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The Daily Reckoning | Friday, March 4, 2011 The biggest winners when inflation comes to town, Memory lane: Housing's epic journey from boom to bust and, now...? Plus, Bill Bonner with the latest on his Trade of the Decade and more... ------------------------------------------------------- Are You Prepared for the Oil Super Spike? Here are the four easiest ways to profit from oil as it shoots to $150 a barrel or more. Don't miss this one chance to turn the biggest oil story of the last three decades into handsome gains! Get all the details - right here. It's FREE. Why You Should Buy a House The Rise and Fall and Rise of the US Housing Market Eric Fry Reporting from the Land of the Setting Home Price... Chairman Ben Bernanke promises to "promote inflation." We take him at his word...and so do the commodity markets. The Reuters/Jefferies CRB Index of commodity prices has soared 80% from its lows of early 2009 - touching a fresh two-and-a-half-year high yesterday. But even if commodity prices weren't soaring (yet), we would take the Chairman at his word. After all, trusting a central banker to promote inflation is like trusting water to flow downhill. Inflation is not good for very many things, but neither is it all bad. For example, inflation is great for debtors who are trying to cheat their creditors. Inflation is also great for the folks who happen to own the stuff that's inflating. The traditional winners during inflationary cycles are hard assets like gold and real estate. The traditional losers are long-dated bonds and, of course, the currency in your wallet. Every cycle is different, but we have no reason to doubt that the upcoming inflationary cycle will produce the typical distribution of winners and losers. Hard assets will win; the currency in your wallets and purses will lose. If, therefore, inflation is taking root in American soil once again, how should the forward-looking investor prepare? "Buy gold," is the time-honored answer...and we would not quarrel with it. But an alternative answer, especially this time around, might be: "Buy a house." Consider the table below, which tracks the price history of specific houses in the United States that were standing in 1913 - the year the Federal Reserve came into existence - and are still standing today. While this sample of homes is not scientific, it does illustrate housing's value as an inflation hedge. On average, this collection of American homes produced the identical annualized return as gold. Obviously, the actual returns on housing would be lower than that of gold, since housing is subject to taxes, maintenance, etc. On the other hand, have you ever tried to raise a family inside a gold bar? Maybe compromise is the best course of action: Buy a house and then put some gold bricks inside. That's right, we said, "Buy a house." As faithful readers would be well aware, we have not always been so sanguine about the US housing market. From early 2005 through early 2007, your California editor published numerous columns predicting the demise of the housing bubble. May, 2005: Affluenza May, 2005: Houses and Spouses June, 2005: The After-Life October, 2005: No Way Out May, 2006: Homeless August, 2006: The Housing Bust Begins October, 2006: A Housing Bubble White Paper January, 2007: When Realtors Become Waiters Your editor also took to the airwaves to offer his gloomy observations and grim expectations for the housing market. In May of 2005, he showed up at CNBC studios to take part in a segment about the housing market entitled "Bubble: Fact or Fiction?" Your editor argued the "fact" side of the debate, while Jerry Howard, the CEO of the National Association of Home Builders (NAHB), argued the "fiction" side. Unfortunately, as we noted in Wednesday's edition of The Daily Reckoning, Mr. Howard's forecast did not pan out. The residential housing market began to implode almost as soon as the two of us unhooked our microphones and stepped away from the CNBC cameras...and that's no fiction. Four months after this CNBC interview, your editor put his home in Pound Ridge, New York, up for sale...and waited. The wait seemed like an eternity. Seven months later, the wait ended...favorably. A few days after escrow closed, in May of 2006, your editor published the following remarks: Ben Bernanke and Alan Greenspan both agree that the housing boom is over and that it will begin an "orderly" decline. We agree that the housing boom is over and that home prices will begin to decline, but we aren't so sure about the "orderly" part. Throughout the seven months that prospective buyers streamed through your editor's home, it became increasingly clear that the prospective buyers were becoming increasingly price-sensitive...and picky...and arrogant. Before our very eyes, literally, we watched the balance of power in the housing market shift from seller to buyer... A home is a wonderful thing to own; but it is also a wonderful thing to sell...especially when prices are slumping and buyers are disappearing... In October 2006, when we published a white paper, entitled simply, "Housing Bubble," we observed: By now, everyone knows the housing boom has busted. Even the National Association of Realtors admits as much... The only issues worth pondering, therefore, are how low prices might fall and/or how long the bust might last. Without trying to be too specific, we'd guess that prices will fall a lot and/or that the bust will last a long time... Without easy credit, and lots of it, real estate could never have achieved its epic valuations. Credit not only enabled first-time buyers to "stretch" a bit, it also enabled and emboldened speculative buyers, speculative builders, second-home buyers, second-home builders and every other variant of housing market participant/speculator. But because financing became so exotic, and speculative participation in the market became so great, the simultaneous unwinding of both will be as pleasant as hanging out with your in-laws during a root canal... We all know what happens NEXT. But we just don't know how bad it will be. Please allow your editor to offer a prediction: Home sales continue plummeting Prices begin to plummet Exotic loans begin to squeeze over-leveraged homeowners Prices plummet some more A bull market in housing begins in 2020...or maybe a little sooner. As a post-mortem to the Housing Bust White Paper, we published a column in January, 2007, entitled, "When Realtors Become Waiters." To lead off this column, we remarked, "Out here in the Golden State, jokes like the one below are becoming all too common: Question: What's another name for a California real estate agent? Answer: A waiter. Home sales volumes in California are sliding sharply... Why should we care what happens in California? We should care because California epitomized the excesses of the late great housing bubble. It was here in California where quirky, high-risk mortgages flourished; it was here where the median home became unaffordable to 84% of the average residents; and it was here where actors became waiters, then became real estate agents...only to become waiters again. What happens in the California real estate market, therefore, might anticipate what will happen in the rest of the country...and that's probably not good news... The increasingly dire conditions of the mortgage industry suggest that a genuine recovery remains a delusional hope. The willingness to lend and the willingness to borrow are both in retreat. This is how cascades start... Over the near-term, therefore, do not be surprised to hear an occasional California diner call out, "Hey waiter! Could we please see a menu...and a copy of your newest listings?" Four years have elapsed since your editor published the column above. During that timeframe, home prices have dropped substantially...and they continue to drop. But now that the bubble has burst, and the housing market is devoid of hope, your editor has become slightly more hopeful. Undoubtedly, the housing market will continue to produce ample pain and suffering in the months ahead...along with ample anxiety in the years ahead. But it is possible, if not likely, that the pain and suffering will yield a highly satisfactory reward. Read on... WARNING: This is Controversial. It Offends "Gloom and Doomers" Here's why it's NOT the end of America... Shocking new presentation reveals epic opportunities - viewer discretion advised for thin-skinned fear mongers. Watch the presentation right here. The Daily Reckoning Presents Houses Love Inflation by Eric J. Fry Inflation is not the only reason to risk diving back into the housing market, but it may be the best reason. John Paulson agrees with this logic. Paulson is the hedge fund manager who placed various negative bets on various mortgage-backed securities during 2007 and early 2008. As these securities plummeted in value during the crisis of 2008, Paulson became a multi-billionaire...and a celebrity. But now that housing has crashed, Paulson likes the other side of this trade. He thinks US houses are a buy. Paulson's extremely prescient bearish call on housing does not automatically validate his current bullish call, but his opinion probably deserves at least polite consideration. "Paulson made three big financial calls [late last year] that you need to know about," The Wall Street Journal's Brett Arends reported at the time, "First, he said that gold could go to $2,400 an ounce based on the fundamentals - and that momentum could carry it to $4,000 an ounce... Second, he said you should get out of bonds while you can: You're much better off investing in blue chip stocks with good dividend yields than bonds. And third, he said you should buy a home. Now." "If you don't own a home, buy one," Paulson said. "If you own one home, buy another one, and if you own two homes buy a third and lend your relatives the money to buy a home." Why would the man say such a thing? In a word: inflation. Paulson anticipates resurgent inflation - not the kind that boosts stock prices and turns mutual fund managers into rock stars, but the kind of inflation that causes the prices of every day goods to soar, and turns homeowners into geniuses. "Paulson sees inflation coming by 2012 or so," Arends wrote. "The explanation isn't hard to find... Put simply: We will get inflation because we have to. It doesn't get any more straightforward than that. We are the most indebted nation in the history of the world... The debt orgy has been everywhere... There is only one plausible route out of this appalling situation. The government needs inflation. The country needs inflation. That will shrink these debts in relation to the economy, asset prices and incomes." Accordingly, when Arends wrote a Journal story entitled, "Ten Reasons to Buy a Home," he did not neglect to include inflation among his "Ten Reasons." In light of Bernanke's QEI, QEII and all the QEs-to-be-named- later, Arends' other nine reasons seem much less compelling. His Reason #4 for example, is: "It'll be yours." Hmmm... Is that automatically a good thing? In this respect, isn't a house somewhat like a spouse? "It'll be yours" may seem like a great thing when you are "closing escrow," but only time can render the ultimate verdict. "A big problem with both houses and spouses as investments is that neither can be counted on to deliver a reliable short-term profit," we remarked in a 2005 column entitled, "Houses and Spouses." "Indeed, a short-term commitment to either a house or a spouse can result in a significant loss of capital." Arends' Reason #10, "Sooner or later, the market will clear," is also a pretty feeble reason to jump into the market. "Sooner or later" is rarely a solid principal upon which to make a timely investment decision. Nevertheless, Arends does offer some valid reasons to buy a house: Reason #1: You can get a good deal. Especially if you play hardball. This is a buyer's market... We're four to five years into the biggest housing bust in modern history. And prices have come down a long way - about 30% from their peak, according to Standard & Poor's Case-Shiller Index. Reason #2: Mortgages are cheap. You can get a 30-year loan for around 4.8%. What's not to like? These are the lowest rates on record. In fact, at one point late last year, 30-year mortgage rates actually fell below the 30-year Treasury yield! Arends continues: As recently as two years ago, 30-year mortgage rates were about 6.3%. That drop slashes your monthly repayment by a fifth. If inflation picks up, you won't see these mortgage rates again in your lifetime. And if we get deflation, and rates fall further, you can refi. Interestingly, when you combine Reason #1 together with Reason #2, an astonishing picture emerges - a picture of generational-low housing affordability. No question about it; housing is very cheap, even before considering the impact of inflation, which is considerable. The following chart depicts home prices in inflation-adjusted terms. Specifically, it shows the median home price, expressed as a multiple of per capita disposable income. Based on this calculation, home prices are as low as they have been in 40 years. But for most homebuyers, the price of the home is only one part of the true cost of a home. Mortgage rates matter as much, or more, than the purchase price itself. To illustrate this phenomenon, examine the chart below. It utilizes the actual, historic 30-year mortgage rates - coincident with historic median home prices - to create a picture of real world housing affordability over the last thirty years. Thus, this chart shows the average monthly mortgage payment on the median-priced home, expressed as a percentage of per capita disposable income. Again, the picture is unequivocal. Home prices are very, very cheap, relative to incomes. But clearly, "cheap" does not preclude "even cheaper." Home prices could certainly continue sliding. Even if that occurs, however, mortgage rates might continue rising, which would cause the effective price of a home to increase. Furthermore, no one should be buying a home with an eye toward "flipping it" in a few months. The observations in this column testify to the long-term potential of housing, based on the prevailing depressed prices - not to the short-term potential. The long-term investment performance of housing relies principally on two inputs - purchase price and inflation rates. Obviously, buying residential real estate at both a housing market low and an inflationary low would be the optimal entry point. And that's exactly what today's circumstances seem to be offering. Inflation is usually very kind to residential real estate, as the chart above illustrates. The top half of the chart displays the inflation- adjusted performance of median home prices, compared to the S&P 500 Index during the hugely inflationary 1970s. Housing trounced stocks during that timeframe. But once Paul Volcker took the reins at the Federal Reserve and quashed inflation, housing languished relative to stocks. Incredibly, after adjusting for the effects of inflation, home prices have barely budged since 1979! But even if the housing market does not rebound on cue and even if inflation does not revive for a year or two, the housing market has probably become cheap enough to offer an exceptional hedge against inflation. Even forgetting inflation, housing is very cheap. Remembering it, housing is cheaper still. Regards, Eric J. Fry, for The Daily Reckoning Now You Can Beat the Bastards at their Own Game... Hidden Gov't Documents Let You Predict Stock Moves Imagine what you could do with this intelligence... Roger Barnes of Colorado used one of these hidden documents to bank $237,000 in just 6 days... It's all perfectly legal and you can do this too! Click here to watch the new presentation now. Bill Bonner Sovereign Debt: a Threat to the Entire Financial System Bill Bonner Reckoning from Waterford, Ireland... "Ireland is broke," said our taxi driver. We like to ask cab drivers about the economy. Not that they understand anything any better than the average central bank economist. But they talk to people. Without cameras or tape recorders in the background. And they have their own businesses too. When times are good, people take cabs. When they are bad, they take the bus. "My bloody income is down by 50%. Most of my fares are people coming or going on business...or just people going to work. But now, who's doing business? Who's working? "The developers and the bankers ruined this country. They pushed up prices. And then, what was the government doing? They haven't a clue. The guy who is head of Ireland's financial affairs is a former schoolteacher. I've got nothing against schoolteachers, but what does he know of finance? And he's over there negotiating with the Germans. "The Germans know what they're doing. They don't want to finance our mistakes. And who can blame them?" In many ways, the Great Correction is hitting Ireland harder than the USA. If the US overbuilt, Ireland overbuilt even more. If the US over- borrowed, Ireland borrowed even more. And if the USA got lost in debt finance, Ireland got lost in dreamland. "We are dreamers, I guess. And storytellers. It's a status thing in Ireland. You go into a bar. Look for the fellow who has the most people gathered around him. He's the big man locally. Not the doctor. Not the politician. Not the rich man. "We're dreamers and storytellers...and then, we come to believe our own stories. " The Irish dream big. The republic is not big enough for them. So they go abroad. Only 4 million of them are left on the island. Some 60 million of their descendants - the Irish diaspora - live in America, Canada, Australia, Argentina and elsewhere. Your editor is one of them. For the first time in more than a decade, the Irish are emigrating again. "If you're a smart young man or woman, what else can you do? It's sad for their families. But Ireland has nothing to offer them. They have to leave. And usually, they don't come back." Yesterday, we went to open an account at the Bank of Ireland. "They must have been glad to see you," said a colleague. "You must be the first person to open an account in years. The rest of us are taking our money out. Every bank in Ireland is insolvent, and everybody knows it." "Well, there was no line," we replied. Instead, we got to the bank door at 10AM. We rang the doorbell (the bank didn't open until 10:30, but we had an appointment). A dignified older man in a sweater and a tie opened the heavy oak door. We stated our business. "Oh...yes... She's waiting for you." In front of us was an attractive woman of about 30. Well dressed. Well coifed. "Will I lose my money if the bank goes broke?" I asked. "Ha ha... There's no chance of that," said the woman with a look of earnest intensity that you usually associate with time-share salesmen and insane people. "I guess you would say that we're already broke, technically. But we have a deal with the European Central Bank. We have a line of credit. We won't default. And even if we did, your money is protected by an Irish government scheme that protects depositors up to 100,000 euros." "Well, isn't the Irish government insolvent too?" "Ha ha... Well, I suppose that it is too. Technically. But so is your American government, isn't it? But this is just a technicality. The whole system is not going to go broke. We're supported by Europe. And Europe does not want to see Ireland default." She was right about that. Europe does not want to see Ireland default. Because the debts of Ireland are the credits of French and German banks. If Ireland were allowed to default, the whole kit and caboodle could come apart. Ireland can't borrow on the open market. Lenders are not idiots. So the Micks and Paddies borrow from the European financial authorities. The low rates keep Irish households above water. Most mortgages here are "floating rate" loans. If the rates were allowed to float up to market levels, Irish households, banks, and the government itself, would all sink. For the moment, Europe lends at low interest rates to the Irish...who keep their banks and voters from going bust. The banks, in turn, keep their creditors from going bust. And so the whole system, in Europe as in America and Japan, depends on a continued flow of artificially cheap money And everyone seems to think this flow of cheap money can continue indefinitely. Welcome to the modern political economy... Small, isolated problems are rolled up into bigger and bigger ones. Soon, the danger is not to a bank...or even to a nation...but to the entire system. We don't know when it will stop. Nor do we know exactly what will make it stop. But we're sure there's money to be made betting on it. And more thoughts... And now, let's update our Trade of the Decade. Our "Trade of the Decade" called for selling Japanese bonds and buying Japanese stocks. The bonds go down when the liquor runs out...and then, when Japan can no longer close its budget gaps by borrowing, it will print money. First, the bonds will crash. Then, the stocks will soar. Has it done well? Not exactly. But the decade has just become. And it looks more promising than ever. Lord Keynes may not have had the Japanese bond market in mind. But almost an entire generation of JGB investors is living proof that "the market can stay irrational longer than you can stay solvent." For nearly 20 years, they thought rising supplies of Japanese bonds must lead to falling prices. As the quantity increased the quality had to decline. It was irrational to think anything else. And yet, Mr. Market not only remained irrational, he seemed to enjoy it. He was like a drunk with a half-finished bottle in his hand. Everyone knew he would have to sober up some day. But as long as there was still liquor left, why bother? Japan borrowed more and more...and speculators went broke waiting for bonds to go down. Here on the back page we yield to no man in our appreciation of the irrational. It is practically boundless, as near as we can tell. Nevertheless, sooner or later the booze runs out. What makes this interesting to readers everywhere is that Japan is a trendsetter. The Japanese stock market headed down 10 years before the NASDAQ cracked in the US in January of 2000. Japan's economy was ahead of the pack too; it went into a long correction 17 years before America's subprime lending crisis. Its central bankers and finance ministers have a long lead too. Every rabbit, currently being pulled out of Ben Bernanke's hat, was hopping around in Tokyo many years ago. For example, the Japanese have been "zero bound" for 15 years. In an effort to restart the economy, the Bank of Japan went to ZIRP (a zero interest rate policy) in 1995. They've been within 50 basis points of zero ever since. So too did Japan's huge central government deficits begin a decade ahead of those in the US. But the rope that was thrown out as a lifeline has become a noose. Japan can't go back to normal policies; it can't afford it. Among all the world's nations none now has more debt per GDP than Japan. For every dollar of output, Japan has $2 of central government debt. The figures are much more striking, and meaningful, when you compare debt to the cash-flow that services it. The central government owes about 1,000 trillion yen. It collects less than 50 trillion in revenues each year. In other words, every dollar of tax receipts must support about $20 in debt. If it had to carry its debt at just 5% interest it would take up 100% of government revenues. And its debt is still increasing; the Bank for International Settlement says it will grow to 3 times GDP over the next 10 years. Pondering these numbers, JGB speculators must have thought they had found a gold mine. Japanese bonds HAD to go down, they said to themselves. What they discovered was that a government can stay insolvent longer than they could stay rational. And now, practically every financial official, householder and investor on the home island is foaming at the mouth. Having avoided sanity for so long, they think they can do so forever. The descent into insolvency was directed by the Bank of Japan and enabled by bond buyers themselves. It did not bother them that Japan was the most broke nation in the world. Or that the Japanese were dying out, with negative population growth and more people retiring than entering the workforce. Or that the primary sources of funding for Japanese deficits were drying up. Corporate profits are pinched between the forefinger of a strong yen and the thumb of higher energy prices. The savings rate for people over 60 has fallen to zero. And as a percentage of GDP, national savings, net of both public and private borrowing, has fallen from plus 11% in 1991 to minus 5% today. Lenders must be as stupid or as mad as borrowers. Even today, they give their money to the government for 10 years, at a yield of only 1.2%. But so far, they have been right. The inflation rate in Japan is negative by about 2%, giving them a real yield of 3.5%. And compared to other investors in Japan, bond-buyers are geniuses. Japanese stocks are down 75% since 1990. Real estate is down about 70%. He should get out more. Take a trip to Japan. He would see where $1.5 trillion deficits, ZIRP, and QE lead - to more deficits, more ZIRP, and QE squared. He would see the madness in investors' eyes...and palsied hands of his central banker cronies. They couldn't stop. Neither can he. Not without higher unemployment and falling prices - the very things he fears more than the fires of Hell. Once an economy drinks deeply, it cannot stop until the bottle is empty. Regards, Bill Bonner, for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com How the US Government Deals With Debt in the Post-Bubble Era The story of the post-bubble years has been the feds’ efforts to put the debt onto someone other than the people who borrowed it. Bailout the banks...stick the public with trillions in debt...or print up more paper money, disguise debt as inflation and spread it all over the world. The Return of Stagflation? The Bond Market’s Search for the Bottom The Benefits of Working for the Government It looks like American people are getting tired of government employees making about twice – twice! – as much in wages and benefits as we taxpayers make, and there are movements to strip government-employee unions of their collective-bargaining authority... Who’s Really Affected By Rising Food Prices Printing Enough Money to Buy the World’s Silver Euro Rallies as Trichet Signals for a Rate Hike Yesterday, European Central Bank President, Trichet, did exactly what I said he would do on Monday... CABAL (Fed) Chairman, Bernanke did what I said he would do on Monday at his testimony on Tuesday and Wednesday.... And last night when I checked the currency prices, the euro (EUR) reacted exactly the way I said it would, as it climbed to 1.40... The Benefits of Working for the Government Who’s Really Affected By Rising Food Prices The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists. Cast of Characters: Bill Bonner Founder Addison Wiggin Publisher Eric Fry Editorial Director Joel Bowman Managing Editor The Mogambo Guru Editor Rocky Vega Editor