamonds. In today’s commentary, I’d like to continue our dialogue on deflation by responding to some of your letters. The first is from Jas Jain, a friend and provocateur, as well as one of the few hard-core deflationists in the bear camp. As you will infer from his comments, Jas makes me look like a Pollyanna. His observation were prompted by the following comment from a mutual friend concerning the housing bubble:
“Along with the passage of the more restrictive bankruptcy bill, the Fed flattening the yield curve, higher energy bills, shrinking home equity, and the Boomer-led demographic drag, the timing of reducing the mortgage interest deduction could not be better to coincide with the abrupt end of the property bubble and associated slowdown in consumer spending.”
Jas replied as follows:
“A few corrections and additions, B___.
- The Fed may be trying to only flatten the curve, but the curve wants to invert. And it will.
- Home equity will not only shrink, it will be negative for 50-60% of the ‘homeowners’ who have a dead-hand (the literal meaning of mortgage!) over their roofs. The need and the desire for refinancing will disappear even as long-term rates fall below 3%.
- You mean Doomers-led, don't you? The thinking of ‘educated’ – I mean, thoroughly brainwashed -- Baby Doomers on the subjects of political systems, economics, and investments has doomed Americans for misery not experienced in centuries. All that Greenspan has done is to postpone the disaster and make it far worse than it had to be. Any American who has faith in continuous government intervention must be a moron.
- As to mortgage deduction, it won’t be necessary if one can't pay the mortgage! Many will have no means, or no incentive, to make the mortgage payments once the housing prices collapse. Our merciful government will take over most of the homes with mortgages and rent them back to the previous ‘owners.’
- Only a ‘slowdown’ in consumer spending? How about a sharp drop? Does a 40% drop in consumer spending, from peak to the trough, sound about right? No, no government will be able to prevent that; unless it means making it worse and worse for longer and longer.
Baby-Doomers
“Wait and watch as the most memorable period in U.S. history unfolds right in front of our eyes. Doomers are totally unprepared. And so are the rest in the U.S. and outside. The price must be paid for the stupidity of letting the Bankrupters and Fraudsters of New York City take control of the global economy. The ‘Saviors of the World Economy’ were in reality agents of Satan.”
Thanks, Jas. I would add only that it would not take a collapse in real estate prices to push the economy into a downward spiral, only a small downtick in prices. That will turn nominal mortgage rates of 5.75 percent into 7 to 8 percent real. For perspective, try to imagine how hard it would be for you to make a real return of 7 to 8 percent. These days, even the hedge funds aren’t achieving those levels.
A subscriber identifying himself only as “Tom” asks the following:
“I have been wondering for quite a while about what it would look like if the scenario you present about deflation and/or a collapse comes to pass. It appears you may be the only one who has the courage/knowledge to offer an answer, so please help. If such an event as you propose -- and I agree with you -- does occur, how does each citizen function monetarily? Is this mainly a warning for those with large debt, or will those with little debt and good savings be affected? You say hard cash will be safe. Cash in banks, or cash on hand? Why will we ‘all go broke’ as I believe you’ve stated? What does that mean actually in day to day activity? What happens to money in savings? Does it disappear because banks won’t allow withdrawals, or does it actually become virtually worthless? Or do I have that all wrong?”
All Debts Repaid
It all goes back to the late C.V. Myers’ dictum, that ultimately, every penny of every debt must be paid – if not by the borrower, then by the lender. This implies that, even if we walk away from our debts, creditors will get stuck with the bill. In other words, someone will have to pay. If hyperinflation is attempted to ease the burden of debt, then savers, including all bond holders, will be destroyed. But if the economy is allowed to deflate, then debtors and creditors will share the pain in whatever proportions it is meted out by the bankruptcy courts. The “virtue” of deflation is that it will at least leave the institutional conduits of lending intact, and the bond markets will continue to function, more or less.
Those who have lived – and borrowed – modestly obviously will not get hit nearly as hard as those who have lived large by borrowing. The main threat to the little guy will be
the possible loss of his job. Mortgage foreclosures and the decline in home prices will track unemployment numbers more than anything else, so don’t expect real estate prices to collapse until millions of people are thrown out of work.
Concerning what sort of money you should hold, there would seem to be only a few possibilities: junk silver and physical gold; and actual currency, in coins and bills.
Simple Definitions?
Here’s a note from Selwyn S.: “There are always some items inflating and other items deflating. Whether there is inflation or deflation depends on what you want to buy. For example, if you want to buy computer memory, processing power, or a digital camera, there is deflation. But if you want to buy gas, oil or firewood, there is inflation.”
As I’ve pointed out, the economy of real goods and services is puny compared to the financial economy. Global GDP is less than $40 trillion, but debt instruments in play total more than six times that in face value. Forget about the price of consumer tchochkas. It is an implosion of a $250 trillion debt edifice that we are concerned about. That will cause the prices of all goods and assets to fall simply because there will be less money around to buy them, and precious little credit.
Here’s one from John Dees:
“I have just read ‘Deflation's Revenge on Illusory Wealth,’ which was published as guest commentary at Prudent Bear.com. I am looking for someone who sells answers other than the current 'everything-will-work-out-fine' refrain. However, I’m puzzled by the following statement: To put it as bluntly as I can, I believe there is a more-than-negligible chance that we will awaken one morning to a financial cataclysm that has left us all flat broke – meaning, for one, bereft of liquid savings that could conceivably be exchanged for bullion. Does this intend to mean the banks are empty? That cash has been wiped out? If so, what possible investment device could [you] be advocating to ‘avoid’ being broke in this scenario?
Funny Money
Even if the banks are “full,” it will be with money that no longer has any fundamental value. This is not speculation, but rather an in-your-face fact that not one person in a thousand seems to understand, at least not yet. That doesn’t mean that hard cash will cease to function in a barter economy, only that it will have to work without the help of credit steroids. Concerning how to avoid being ‘broke,’ the only bomb-proof answer is to become self-sufficient in food, water and energy. A friend of mine who lives in the Southeast has been working toward this goal for more than a year. He and a group of friends have bought and developed what might be described as a high-end commune, and they have been working diligently to provide for all of their conceivable needs.
A related question, from Roger L.:
“After reading your piece on deflation and its possible effects on cash, I was confused. You implied that gold would be a lesser valued asset than cash. I understand that an ounce of gold might be tough to get change for at McDonald’s, but it is a valued asset. In an inflationary crash, wouldn't cash dollars be around in abundance, so that the trip to the store would involve the question of one wheelbarrow or two to carry the money?
The gold-for-hamburgers problem should not be underestimated. Even if you are exchanging currency for bullion, the transaction ultimately leads to something you need even more than gold. It is this fact that could keep a lid on the price of gold. As I’ve implied above, junk silver could turn out to be the exchange medium of choice.
No Repeat of 1923 German
Meanwhile, I don’t see a repeat of the 1923 German hyperinflation. In the first place, the German government chose this ruinous course – one, I might add, that can only precipitate out as deflation – mainly to end-run onerous reparation payments demanded of Germany after the First World War. Secondly, unlike the dollar, the Reich mark was never the world’s reserve currency. No currency with the global importance of the dollar has ever been hyperinflated, and the very size of the dollar reserves held by foreign governments argues against our even contemplating such a course.
But, as I have pointed out here many, many times before, hyperinflation even if tried would not be the answer, or even an answer. By definition, it is unsustainable, and few are even arguing that hyperinflation would not wreck the global financial system. And you can forget about Ben Bernanke’s printing-press blather. Monetization may have been adequate in times past, when just a little stimulus was needed to push the economy out of cyclical recession. But this time around we will face a secular disaster that has been building for two generations. This suggests that the amount of debt that would have to be monetized is beyond the reckoning, not only of “Printing-Press Ben,” but of all the central banks acting in concert. Also, keep in mind that, other than shoveling $100 bills out of helicopters, there is no way to put that money in the hands of consumers unless they borrow it. That will require massive collateral – i.e., an asset class that can be inflated. Unfortunately, we have already used up the biggest class of assets we’ve got – housing -- just to keep the economy marginally afloat.
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Information and commentary contained herein comes from sources believed to be reliable, but this cannot be guaranteed. Past performance should not be construed as an indicator of future results, so let the buyer beware. Rick's Picks does not provide investment advice to individuals, nor act as an investment advisor, nor individually advocate the purchase or sale of any security or investment. From time to time, its editor may hold positions in issues referred to in this service, and he may alter or augment them at any time. Investments recommended herein should be made only after consulting with your investment advisor, and only after reviewing the prospectus or financial statements of the company. Rick's Picks reserves the right to use e-mail endorsements and/or profit claims from its subscribers for marketing purposes. All names will be kept anonymous and only subscribers’ initials will be used unless express written permission has been granted to the contrary. All Contents © 2005, Rick Ackerman. All Rights Reserved. www.rickackerman.com
-- Posted Thursday, 13 October 2005 | Digg This Article
