Fact or Fiction: We're going down!

I just finished reading, Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown by David Wiedemer, Robert Wiedemer and Cindy Spitzer.  As you can imagine by the title of the book, the authors are not too bullish about our future.  Let me restate that: they are down right pessimistic about our chances of correcting our economic ship.  As far as they're concerned it's not going to happen. We're going down in flames and we're going to pull down the rest of the world with us.  

Now before you go and find a bridge to jump off of, the world will go on, a new economic order will eventually emerge from the ashes and the U.S. will likely lead the way again, this time a whole lot wiser as we learn from the mistakes of the past 30 years that set us on this course in the first place.  That's the gist of the book.  
The question that we need to ask ourselves is: How true are the premises presented in the book that lead to this conclusion?  Are these authors a bunch of nut jobs or do they have valid points? While I don't agree with some of their conclusions, I believe the overall framework that they present is both logical and intuitive. Let's see what you think as I outline the basic premises of their book.

The authors believe that beginning in the early 1980s, with the decision to run large government deficits, six co-linked bubbles have been growing bigger and bigger, each working to lift the others, all booming and supporting the U.S. economy.  A bubble is defined as an asset value that temporarily booms and eventually busts, based on changing investor psychology rather than underlying, fundamental economic drivers that are sustainable over time.  The six bubbles are:

1. The real estate bubble
2. The stock market bubble
3. The private debt bubble
4. The discretionary spending bubble
5. The dollar bubble
6. The government debt bubble

The first four of these bubbles began to burst in late 2008 and 2009 which rocked the U.S. and world economies.  It's kind of difficult to disagree with this premise with maybe the exception of the stock market.  Was the stock market crash of 2008 as a result of a bubble? The authors make a compelling case (which you'll have to read) that the stock market crash of 2008 was in fact a bubble that was not supportable by sound economics.  

The second major premise of the book is that while most people think the worst is over, the coming Aftershock will bring down all six bubbles in the next two to five years.  Whoa!  So what's the evidence to support their view.

The authors go on to explain that money, like all assets, is also affected by the law of supply and demand.  If there are too many dollars available their value falls.  In the past four years The Federal Reserve, in order to avoid a collapse of our economy, has increased the money supply through Quantitative Easing from $800 billion to $2.6 trillion.  This is an unprecedented increase in the money supply. The final bubble to pop is the government debt bubble.  Our national debt in that last four years has increased from $10 trillion to $16 trillion!  Both the dollar bubble and the U.S. government debt bubble have been pumped up to offset the other popping bubbles.  Both are on unsustainable paths and they too will pop bursting America's and the world's economy.  

As I mentioned earlier I don't agree with everything they say in this book.  My fundamental disagreement is in the inevitability of the last two bubbles popping.  If present trends continue, i.e., we continue to avoid making difficult decisions, then I absolutely agree that the dollar and government debt bubbles will pop as predicted.  I also believe that nothing will get done to solve our economic problems until there is a crisis.  

The good news is there is a crisis looming which should get our politicians' attention: Europe.  There is no solution to Europe's debt crisis.  None.  Anyone who thinks otherwise is living in "la la land." Europe's days are numbered.  When they falter, and they will, this catastrophic event should give our political leaders the impetus to make the necessary, painful decisions to keep us from following Europe over the precipice.  Just like the days immediately after 9/11 both political parties will come together for a short period of time.  As Rahm Immanuel once said, "You never want a serious crisis to go to waste."  Let's hope they take advantage of the collapse of Europe to right our economic ship so we can avoid following in their footsteps.    

Why Inflation Is Just Around the Corner

Thirty years have passed since we’ve had a significant bout of inflation in this country.  At the peak of this inflation battle my money market account earned 21 percent interest!  That was the good side of inflation.  The bad side of inflation was banks pretty much stopped lending and the only lending getting done was seller financed or other creative forms of hard money lending.

For the past 30 years we’ve seen interest rates slowly decline on commercial real estate from 12 percent to now 4 percent or less.  I believe the days of ever lower interest rates are coming to an end.  In fact, I believe the days of double digit inflation is inevitable and I believe it’s just around the corner.

But before I go further on what I believe is in store for us as a nation, let’s review what inflation is and what causes it.

What is inflation?

Inflation is an increase in the price of goods and services not due to growing demand or shrinking supply for those goods and services (which also affects price) but due instead to the dollar losing its buying power.
There is a difference between real price increases and inflation.  The price of oil could be going up because we are running out of easy-to-find oil, or demand has gone up because China’s rapidly growing economy is demanding more oil.  That’s not inflation; that’s a real price increase due to the forces of supply and demand.

What causes the dollar to lose buying power?

The value of money is affected by supply and demand.  If there are too many dollars available their value falls.  When the money supply is dramatically expanded in an economy with no or slow growth, as is happening today, the value of the dollar will eventually decline.  In short, too many dollars (too much supply), relative to the slow growth of the economy (too little demand), leads to the falling value of the dollar, a.k.a, inflation.  Therefore, real cause of inflation is increasing the money supply beyond what is needed to keep up with economic growth. 

What is causing the money supply to expand so rapidly?

The Federal Reserve in an attempt to rescue the economy began in early 2009 purchasing $2 trillion in U.S. mortgage and treasury bonds with printed money.  The technical term for these big bond purchases is “quantitative easing” or QE. Then in November 2010 the Fed began more bond purchases (QE2), adding an additional $600 billion to the nation’s money supply over the next year.  Again the goal of the money printing is to stimulate the economy back to health.

How much has the money supply increased in recent years?

In 2008, before QE, the U.S. money supply totaled $800 billion.  Today, the money supply is $2.6 trillion or more than triple what it was in 2008.  This is a stunningly large increase.  Nothing like this has ever occurred before in the United States.

Why aren’t we experiencing inflation now?

A paper written in 1999 by Ben Bernanke, the Fed chairman, et.al., examined past periods of inflation and determined there is about a two-year lag between increasing the money supply and the onset of inflation.  It can be delayed further if the Fed takes other actions to create more lag time, which I’m sure they are trying to do.  It can be delayed but it can’t be prevented. 

Exactly when will inflation begin?

Good question.  The truth is no one knows when it will begin in earnest.  The authors of Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown believe that significant inflation will begin in the 2013-2015 range.

What does this mean for commercial real estate?

We live in uncertain times.  Many factors lie outside of our control to influence. As property owners refinancing our real estate is one area of our lives that we can be proactive and take control of the situation by locking in low interest rate, long-term financing.  Those who do will be the big winners. 

Source: Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown by David Wiedemer, PhD, Robert Wiedemer & Cindy Spitzer; John Wiley & Sons, Inc., 2011.

A Policy That Both Obama & Romney are Right About

It's not often that two presidential candidates agree on much of anything.  That's not good politics!  But I digress. 

Two weeks ago I wrote a blog post titled, Why Obama and Romney are Both Wrong About the U.S. Economy.  In this blog post I stated my basic premise that the U.S. economic model of the past 40 years is broken and cannot be fixed with the trite solutions offered by both parties.  It reminds me of the beer commercial where two groups of men shout at each other, "Tastes great" and the other group shouts "Less filling."  Rather than these trite slogans our major political parties shout at each other their equally trite slogans: "More government programs", "Less taxes" with no one listening to the other side's argument.  Kind of sophomoric isn't it?  

In this previous blog I outlined that there are only five ways to stimulate the economy: 

1. Increase exports
2. Decrease imports
3. Increase business investment
4. Increase government spending
5. Increase consumer spending

I discussed each of these five ways to stimulate the economy but quickly came to the conclusion we needed to focus our attention on consumer spending because historically 70% of our economy is driven by consumer spending. 

Many economists believe that excess household debt is the biggest factor holding back the economic recovery as 25 percent of all homeowners owe more on their homes than they are worth.  When you add the amount of credit card, auto loan and student loan debt to this mix the American public is awash in personal debt.  This leads to a situation in which people are trying to spend less than their income to get out from under their debt load.  And without consumers spending money the chances for a robust economic recovery go out the window.

A recent proposal that could change all this has been presented that has surprising support from both presidential candidates.  Romney advisers and the president are both in favor of allowing homeowners with little or no equity in their homes to refinance their mortgages.  With interest rates at historical lows this would substantially lower their interest payments with the potential of providing a major boost to the economy.  There are 80,000 households in Oregon that could benefit from this proposal.  Logically, why wouldn't you be in favor of lowering the interest rate on underwater borrowers?  It's a no brainer.  In many cases, these homeowners did everything right, but they are unable to refinance to today's lower mortgage rates.    

But Edward DeMarco, the acting director of the agency that oversees Fannie Mae and Freddie Mac, has refused to move on this proposal put forward by the Obama administration.  He believes that it would be a net loss to taxpayers, a conclusion not supported by his own staff's analysis which showed a net gain.  And of course Republicans and Democrats are squabbling over what to do about this impasse.  So nothing gets done as Congress adjourns for its summer recess.       

Admittedly this is a proposal by the Democrats in Congress.  Wouldn't it be refreshing if the Republicans would set aside partisan politics to support this legislation for the good of the American public (by the way there are plenty of other examples of Democrats acting childish too).  This legislation has the potential to spur the economy so that us all would benefit without costing the taxpayer a dime.  If Mr. DeMarco remains a roadblock, then its time to find his successor.

Source: Debt, Depression, Demarco: Lay the blame where it belongs by Paul Krugman, The Oregonian, August 4, 2012; Once again: Why not help people keep their homes? by Peter Buckley, The Oregonian, August 6, 2012.