Friday, June 26, 2009

Inflation? Americans Pay 300% More: Prices, Rents, Land, Gold, Hedges, Plays, Trades

What are people paying and buying and what does it tell us about prices and inflation?

Are Rents Rising?

Landlord Kyrgyzstan raises rent more than 300% on tenant USA

The United States will pay more than triple its current $17.4 Million annual rent to use the Manas airbase outside Bishkek in Kyrgyzstan in Central Asia.

In addition, Uncle Sam must pay "$37 million to build aircraft parking slots and storage areas, plus $30 million for new navigation systems" (hoping that it does not fall into Russian hands like the base the US accidentally built for the Soviets at Cam Ranh Bay).

Obama says thanks for tripling our rent and having us build a base that might fall into Russian hands:

President Barack Obama recently sent a message of thanks to Bakiyev for Kyrgyzstan's support of U.S.-led military operations in Afghanistan, according to U.S. Embassy officials in Bishkek. ("US, Kyryzstan reach deal on air base use," Leila Saralayeva, Associated Press (AP), 6/23/09)
The 300% price hike is probably a "production" phenomenon (supply-demand), not a monetary phenomenon--it neither proves inflation nor disproves deflation.

Rents Fall across America

Rents from Boston to San Fancisco are falling for several reasons:
  • Building boom creates oversupply of houses (Residential Real Estate)
  • Building boom creates oversupply of apartments (Commercial Real Estate (CRE))
  • Building boom creates oversupply of hotels/motels (Commercial Real Estate (CRE))
  • Housing bust (foreclosures, etc.) decreases demand (increases vacancies)
  • Recession/unemployment decreases demand (consolidates more people in fewer households)
Desperate, often underwater, investors (intentional landlords) face additional competition from "accidental landlords" (people who rent as a last resort after being unable to or unwilling to sell after moving) and hotels/motels with crashing vacancy rates which offer extended-stay discounts to save their crashing RevPAR (Revenue Per Available Room).

Falling rents are probably a "production" phenomenon (supply-demand), not a monetary phenomenon--they neither disprove inflation nor prove deflation.

Some people mistake these falling rents to mean too little money/credit (deflation) rather than the more likely explanation of too many houses/condos/apartments/motels/hotels (where prices can fall in several sectors despite general inflation of the money/credit supply).

Mish argued that there never has been "hyperinflation" with "crash"-ing "home prices"--although Keynesians likewise believed that we could not have inflation will falling employment--until we did (1970s stagflation).
  • Inflation easily can coincide with falling house prices (falling nominal prices and falling real prices).
  • Hyperinflation easily can coincide with falling real house prices (but rising nominal prices). Hyperinflation in Zimbabwe caused a loaf of bread to cost Z$10 Million and obviously one house can cost more than one loaf of bread but investors need to know if houses will crash in real terms, relative to other goods (is it better to invest in houses or in bread?).
Inflation Plays? How To Trade Inflation?

Mish argued that people claiming "hyperinflation" should be advocating "houses"--and he asked who was advocating "houses." The premise is flawed because there is no reason to assume that houses are always the best investment in hyperinflation but to answer the question generally about who is seeing inflation and/or considering real estate:

Jim Rogers sees inflation from central banks "printing money" and he has been buying farmland (real estate, perhaps with a farmhouse) as part of his commodities strategy and in a separate interview (not the one below) he would consider some Asian real estate (not in China/Hong Kong):

Marc Faber predicted possibly 10%-20% (annual?) inflation in the US within 5-10 years and said that he preferred US real estate over US Treasury 30-year bonds (but he recommended other assets or equities):

China's party policy research office economics head Li Lianzhong recommended buying real estate (as well as commodities, energy, gold):
A top Communist Party research chief said Thursday that China should buy gold and U.S. real estate rather than Treasurys . . . the U.S. dollar is poised for a fall, making gold and land better investments for China's $1.95 trillion in foreign exchange reserves. (citing Reuters report, "Chinese official urges buying of gold, U.S. land: report," MarketWatch, 6/24/09)
Note that China mentions US assets because it is trying to recycle its US dollars from its trade surplus and foreign-currency surplus.

Rogers, Faber, and Li at minimum see real estate as a defensive inflation hedge to pace inflation (capital preservation in real terms) under the assumption that, whatever the inflation rate, real estate nominal prices tend to float by a similar amount (Rogers reminded that he wants to make money, not break even, but he also recommended to hedge risk). However, remember:
  • US residential real estate in the last century saw real growth of the sales price only slightly above 0%.
  • Real estate can charge significant carrying costs such as repairs/maintenance and property tax (analagous to mutual-fund/brokerage fees) that can cause real net negative ROI.
  • An alternative to land is cash, if you expect that even during 100% inflation a bank account will pay 101% with FDIC insurance (principal guarantee) and not charge $100k of property tax.
  • Cost-Benefit analysis requires opportunity costs of relative prices and values (price:rent ratio, stocks price: earnings (P/E) ratio).
Beware that many people who talk of acquiring real estate actually mean acquiring debt, using land as collateral to make a leveraged bet which can multiply ROI gains but also ROI losses (leveraged investments gone sour including buying stock with mortgage debt are components of the current financial mess).

What is inflation/deflation, which do we have now, and how to measure it?

Thursday, June 25, 2009

What Leading Economic Indicators Predict Inflation or Economic Growth?

Comrade Coinz asked what leading economic indicators do you watch.

The Conference Board is a good start:

  • The Conference Board Leading Economic Index™ (LEI)
  • The Conference Board Coincident Economic Index™ (CEI)
  • The Conference Board Lagging Economic Index™ (LAG)
The Organization for Economic Co-Operation and Development (OECD) Composite Leading Indicator (CLI) is another source.

Both organizations also track international data.

The Conference Board LEI components are summarized by
  1. The average manufacturing-worker workweek (from the employment report)
  2. Initial jobless claims
  3. Manufacturers' new orders for consumer goods and materials (from the factory orders report)
  4. Vendor performance (from the Purchasing Managers' Index report)
  5. Manufacturers' new orders for nondefense capital goods (from the factory orders report)
  6. Building permits (from the housing starts report)
  7. The level of the S&P 500
  8. The inflation-adjusted measure of the M2 money supply
  9. The interest-rate spread between the 10-year Treasury note and the fed funds rate
  10. The expectations portion of the University of Michigan's Consumer Sentiment Index
Consumers often reduce durables and big-ticket items before non-durables (including services) and small-ticket items.

Companies often increase/decrease hours before they increase/decrease people.

Unemployment is more of a coincident (on recession start) or lagging (on recession end) indicator and unemployment insurance benefits claims do not count the armies of ineligible workers:
  • Self-employed
  • Sub-contractees ("independent contractors," freelancers, nonemployee compensation, 1099 IRS tax form)
  • Underemployed workers (part-time instead of full-time involuntarily)
  • Discouraged workers (unemployed and stopped looking)
  • Expirees (unemployed but benefits ran out after time limit)
I also might note (if reliable data):

For economic growth/decline:
  • Energy consumption (volume, not cost)
  • Miles driven
  • Shipping (retail package volume (UPS, etc.), port activity, Baltic Dry Index (BDI))
  • Garbage volume
  • Inventory (housing inventory, manufacturer inventory, retail inventory, food-bank inventory and turnover)
  • Production (percentage of industrial capacity utilized)
  • Productivity (labor productivity and capital productivity)
  • Stocks Price/Earnings ratio (P/E ratio) (S&P500 real P/E debate)
  • Business capital investment (ex commercial real estate (CRE), which lags residential real estate)
Housing inventory declines precede/determine significant new residential construction starts, although even high inventory will see some new starts because of custom dream homes, location assymetries, or regulatory devaluation of older homes (environmental, health, or energy-efficiency taxes/subsidies, etc.).

For prices:
For inflation:
Bubble Mafia Wrongly Call for High Prices under Guise of "Stabilization"

Increased productivity is the true source of real growth and real wealth and naturally results in lower prices (the falling real price for the Ford Model T or an IBM laptop computer).

"[S]table" real-estate or stock prices might mean a freeze at 2005 prices or a freeze at 80% below 2005 prices but most people who say "stable" want bubble pricing.

Increasing stock prices, home prices, or home construction (none necessarily a good thing) might be an indicator of "recovery" but not causal of recovery ("bullish" as consequence, not cause, of underlying/preceding real growth).

Confusing cause with consequence is like Homer Simpson using pliers to force the temperature-gauge needle to a safe reading even as the nuclear reactor melts down.

Bad information causes bad decisions.

Central planners tried to pump the housing indicator artificially through inflation, debt, and regulation--and catastrophically brought the world financial system to its knees.

Tuesday, June 23, 2009

Housing Wealth Effect on Non-Housing Consumption: MEW Credit Bubble Vs Real Estate ROI

Ringing in the MEW Year and the Illusion of Real Estate ROI

A recent Wall Street Journal (WSJ) article hints at but underdevelops a crucial distinction (the first point is closer to a psychological wealth effect while the second point is more likely to involve a functional change in credit access):

  • Fixed income, increased wealth: Spending more of your current income by decreasing your savings rate (but not your total savings), because of feeling richer from an appreciating asset but without tapping that asset.
  • Increased income, fixed/decreased wealth: An increase in current income via an increase in credit/debt on the appreciated asset, tapping the asset, negating the appreciation, leveraging/mortgaging the appreciated asset, spending the nest egg.
The WSJ article is correct that a policy to try to prop up housing prices is a mistake--but for many reasons well beyond the article's argument:
Many economists have stated that consumer spending can’t rebound until house prices stop falling. But Charles W. Calomiris of Columbia University, Stanley D. Longhofer of the Barton School of Business and William Miles of Wichita State University argue that the wealth effect of housing has been overstated. ("The (Mythical?) Housing Wealth Effect," Wall Street Journal, 6/22/09, hat tip: CR)
However, this next statement confuses a credit boom with real estate Return on Investment (ROI):
[A]n increase in house prices raises the value of the typical homeowner’s asset, but such a price increase is also an equivalent increase in the cost of providing oneself housing consumption. In the aggregate, changes in house prices will have offsetting effects on value gain and costs of housing services, and leave nothing left over to spend on non-housing consumption. ("The (Mythical?) Housing Wealth Effect," Wall Street Journal, 6/22/09, hat tip: CR)
The flaw confuses immediate lump-sum consumption with postponed financed payment--a flood vs. a drip.

If all houses increase $100k, both the Mortgage Equity Withdrawal person (MEWer) and the new house buyer are consuming an additional $100k each while paying only an extra $500/month ($100k @ 5% 30yr Fixe-Rate Mortgage (FRM), rounded off), so the new non-housing consumption from $100k MEW is only partially offset by $12k/year finance payments (extra $6k each from MEWer and new buyer)--and that does not even consider if the number of MEWers (seller pawning his/her house back to the bank) exceeds the number of house buyers.

The home ATM (MEW) accounted for 75% of GDP growth between 2003 and 2006.

The WSJ article's argument that higher house prices constrain renters' non-housing consumption overlooks that a key feature of the housing bubble was the massive divergence in the house-price:rent ratio.

The WSJ article tries to address housing as consumption but still seems to confuse houses with housing (asset vs. consumption).

There is an offset (cancelling out) with a trade-up house buyer who both buys a house and sells a house at the same time but that situation says more about the illusion of real estate ROI:

In other words, when you [a trade-up house buyer] calculate your real appreciation from your house-sale as investment, the proper deflator for the first house is the replacement house’s appreciation over the time period that you lived in the first house (do not use a CPI deflator). Many people will learn that trading keys is like getting a 10% raise to buy items which cost 10% more--they realize no real net gain from appreciation. The profit truism is “Buy low. Sell high” but sell-high-then-buy-high makes no money. You are running yourself ragged on your hamster wheel. ("Homeowner Profits Ignore Huge Costs: Housing Myths Part 4")
High house prices are bad policy and good policy would be to let the housing/credit bubble deflate.

Wednesday, June 17, 2009

Great Depression: Bernanke Krugman Learn Wrong Lesson

Federal Reserve Chairman Ben Bernanke learned the wrong lesson on the Great Depression from Milton Friedman and Anna Schwartz, citing fascism, war, and inflation as cases of succesful monetary policy.

Economist Paul Krugman admitted that the economy would fix itself with no government intervention yet still learned the wrong lesson from Japan's Lost Decade, calling for bridges to nowhere and irresponsible monetary policy.

Ben Bernanke and the Great Depression

Bernanke claims to follow Friedman and Schwartz but Schwartz recently criticized Bernanke's actions.

Bernanke said:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again. ("On Milton Friedman's Ninetieth Birthday," Remarks by Governor Ben S. Bernanke At the Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois, November 8, 2002)
Milton Friedman and Anna Schwartz's Monetary History of the United States 1867-1960 did conclude that the Fed's tight monetary policy caused or exacerbated certain downturns but (despite at one point writing that there was no inflation in the 1920s by confusing money supply with wholesale prices) their data also show that first the money supply (stock of money) soared almost 50% 1921-1929:

Bernanke seems to have learned only half of the lesson, how to inflate to stimulate the economy through a crash, but not the more important lesson, not to cause a crash in the first place by having overinflated an overheated bubble that pops.

Bernanke's "won't do it again" seems to refer not to blowing another bubble--he has no qualms about that--but to a confidence that he will not allow the bubble to deflate.

Bernanke's mental toolbox contains only 2 tools, inflate and inflate more.

Bernanke is so paranoid of deflation and the gold standard that he does not seem to notice how many of his "successful" inflation cases involve fascism and/or war (1920-30s Germany, Japan, Spain, China . . . and even 1930s Sweden embarked on a military buildup and eugenics program of forced sterilizations).

Bernanke also failed to learn the lessons about transparency and consistent rule of law (a nation of laws, not of men):
Anna Schwartz stepped forward to rebuke Bernanke and insist that he failed to learn her and Friedman's lessons:
SCHWARTZ: [T]he trouble with the way the Fed operated when it rescued Bear Stearns, the market then believed this was a signal of the way the Federal Reserve would perform. If the Fed and the Treasury made a candid statement to the market: We will help a bank, which basically is solvent. We will not do that for a bank, which is on the verge of bankruptcy. And then the market understands there are principles. That's why when Lehman Brothers was permitted to fail, the market was simply bewildered. Because here you had treated Bear Stearns in this kindly fashion, and what reason was there not to do the same when Lehman Brothers arose?

...The market is just bewildered. Bernanke came into office insisting that the Fed would be much more transparent than it had been in the past. But I don't believe that it's lived up to that. If the market understood what the Fed was planning in each case, and could see a design, then I think the market would have reacted much more positively.

Ryssdal: It sounds like you're frustrated with Chairman Bernanke and the White House, that they maybe haven't learned the lessons of history that you and Milton Friedman wrote about.

SCHWARTZ: Well, I think that that's a fair statement. Considering Bernanke's background, you would have expected a much more, should I say a tidy kind of performance by the Federal Reserve. Seemed to be something that was ad hoc and introduced without considering all the implications.

Ryssdal: You know, Alan Greenspan was lionized in this country for many years. And then a year ago went up to Capitol Hill and said, "You know what, I blew it." Does he get the appropriate amount of credit and/or blame for this whole thing?

SCHWARTZ: Well, I think the verdict of history will be different with regard to his stature than it has been so far.

Ryssdal: When an economic historian comes along in 25 or 30 years and tries to do for this episode what you and Professor Friedman did for the Great Depression, what's their verdict going to be on the monetary policy that the Fed has been following?

SCHWARTZ: Well, there has not been a straight line in the programs that the Fed has introduced over this period. So, I don't know whether the verdict will be charitable. It's always possible to find reasons why other alternatives were not really available. But I think on the whole the performance has been disappointing. Because now two years and more after Bernanke came into office we don't see visible signs of change for the better.

("Taking Stock: Lessons from History," Marketplace radio, 6/9/09)

Schwartz also condemned Bush and Obama for the bailouts.

Paul Krugman, the Great Depression, and Japan's Lost Decade

Krugman admitted that economies would fix themselves yet he remains a compulsive debt addict and serial bubble blower.

Economist Paul Krugman in 2002 gave a nod to the 2002+ Greenspan-Bernanke debt bubble as a "solution" to the previous debt bubble (1990s stock/, when Krugman wrote about the 2001 recession and official policy to create a housing bubble intentionally:
To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble. ("Dubya's Double Dip?" Paul Krugman, New York Times, 8/2/02, hat tip: Mish)
Update 6/18/09: Krugman is now trying to deny that he supported the housing bubble as stimulus. He argues that the quote is analysis, not endorsement. However, his analysis of the possible pushes a binary choice: If fighting the recession requires a housing bubble (which is what his 2002 quote says), then no housing bubble means not fighting the recession. Was Krugman pro-recession?

Are we supposed to believe that Krugman is a liquidationist? No, Krugman rejected 1929 Treasury Secretary Andrew Mellon's advice, "Liquidate labor, liquidate stocks,liquidate the farmers, liquidate real estate . . . purge the rottenness out of the system." Instead, Krugman in 1998 advocated fear to spur inflation and spending:
The only thing we need to fear is the lack of fear itself. ("Don't Panic Yet," Paul Krugman, New York Times, 8/30/98)
Krugman in 2002-2003 used fear and an "analysis" that bubbles were necessary to create a false choice between a housing bubble and dying children:
This is not just a recession, . . . Not just an economic challenge. We've gone off the rails. . . . you want to think Charles Dickens. It's going to be poverty of a kind that we don't think of as happening to people in America. If you look at the things that are actually being severely underfunded now, the biggest burden seems to fall on children. We're stripping away programs that provide that basic floor for medical care and for nutrition. I'll bet we're going to see a substantial rise in infant mortality and more low-birth-weight infants. We'll see more children dying because their illnesses were untreated. It's gonna be a pretty harsh place. You can come back to me in fifteen years and see if this is right. (Paul Krugman, quoted in "Voodoo Economics," Will Dana, Rolling Stone, 5/29/03)
If we needed a housing bubble to fight a recession that was barreling toward Dickensian poverty and dying children, and Krugman refused to support a housing bubble, is Krugman now saying that he preferred dying children?

Be careful when you claim that we have no choice but to "need" bubbles.

Are the bubbles in our stars, or in your heart, Dr. Krugman?

Krugman in 2009 is pushing yet another debt bubble as a "solution" to the housing-bubble crash, citing both the Great Depression and 1990s Japan's Lost Decade:
The second example is Japan in the 1990s. After slumping early in the decade, Japan experienced a partial recovery, with the economy growing almost 3 percent in 1996. Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession. ("Stay the Course," Paul Krugman, New York Times, 6/14/09, hat tip: CR)
Can you find Krugman's draconian frugality in these graphs of Japanese deficits and debt?

Japanese budget deficits as a percentage of GDP show only slight bumps on a decade of descent into red ink:

Japanese gross government debt as a percentage of GDP skyrocketed toward 200% of GDP:

Krugman in 1998 called for wasteful bridges to nowhere (long before other people attached the term to the Gravina Island Alaska "bridge to nowhere" in 2005) despite the failure of fiscal stimulus:
Japan has already engaged in extensive public works spending in an unsuccessful attempt to stimulate its economy. Much of this spending has been notoriously unproductive: bridges more or less to nowhere, airports few people use, etc.. True, since the economy is demand- rather than supply-constrained even wasteful spending is better than none. ("Japan's Trap," Paul Krugman, May 1998)
Krugman in 1998 literally called for irresponsible monetary policy and negative interest rates:
The way to make monetary policy effective, then, is for the central bank to credibly promise to be irresponsible - to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs. (original emphasis, "Japan's Trap," Paul Krugman, May 1998)
Instead of learning not to do drugs, Krugman and Bernanke think they have learned how to stay permanently high.

Bernanke and Obama are trying to concentrate even more centralized authority even though Bernanke knows Friedman and Schwartz's analysis that the DEcentralized pre-Fed system would have resulted in LESS of a banking crisis in 1929-1933:
[U]nder institutional arrangements that existed before the establishment of the Federal Reserve, bank failures of the scale of those in 1929-33 would not have occurred, even in an economic downturn as severe as that in the Depression. . . . Before the creation of the Federal Reserve, Friedman and Schwartz noted, bank panics were typically handled by banks themselves--for example, through urban consortiums of private banks called clearinghouses. If a run on one or more banks in a city began, the clearinghouse might declare a suspension of payments, meaning that, temporarily, deposits would not be convertible into cash. Larger, stronger banks would then take the lead, first, in determining that the banks under attack were in fact fundamentally solvent, and second, in lending cash to those banks that needed to meet withdrawals. Though not an entirely satisfactory solution--the suspension of payments for several weeks was a significant hardship for the public--the system of suspension of payments usually prevented local banking panics from spreading or persisting (Gorton and Mullineaux, 1987). Large, solvent banks had an incentive to participate in curing panics because they knew that an unchecked panic might ultimately threaten their own deposits. ("On Milton Friedman's Ninetieth Birthday," Remarks by Governor Ben S. Bernanke At the Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois, November 8, 2002)
Krugman admitted in 1998 that economies auto-regulate to fix themselves:
Even without any policy action, price adjustment or spontaneous structural change will eventually solve the problem. In the long run Japan will work its way out of the trap, whatever the policy response. ("Japan's Trap," Paul Krugman, May 1998)
The next time anyone says that the economy would have been even worse without the government policy, remember that even Paul Krugman said that economies tend to fix themselves, despite whatever headless-chicken government policy delayed the recovery.

Someone should tell Obama and Bernanke that economies do fix themselves after all.