Living La Vida Loca

“Most modern economic theory remains based on the premise that man is a rational being. Anyone who’s spent more than five minutes on planet Earth knows that man is rarely a rational being. As Bonner explains: ‘Human beings are neither good nor bad, they’re merely subject to influence.’

“The reason seems simple. People find comfort in knowing lots of other people have made the same choices…like fans routing for a sports team. Human beings naturally gravitate towards the crowd. And ‘crowds cannot think. They can only feel and act.’

“So their behavior only seems rational in the fact that ‘everybody’s doing it.'”

Christopher Hancock
October 12, 2007

Keep reading today’s essay here:

Living La Vida Loca

Now over to Short Fuse, reporting from Baltimore…


Views from the Fuse:

Move over subprime ARMs – there’s a new beast to deal with in the housing market.

An article on Reuters says that while many have been singling out the rate resets on ARMs as the reason for the surge in loan defaults as of late, the actual answer is much simpler: falling home prices.

Says Reuters: “A drop in home prices pushes up defaults and forces more leveraged borrowers into foreclosure. This, in turn, puts extra supply to the housing market and pushes down home prices at the margin and the cycle starts again ultimately.”

Basically, what’s been happening is a nationwide overvaluation of home prices during the peak of the housing boom. But now that prices are starting to fall off (dramatically in some areas), many homeowners are left “upside down” in their mortgage – owing more on their loan than their house is actually worth.

This is occurring with a frequency more than anyone is realizing, warns our friend Mike “Mish” Shedlock, over at the Survival Report, and housing is nowhere near its bottom.

“Weakness will continue at least through mid-2008,” he says. “If the general economy heads into a slump, as we believe likely, housing will remain weak all through 2008 and perhaps substantially longer. Twenty-year manias are not resolved in two-three years.”

Another factor that is irritating the housing market are the lax lending standards that we saw last year, which permitted borrowers – often of the subprime persuasion – to take on too much debt.

Case in point: Beazer Homes. Yesterday, the major home builder admitted that “it had broken federal rules to help buyers of its homes qualify for federally insured mortgages,” reports the New York Times.

“The statement did not indicate precisely how the rules had been broken, nor did it disclose the volume of mortgages involved. Beazer said it hoped to reach a relatively inexpensive settlement with federal regulators over the practices, which it said were related to rules governing down payment assistance for home buyers.

“Beazer’s statements came as it reported that sales of new homes plunged in the third quarter. It also said it would restate several years of financial statements, with changes going back to 1999, because it had improperly used reserves to first hide earnings and then to overstate them.”

Yikes. We’ll keep you updated…

It’s the end of the world as we know it…and we feel fine!

India is booming. China is booming. The latest news from the Middle Kingdom tells us that its trade surplus is rising at a 56% annual rate.

Heck, even Argentina is booming. Its economy has been growing about three times faster than the U.S. model for the last five years.

Yesterday, your editor and his old friend Doug Casey were invited to lunch at the American Club in downtown Buenos Aires. Our hosts were mostly men who have been living and doing business in Argentina for decades. They’ve seen it all – corruption, hyperinflation, defaults, chaos, riots, depression…you name it. “What’s the real story down here?” we wanted to know.

“I wish I could tell you,” said one gentleman from Texas. “I’ve been down here for more than 30 years…and I don’t know what’s going on. Nobody does.”

“I work in the government,” said another young man. “And I can tell you, they don’t have any idea. It is an incredible, unbelievable mess. Everything is spin…not substance.”

“Hey…how’s that any different from the United States?” asked Doug.

Many people come to Argentina for the tango or the beef or the property values. We come to have a look at the future. Whatever drama lies ahead for the United States of America…we have a feeling it has rehearsed down here on the pampas.

Yesterday, the Dow went down a bit. But it could still be in a bullish phase. The index is still near an all-time high. And even the homebuilders look as though they may be bottoming out. Not that it particularly matters to us. Even if stocks continue to rise in nominal terms, it is of no interest – because they are too expensive to be good investments. And what we care about is real value, not just the numbers that follow a dollar sign.

In real terms, the Dow has been cut in half since 2000. You used to be able to sell all your Dow stocks and buy more than 40 ounces of gold. Now, sell them and you get only enough money to buy 18 ounces.

No, dear reader, the Dow is a fake-out…a sideshow…a distraction. The real drama is in the dollar itself. And the real excitement is in the gold market. Yesterday, gold rose more than $10 – to a new high for this cycle…at $758.

Oil rose to almost $83 yesterday, too. And the dollar fell to less than $1.42/euro (EUR).

The falling dollar is not just a speculator’s plaything. It is the dollar in which almost all Americans’ hopes and dreams are calibrated. If a house is worth 300,000 dollars…those 300,000 pieces of paper may represent a lifetime’s worth of past effort…and it may also represent hope for future repose. Pensions, insurance plans, stock portfolios, bonds…everything we earn and everything we spend – it’s almost all in dollars.

As we pointed out yesterday, the dirty little secret of America’s advanced capitalism is that it socializes much of the risk…and most of the losses. The big banks…big financial houses…or even the little householders…get in trouble and the government rushes to their aid. “Here, have some more money,” says the Fed.

Where does that money come from? It’s a long story…but it’s not a new story. It’s a story that was played out in ancient Rome…in 18th century France…in 20th century Germany…and now is a long-running show north of the Rio Grande.

In effect, and often literally, central bankers create the money – as Keynes put it – “out of thin air.” No harm in that, you say; it’s got to come from somewhere. Except, this new money competes with all the old money that people worked so long and hard to accumulate. As you will see, below, neither an economy nor a person can tell the difference between a dollar that came from the sweat of one’s brow and one that came out of thin air. The result is to increase the overall supply of dollars and reduce the value of each and every one of them. That is the phenomenon we know as “inflation.”

The consequences of inflation are well known. So is its source. Everyone knows, in other words, who gets killed and who fires the gun. What we add today is just an incriminating detail – the motive.

Why would the U.S. central bank want to create inflation? Blame Congress…the politicians always want to spend more money than they can raise in taxes. They make the difference up by borrowing…and then the loans need to be refinanced…and more loans added…and the whole thing just goes down a lot more easily if there’s a little extra money floating around.

Or, blame consumers. They spend money they don’t have on things they don’t need. Who do they think they are, members of Congress? They, too, are a lot happier when the money is flowing. And, when the voters are happy, the politicians are happy…and when the politicians are happy, they don’t put a lot of difficult questions to their central bankers…so the central bankers are happy too. Let’s face it; everyone is happier when there is a little inflation in the system. Economists even came to believe that inflation helped boost employment…and that it encouraged consumers to spend…and that it actually helped created a more dynamic, more robust economy. So, you see, dear reader, even economists are happier with a little whiff of inflation in the air. And if you can make economists happy…aren’t you doing God a service?

Okay…now we’re getting to the deep, dark heart of the matter. Blame God. God created man. And man likes a little inflation. A little extra money makes people feel like they are getting something for nothing. Who doesn’t like that?

But God didn’t stop there. He made man. And man likes to get something for nothing. But God made sure there was a worm in this apple. “Something for nothing” always comes at a high price. If the dollar had merely retained its value since 2002 and all else remained even, Americans would have about $10 trillion more of purchasing power today. Instead, they are getting used to foreigners coming in, buying their assets and telling them how cheap everything is. Yes, things are cheap to foreigners; they have real money. But things are not cheap to Americans.

The crisis of 2001-2002 reduced Argentines’ wealth by nearly two-thirds. All of a sudden, if they took a trip to Europe, for example, they found they had only a third as much money as they had had before. Foreigners were coming into the country to buy apartments and farms…the Argentines themselves didn’t have the money to compete with them. Argentina’s rich were fine. They had always kept their money in Miami or Switzerland. They had assets outside of the country. They had sources of revenue and ways to protect them. But the middle classes had their money in pesos. They earned their money in pesos. They counted on the value of their peso-pensions…and their houses…and their savings. But when the crisis came…their money disappeared. Argentina’s middle classes were practically wiped out.

Argentina? Look at Zimbabwe, says old friend Marc Faber. The story is the same, but it is more entertaining. And it is still in the hyper-farce stage. Inflation is officially running at about 7,000% per year. But unofficial estimates say the rate for this year will turn out to be more like 100,000%. Marc visited Zimbabwe recently. He says he went out to buy a bottle of orange squash on Monday; it was 120,000 Zim dollars. On Tuesday, the price had gone up to 180,000. And by Friday, it was at 600,000.

This would seem all very funny, but currencies mean something to ordinary people. At the margin, they can make the difference between life and death. Thanks to Robert Mugabe’s financial management, the average man in Zimbabwe can expect to drop dead at the age of 37. As recently as 1990, he could have looked forward to 60. While life expectancy plummeted, so did job expectancy. The average guy has only a 50/50 chance of finding work.

But here’s the kind of detail that gives us hope for the future. We may not survive it, but at least it will be amusing. It’s apparently the Africans’ turn to head the UN Commission on Sustainable Development. Naturally, they turn to a country that has found a way to sustain un-development – Zimbabwe. The country has been going downhill ever since they kicked Ian Smith out of office in 1979.

(Ian Smith is still alive, we believe. He is living in Cape Town, South Africa. Perhaps he should be called back to service…like Churchill in WWII…or Petain.)

The man given the post of heading up the commission on sustainable development is named Francis Nhema, a crony of Robert Mugabe. His personal contribution to sustainable development is that when he was given one of the farms stolen from white farmers, he let it go to rack and ruin.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning