Inflation, It's There Somewhere

We went to Berkeley last week to see where my son will be going to college. The two pictures below are of a parking meter that was a block from the campus.

Notice the rates in the second picture. Two minutes for a nickel and a dime is good for 4 minutes (minimum transaction is 30 cents). The thing that surprised me was that it also accepts credit cards. Three of the cars parked in front of this "Revenue Raising Tax God" had handicapped tags swinging from the rear view mirror. If you're handicapped, you don't have to pay. Notice the bicycler chained his bike to the machine.

You have to wonder about this 12 minute minimum charge. The nearest public restroom is a 6 minute walk (if you know where it is).

30 years ago, a quarter would have bought an hour of time on the meter. Now it buys 12 minutes. So the quarter buys only 1/5th of what it used to. Put another way, our dollar has lost 80 percent of its value in 30 years.

The dollar's devaluation has been very gradual and spread out over time. California is about to raise the state sales tax to around 10%. If you study history, you'll notice that the sales tax was started during the Great Depression as was Social Security. These two taxes are approaching absurd levels and now we will face a health care tax.

Here we sit arguing over whether or not we are going into inflation or deflation and the real question is; have we had enough of incompetent government yet? The Mayor of Bell California was getting $787,000 until it was put in the press. The price tag for running a photo red light in California is $400, thats enough to start a divorce among young newlywed couples.

I would like to suggest that the reason we haven't seen any inflation is because of the obscene salaries of many people, they can't spend it that fast so they put it in the bank. As long as it is in the bank, there is no inflation effect, if the bank can't find anyone credit worthy to loan it to. Of course the little people like you and me don't have to worry about how to keep $250,000K FDIC insured in a bank (we don't have it to begin with).

Bernanke's goal is to stave off deflation. It's kind of like him going into a "house of ill repute" and slashing rates 50% and claiming it will bring in more business. He's right, but he's wrong. You'll get more business, but it is business you never wanted to see in a lifetime. Common sense rules when you have to work for a dollar the hard way. It is a shame that the government doesn't do it's COLAS off of hooker revenue. Minimum Social Security might approach 100K a year.

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It's Never Been This Bad Before (Reprinted)

I've been on vacation the last 10 days. This is a reprint from January 16, 2008 that is worth a second look.

Here is a little bit of history. It gives you an insight into real estate during the Great Depression from people who lived through it. Quoted from: http://xroads.virginia.edu/~HYPER/ALLEN/ch11.html

By 1927, according to Homer B. Vanderblue, most of the elaborate real-estate offices on Flagler Street in Miami were either closed or practically empty; the Davis Islands project, "bankrupt and unfinished," had been taken over by a syndicate organized by Stone & Webster; and many Florida cities, including Miami, were having difficulty collecting their taxes. By 1928 Henry S. Villard, writing in The Nation, thus described the approach to Miami by road: "Dead subdivisions line the highway, their pompous names half-obliterated on crumbling stucco gates. Lonely white-way lights stand guard over miles of cement side- walks, where grass and palmetto take the place of homes that were to be .... Whole sections of outlying subdivisions are composed of unoccupied houses, past which one speeds on broad thoroughfares as if traversing a city in the grip of death." In 1928 there were thirty-one bank failures in Florida; in 1929 there were fifty-seven; in both of these years the liabilities of the failed banks reached greater totals than were recorded for any other state in the Union. The Mediterranean fruit-fly added to the gravity of the local economic situation in 1929 by ravaging the citrus crop. Bank clearings for Miami, which had climbed sensation- ally to over a billion dollars in 1925, marched sadly downhill again:

1925.............................$1,066,528,000
1926................................632,867,000
1927................................260,039,000
1928................................143,364,000
1929................................142,316,000

And those were the very years when elsewhere in the country prosperity was triumphant! By the middle of 1930, after the general business depression had set in, no less than twenty-six Florida cities had gone into default of principal or interest on their bonds, the heaviest defaults being those of West Palm Beach, Miami, Sanford, and Lake Worth; and even Miami, which had a minor issue of bonds maturing in August, 1930, confessed its inability to redeem them and asked the bondholders for an extension.

This next bit discusses the dire straights of many states in 1933: Pg 285 America’s Great Depression by Murray Rothbard. Quoted from Agricultural Discontent in the Middle West, 1900-1939,Wisconsin Press 1951 p.448

As in most depressions, the property rights of the creditors in debts and claims were subjected to frequent attack, in favor of debtors who wished to refuse payment of their obligations with impunity. We have noted the Federal drive to weaken the bankruptcy laws. States also joined in the attack on creditors. Many states adopted compulsory debt moratoria in early 1933, and sales at auction for debt judgments were halted by Wisconsin, Iowa, Minnesota, Nebraska, and South Dakota. Governor Clyde Herring of Iowa asked insurance and mortgage companies to stop foreclosing mortgages. Life insurance companies protested that they were being very lenient, yet in many areas the courts would not enforce foreclosures for insurance companies, enabling many borrowers arrogantly to refuse to pay. Minnesota forbade foreclosures on farms or homes for several years.

So we can say without a doubt that we have never seen anything like this, but it did happen here about 78 years ago. We could be on our way to an experience of a life time. Are you ready?

We Have Been Here Before (Reprinted)

Reprinted from 2/1/07.
Today we read that the savings rate in the US has dropped to a negative one percent. It is also mentioned that it hasn’t been this bad since the Great Depression years of 1932 and 1933. The following is an article from way back when, that appeared in the Saturday Evening Post, CCV (November 5, 1932), pp. 3-4 titled" What about the Banks." It was written by Frank A. Vanderlip, former president of the National City Bank of New York. Bear in mind that 1932 was three years into the Great Depression. So if we carry forward to today, this would have appeared in the future year 2012. So we are not really where he was at, when he wrote this.

The present economic disturbance has been so severe that it as make even some changes in our language. No longer is it an apt metaphor to say that anything is “as safe as a bank.” The word “securities” has almost become obsolete. An investment that drops in price to a tenth or, perhaps, even to a twentieth of its former range is not a security; it is a jeopardy. The page of stock-and-bond quotations might well be headed Quotations of Risks and Hazards. To call them securities in the light of their fluctuations is ironical.

In 1720, a financial debacle added to the English language a phrase which has persisted in common world-wide use for two centuries. A hopelessly exploded financial venture is to this day called a South Sea Bubble.

The South Sea Company in its time was the rival of the Bank of England. It was the ambition of the Tories that it should supplant the Bank of England. When the bubble burst, the extreme decline in the price of the stock was from 1,000 to 135. The company withstood the shock, however and continued in business for eighty years.

Here is an example from out own times: United States Steel and General Motors stocks, the two leading industrials of the country, declined from the high quotations of 1929 to 8 per cent of that price. The decline in the stock of the South Sea Company was only to 13 ½ per cent of its highest quotation. Take another: The stock of what has long been one of the premier banks of the country declined from 585 to 23 ½. That is to say, it fell to 4 percent of its highest quotation. The decline in the market price of this great American banking institution was therefore more than three times as severe as was the fall in the stock of the South Sea Company.

That illustration is by no means a unique one. There were innumerable American bank stocks which made a more distressing record. Between October 1, 1929, and August 31 1932, 4,835 American banks failed. They had deposits aggregating $3,263,049,000. . . . .

The decline in the price of bank stocks was only a minor phase of our debacle. The quoted value of all stocks listed on the New York Stock Exchange was, on September 1, 1929 $89,668,276,854. By July 1, 1932, the quoted value of all stocks had fallen to $15,633,479,577.

Stockholders had lost $74,000,000,000. This figure is so large, that not many minds can grasp it. It is $616 for every one of us in America. It is, roughly, three times what we spent in fighting the World War (WWI). . . . . . .

Not only did our investments shrivel in the last three years but we even frequently lost our pocketbooks. Cash in hand, left for safekeeping in a bank, often went the way of our investments, and worse. Almost $3,000,000,000 of our daily-used cash funds were sequestered in the doubtful assets of the 4,835 insolvent banks. Widespread communities were left with only the mattress as a safe depository, and with little to put into it. People became so frightened in regard to the safety of the banks that they locked up in safe-deposit vaults, or secreted elsewhere, more than $1,500,000,000.

In the Great Depression there was a very good reason for feeling negative about life. The interest only mortgage loan had ruined many banks. If you had any money invested, it was probably gone by then. Age 65 ready to retire, it must have been very depressing to some.

This bit of history was full of pain, the players from that era are just memories. The show will play again and we will be the actors upon the stage. The trouble is, we are not willing participants.

Invisible Inflation

Some prices seem to be declining, and others are increasing. So if one looks for inflation or deflation, it doesn’t take much searching to find an example to fit either argument. There are two different things happening here. One group of items that have been produced for retail sale, are also being resold by end consumers to raise cash. When you have consumers reselling into the market against retailers, prices will drop. The second group of items is pretty much just for consumption without a resale option. These prices are rising dramatically; food, beer, cigarettes, gasoline, drugs, and health care.

With prices rising the consumer has a choice, pay the higher price or switch to an off brand or generic. Blue Goose Vodka at $35 a liter doesn’t have quite the bang of a generic 1.75 liter bottle of the store brand at $10. Of course, then there is the nagging sleight of hand trick where the product size gets reduced and the price stays the same. The family size bag of potato chips now fits in a lunch box.

It’s not hard to notice the decreased consumption of optional goodies; cable, cell phones, internet, the second car, eating out at restaurants. This decreased consumption has a peculiar effect on public utilities. If everyone decreases their water consumption, water bills increase (this happened in our area). Why? Every company has fixed costs that don’t decrease when consumption decreases. With government services, the costs will increase or stay the same, even though they lay off police, firemen and teachers. You get less, so you’re really paying more for it.

What we are going to see from here in the coming year, is a concentration of thought, on how to enjoy our lifestyle by spending less. By shopping more carefully we get better prices from everyone. Some of us know how to do it, the rest of us will learn by going hungry now and then. The real question to ask is, are we able to buy more with our paycheck (deflation) or less (inflation)?

If you buy the premise that Bernanke and the Federal Reserve are saving us from deflation, then you’ve bought into the assumption that printing all these dollars is good for the economy. If you buy the premise that raising the national debt level passes these costs on to our kids, you have bought into the assumption that it’s free for now, and you’ll struggle with the morals of this despicable act of passing our debts onto future generations. If you reject both, you realize that we have a debt problem that will never make it to the grandkids. Our government has borrowed every penny in our banks and spent it.

One of my readers (Rob) commented that the candy bars he purchased had gotten smaller. My half gallons of ice cream are now 1.75 quarts and they take up more space in the freezer. The gallon bottles of ammonia for a dollar are now half gallons. If you have gotten on an airliner lately, there is a new seating section called “cattle class.” What is happening to us is almost invisible. It is a little like sawing a quarter inch off of Grandpa’s walking cane every week; sooner or later, he’s going to catch on. Old Ben Bernanke might convince Grandpa that he’s growing taller and sell him a new cane.

This Great Depression is Different

During the Great Depression of the 1930’s the banks, trust funds, and stock market lost 90 percent of their value. If you had a thousand dollars saved up or invested back then, you were left with one hundred dollars. If you lost your job there was no unemployment or Social Security. Deflation became a very serious issue; nobody had any money left to speak of. If you had been living paycheck to paycheck, all you could lose was your job (a rather anemic understatement).

March forward to today. No depositor has lost a dime in the banking system. All of the foreclosures will be bought by the government. Unemployment is collectible for two years. There has been no 90% loss of savings. The government has printed dollars to cover all bank failures.

Millions of people are collecting unemployment and not producing anything, but they are consuming product using their government check. At the same time, tax collection revenues have been decreasing at an alarming rate while government expenditures have been increasing geometrically.

Our government has no increased tax revenues coming in unless you count the new health care. They are printing money to pay the bills. At some point this leads to inflation. Deflation cannot happen, everyone has their dollars. The unemployed are consuming the products we savers chose forego, when we deposited our money in a retirement account. Our savings were a way to defer consumption into the future.

As long as retirement redemptions are minimal, inflation does not even enter the picture. The product produced matches the printed dollars spent. We will see inflation when the baby boomers decide to spend some of their deferred consumption.

The Economic rhetoric from Bernanke claiming his actions will save the country from a deflationary spiral, is pure nonsense. The Emperor is wearing no clothes, claiming otherwise changes nothing. Inflation is the name of the game, and hyper inflation is our destination. It cures all of Fannie Mae’s and Freddie Mac’s problems. They don’t have to mark down to market; they get to mark up to market.

At one point the government had a choice of deflation or inflation to solve this bubble. If we had done nothing, we would have had the 90 percent haircut and deflation just like the 1930's did. We chose to solve the problem differently with a printing press.

What’s it mean? The government can’t stop the inevitable; they can only slow it down. Our dollar will be the new dime of the 21st century. We still get the 90 percent haircut. The money borrowed was squandered on consumption. It is gone, it can't be undone. This is not something that can be reversed with a printing press. The government is only increasing the number of dollars chasing a decreasing inventory of product.

Where to from here? 15 trillion in debt and we have a President who keeps on saying “We are not out of the woods yet.” If you owe 15 trillion dollars, why get out of the woods? Stay there and hide!

Robbery Royale at Fannie Mae

Karl Denninger of the Market Ticker had a bit today on Fannie Mae giving everyone the green weenie. It’s worse that what he stated. Fannie Mae has a delaying tactic. They have a deed for lease program where you can rent back your property from them at the current market rental rate. Here is a Link. So, instead of a walk away home that gets stripped, you have a home that is being lived in by the previous owner. The lease is for one year and that could extend for many more if you read the tea leaves.

This program delays real estate from hitting the market in the form of a foreclosure. The inventory is eased into the market gradually instead of all at once. This is the hidden inventory that everyone talks about. The other thing is their great financing program for new buyers, here is a link.

If you read their boilerplate carefully, you don't need to pay for an appraisal, which costs dollars. My question, would the property appraise for what they are trying to sell it to you for? Probably not, it is called rip off the poor and uninformed, sell them that dream of home ownership. A dollar down moves you in. If you look this gift horse in the mouth, you would walk away.

Fannie will give you 3 1/2 percent of the home’s value for closing costs or whatever. You need to have 3% down, but you could get a check cut for 10% of the home’s value for repairs. Oh goodie free money.

Here is an article I wrote showing my frustration with what they were doing two years ago link . The couple that bought this home both worked at a movie theater making $8 per hour. They got $10,000 for repairs and spent it on a bike and a pick up. It ended up going back to the bank (Fannie Mae). It only cost them a dollar to move in.

The thing to take pause at here are the Realtors. Commissions are 6% so we know whose raking in the real money.

I use to sell VA repos, and that was on an auction basis. High bid won. Now we have a candy ass program; Fannie Mae will finance your dream, if you agree to pay their price. The people at Fannie Mae need some jail time.

The Low Bond Yield Conundrum (Reprinted)

This is an edited reprint from November 19, 2006 which demonstrates what large swings in interest rates can do of the bond market. Note the interest rates are off a bit; at the time of writing, there was less than 100 basis points between the 30 year Treasury bonds and the one year T-Bills. The 30 year interest rates have remained constant, the short term rates have gone to hell. Greenspan was the man in charge at the time.


The bond market is at a point right now that leaves an awful lot of long bond holders (buyers of the 30 year) very vulnerable.

With the coming vaporization of the second trust deed market, there should be a scarcity of funds. Add to that, marking to market of foreclosed homes adds even more to this up and coming "enterprise." Seventeen interest rate increases by the Fed and the long term rate comes out very little changed.

In Greenspans speech to Congress last year June 9, 2005 he is quoted:

Among the biggest surprises of the past year has been the pronounced decline in long-term interest rates on U.S. Treasury securities despite a 2-percentage-point increase in the federal funds rate. This is clearly without recent precedent. The yield on ten-year Treasury notes, currently at about 4 percent, is 80 basis points less than its level of a year ago. Moreover, even after the recent backup in credit risk spreads, yields for both investment-grade and less-than-investment-grade corporate bonds have declined even more than Treasuries over the same period.

What it really boils down to is; there is a very large demand for long term bonds. More than the market can supply. Otherwise interest rates would rise to attract buyers (this may not seem obvious, but as the price of a bond drops, its interest rate increases and vise versa). The Baby Boomers could be going to less risk in their portfolios. An insurance company locking in rates on an annuity for thirty years, this would be a smart call.

Where it gets kinky, is the fact that everyone is loaning 30 year money at close to the rate paid for the one year Treasury. Look at a 30 year bond issued today at say 5%.

Value of Face amount-------interest rate--------interest paid
----$1,000,000-----------------5%-----------------$50,000

No problem with the investment, but if the interest rate went to 10%, the dynamics change. Using that same 1,000,000 bond we now have:

Value of face Amount-------interest rate--------interest paid
------$500,000------------------10%-----------------$50,000

What this shows, is that your market portfolio could, if marked to market have a haircut of 50 percent. Notice however, if you hold on to maturity, there is no "real" loss of principle. 30 years is a long time to wait if you are already 60 (I turned 60 yesterday).

The real pure play for the bond market is to buy when the market is at 10% and sell when it goes to 5%. That play, a reverse of the first example, would net a cool half million. This is where the money is made in the bond market. (Note if you were to buy at 10% and it swung even lower to 20%, your jaw could hit the floor rather hard.)

The only thing that makes today a buying opportunity, is the belief that the interest rate will drop to 2.5%, this would double your bond portfolio's value, and it just ain't going to happen.

Another thing that Greenspan mentioned, that people were willing to accept more risk with less reward. Everything except Delta Airlines Bonds are trading as if they are US Treasury's (admittedly an exaggeration, but the rates commanded are rather unrealistic if not pathetic).

We seem have a market running on the herd mentality of "If it works, go with the flow." At some point there will be a demand for funds that could raise the interest rate to quite a spectacular level, even if for a short period of time. It is at that point, that cash can buy into the bond market and make a killing.

A stock has to double to double your money. With a bond a 50% drop in the interest rate doubles your return. The thing to remember in a panic, it's like going into a pawn shop with a $10,000 wedding ring, you're not going to get list price or anywhere near it. You're are going to take what you can get according to how desperate you are for cash funds.

What you really have, is a mistake being made by retirement funds, that will take them 30 years to fully appreciate. Your clients only have 15 to 35 years to live. They just might need the money before the call date. The real culprit is unperceived inflation --your monthly retirement check might only buy a weeks worth of groceries. I guess this is how you get "saved" from a severe deflationary spiral--more government printing.

The Conundrum is, why invest in bonds? You're guaranteed a loss at present interest rates.

Read Between the Lines

Tuesday's San Diego Union Tribune ran a front page story; the county's median home prices were up 15.3 percent.

San Diego County home prices, which were falling at double-digit rates a year ago, are now rising rapidly as investors grab the last remaining bargains and upper-end buyers find deals to their liking.

It makes you wonder a bit about their chart below, until you look at the new homes for May 2009 and compare them with new homes for May 2010. [double click for a clearer image]

Looking at it realistically, the buyer lost $77,000 if they bought a new home last May (highlighted in yellow). And now there are a lot of 600K "used" homes that are now selling for 400K. The condo sales don't make much sense unless the new units in downtown San Diego (previously selling at 600K) have been reduced to move at 250K. Just try and find a banker that will finance a condo.

The other thing to realize is that used home totals are actual, new home sales are usually 2/3's of those listed; they are counted the minute the contract is signed and a lot fail to close. Another item to take into account, the tax incentive just expired so the totals for May stole from June.

You can't fault the newspaper for printing "Good News."

The Anatomy of a Bubble

In order to understand a bubble, one has to examine two conditions of our environment. One, there is a randomness with the way we interact with our economic community; everybody works, but we all have different types of jobs. Two, our resources are finite; they can be exhausted by consumption.

The first step of a bubble is the severe misallocation of resources. Production focuses on one particular item. The misallocation, means that we are about to allocate most of our resources towards that one goal. This starts out gradually and then progressively consumes more and more resources.

In the second step of a bubble, a large group of people are no longer interacting with the economy in a random fashion; they are all pursuing the same wealth creation formula. This too, starts out with a normal amount of people employed in the bubble sector of the economy. As the bubble gets more robust, more people with a desire for riches join in with lost abandon.

As we enter step three, there is the comfort that everyone participating in the bubble, feels sort of group camaraderie (the herd mentality). Notice as people acquire more riches from their venture, they come to accept the fact that they’re just MORE intelligent than ordinary people. At this point greed and stupidity mix well; double your investment and in turn, double your profit.

Then we come to the final stage (step four) loss of control; the resources are exhausted and the bubble collapses. The damage has been done and it is real.

Examine these two bubble examples from the past:

A river boat ferry, in India 20 years back, was packed with 600 people. Two teenagers in love were going to jump off the boat and commit suicide (their parents wouldn’t let them get married). Needless to say 600 people rushed to one side of the ferry to witness the event. The ferry capsized with a very large loss of life. What happened was sudden and very unexpected by all involved.

The second case was in Africa 50 years ago. Wealth was measured in cattle. The more cattle you owned, the more wives you could afford (this also produced a lot of kids that had to be fed). Cattle production shot through the roof over several years, everyone was getting rich. Even the people growing the hay to feed the cattle were making money. The price of cattle feed started to increase; there wasn't enough supply to meet demand. The cattle were starting to exhaust their food supply. Farmers found it difficult to feed all of their cattle, so more went to market for sale. Prices started to drop and the cattle market collapsed. The livestock died off in mass and the general population faced the aspect of starvation. There wasn’t any drought that brought this famine on, just the misallocation of resources.

Identifying a bubble is at best, very difficult in the early stages. The housing bubble over time has become obvious. Medicare is a bubble in progress. Resources are limited more so than is apparent; high costs in the past have kept medical demands in check.

The national debt is also a bubble but the concept of what constitutes resources (real money) is one of those magic acts, that go on forever. An increase in the interest rate to 9% could spell doom for the US Treasury and the national debt (of course that could never happen).

The ferry boat (our Ship of State) is full and pushing away from the dock; I wonder if Romeo and Juliet are on board?

Live Rent Free, Don't Give the Bank the Keys (Reprinted)

Here is a reprint from this blog back 3 years ago, September 6, 2007. The probability of it, has come to pass.

Everyone is talking about all of the foreclosures and how rental rates will rise because of the demand from all of the displaced owners. Maybe there is one item that has been overlooked.

When banks foreclose and get title, there is a year or two wait to complete the process. We are talking about the actual deed, not a note saying that the title was conveyed and it is free and clear. The paperwork takes a while.

In the mean time, the neighbor across the way trades out his broken dishwasher with the one in the foreclosure. In California, the air conditioner would probably grow legs in two weeks. In a year’s time, there might not be much left. I’ve seen places that the neighborhood kids would use and by the time they are finished with it, you really wouldn’t want it at any price.

This can even get worse. Consider a foreclosure in Colorado, the pipes freeze and break. In Florida, a closed up house might mold over like a loaf of bread. Some states have laws on the books that allow the foreclosed owner two years to redeem the house after the event. So, clear title could be a very long wait.

Considering the length of time needed to sell a house lately, a year is not an unreasonable estimate of time. The note holder has a chance to lose big time. His asset could be run through the local recycler without his knowledge, copper pipes and all. It behooves him to have the house occupied.

The foreclosed home owner can’t lose if he plays his cards right. Walk up to the lender handling the foreclosure, and offer to keep living in the house rent free until it is sold, on the condition that you take care of the lawn and the house in general. Sounds crazy, but who the hell is going to buy it in this market? At least nobody is going to steal the air conditioner before you have a chance to sell it. At the present time, things aren't quite that bad, so you might have to pay monthly rent payments.

An impossible pipe dream? People living in foreclosed homes and not being tossed out?? It’s happened before, just not in the last 75 years. States even passed laws so it could happen.

Post-note June 5, 2010:

The property tax arrears on these homes could become a nightmare. They are not being paid and the states depend on the dollars for their budgets. Just who owes the money is the real question. Some states allow you to pick up a home for back taxes, others don't. In California it looks like the bank pays the back taxes from the proceeds of the foreclosure sale. If the home is upside down, the FDIC, FANNIE, or FREDDIE become the indirect guarantor of the taxes. It's just another way of saying this is a free ride on the taxpayer.