We're on a Road to Nowhere

Not that the Mogambo Guru is an overly optimistic, glass-half-full kind of guy, but lately he’s been more downtrodden than usual. He’s realized inflation is eventually going to destroy us all, but he’s not going to take it sitting down.

The question was posed last week in The Economist, "Are central banks watching the wrong measure of inflation?" Well, of course they are, but when you are a magazine with a reputation to uphold, you gotta ask these kinds of silly questions to set up the rest of the article.

Anyway, they reference a guy named Ian Morris, who is an economist with HSBC, who includes in his estimate of inflation the things (like housing prices) that the government "conveniently" leaves out when they are desperately trying to disguise inflation. When Mr. Morris does this, he figures that inflation was actually running at 4.9%, which is bad enough, but in the true spirit of "You ain’t seen nothin’ yet," The Economist magazine updated their methodology to show that inflation is currently running at 5.5% in the United States!

But the damn lying government is still maintaining that inflation is low, very low, almost non-existent low, which is such an obvious lie that the Mogambo laughs – hahahaha! – when he hears those lying idiots say such things, although he knows why they are doing that: So that people do not freak out, and so The Mogambo does not freak out, and so that The Mogambo will not be calling them up all the time and screaming at the poor receptionist at the Federal Reserve about how the damnable Fed is creating so much money and credit that they resultant inflation is going to destroy us all and how I want to talk to Alan Greenspan or whoever in hell is in charge down there and I am yelling, "Don’t you hang up on me again!"

But it is not just me, as Safehaven.com did some looking at the calculation of the Consumer Price Index, particularly at the fraction of the index for housing, which constitutes about a third of the entire index. They write, "NEVER before have we seen this type of rate of change differential between the rate of change in the OFHEO home price data and the rate of change seen in the housing costs implicit in the CPI-Shelter data. NEVER. Is it fair to say that NEVER has the headline CPI been less reflective of real U.S. residential housing price inflation? Or alternatively, is it fair to say that NEVER has the CPI been so understated relative to the actual accelerating cost of U.S. residential real estate? In all sincerity, we believe the answer to both questions is a resounding yes." Note the use of all-capital letters in the word "never," which indicates that this is something significant.

As to the CPI as a whole, they write, "The current ‘core rate’ quotes are really excluding the true costs of food, energy and housing. That being the case, how can we really consider this a ‘consumer’ price index when it is essentially excluding the true nature of the three largest and most important consumables, so to speak, in any consumer’s life? Although this is really a point in time comment more than anything else, the current CPI is telling us very little about real world cost pressures at the consumer level." Exactly!

Inflation and the Consumer Price Index: Going Nowhere For Five Years

Bill Buckler, of the Privateer newsletter, says, "The central thing to understand, [is that] it is of fundamental importance to understand that the total U.S. economy has essentially gone nowhere since 2000." To put this in terms that make The Mogambo jump up and froth at the mouth, and then all the security guards keep fingering those damn electric shock devices because they know that once The Mogambo starts getting worked up, things are going to escalate until they are out of control.

But keep this "going nowhere" phrase in mind the next time some yahoo Wall Street chucklehead clueless tout tells you that you can make money ("make a fortune!") by investing in the stock and bond markets over the long term. I mean, I am not going to get out a calculator, but exactly what return do you need to make up for five freaking years of zero growth in your retirement account? And how long do you think you are going to live, and make a living, that that you can make up for five years of standing still? Especially five years when inflation is eating the guts out of your money?

He goes on to say, "The real economic danger to the U.S. economy is that were these massive increases in credit, and therefore debts, to ebb away, the entire U.S. economy would cave in. Economically, any slowdown of going into debt will act as a massive contraction in total (earned and borrowed) monetary demand for goods and services. " Knowing that you are as curious as I am, I leap to my feet and shout, "I have a question! I have a question! And what happens to total sales and total income and total taxes paid when there is, as you call its, a ‘massive contraction’ in demand?" He looks at me like I have just coughed in his face and he got a nose full of my bad breath, and he says, "What kind of stupid question is THAT? That is the most stupid question I have ever been asked! What are you? Some kind of moron?" and I say, "Yes! I am a moron, and I am real sensitive about it, too, and I prefer to be called ‘intellectually challenged!’ "

Inflation and the Consumer Price Index: "The Economic Truth Explained The Simplest Way."

Mr. Buckler suddenly realizes that I am some kind of handicapped person, which he should have guessed just by looking at me, since normal people don’t look like this, or drool as much. And as some pathetic handicapped person, I can sue him if my feelings get hurt, and I can really take him to the cleaners. So he changed his tune pretty quick, and he was all sweetness and light as he went on to say, in a soothing voice, "The Economic Truth Explained The Simplest Way: In effect, the United States has borrowed very close to one-third of its total Gross Domestic Product (GDP) since 2000. Economically, that one-third of GDP has been borrowed into existence. Should the borrowing slow down or end for whatever reason, the U.S. GDP would contract by very close to the same amount over the following year. Once U.S. expenditures (of all kinds) match and balance with earned incomes (of all kinds), then the U.S. total economy would be only about two-thirds of the size it is now."

And if you are thinking to yourself, "Hmmm! I wonder what stocks will sell for when the economy has shrunk by two-thirds?" Then I am happy to finally show everybody in the class that I finally know the answer to one damn question, and the answer is, "Less! A lot less!" But instead of letting me bask in my one lousy moment of glory, Mr. Buckler takes control of the class and tells us that as bad as that is, the bad news is yet to come. He says, "But even then, the total sum of outstanding debt would not have contracted in the slightest. Picture the plight of a man with an annual income of $US 60,000 and debts outstanding of $US 60,000 who had to take a pay cut down to $US 40,000. When geared to what he now earns, his debts have gone up by 50%. He still has to service these debts with his now lower income. Blown up, this is the situation of the entire U.S. economy."

Now, once you have digested that, then you will know why I spend so much time in the Mogambo Bunker with the door locked, Intruder Alert System on and turned to "maximum," and ceaselessly carrying boxes of ammo from room to room while muttering to myself, "Be Calm! Be calm! It’s going to be all right! It is going to be all right!" and then saying, "You liar! We’re all going to die a horrible death when our money dies! " and then I answer myself by saying, "NO! NO!" and then screaming screaming screaming until I fall to the ground, exhausted and spent. And then wiping my pitiful tears from my bloodshot eyes, I realize that gold will do very well, and I have some gold, so I will be fine! And then I don’t feel so bad! Angry and betrayed, of course, but not so bad. Screaming at the neighbors and writing rude and threatening letters to the Federal Reserve about how I am going to come up there and slap the living hell out of all of them, of course, but not so bad.


The Mogambo Guru
for The Daily Reckoning
March 07, 2005

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter, an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications.

Ooh la la…we’re back in Paris…back on the job.

There’s snow on the ground in France. The temperature yesterday barely rose above freezing. What a change from Nicaragua!

And so we take up our post – our cold and lonely vigil, waiting for the credit bubble to pop.

It didn’t pop when we were on vacation, did it? No…au contraire…it got bigger than ever.

The week ending Feb. 21st saw $43 billion of additional liquidity (M3) pumped into the bubble. Not surprisingly, everything is going up.

We were just in San Diego. The weather was a disappointment. It was cool and rainy. But the housing market is hot, hot, hot. Practically any cottage in the city will cost you more than $1 million. They’ve been going up at 20% per year for the last five years. Add in the effects of typical 5-to-1 mortgage financing, and house speculators have been doubling their money every year!

For the last five years, too, homebuilders’ stocks have been rising like the NASDAQ. In the five years of the tech bubble, 1995-2000, the NASDAQ rose 44% per year. Now, it’s the homebuilders that have gone wild – up 46% per year since 2000, says Kevin Duffy.

Duffy thinks the tech bubble was largely a male thing. Men got excited about making a lot of money by investing in companies that made tech gadgets. When the bubble blew up, the wives said, "I told you so." When Greenspan cut rates, he saved not only the credit bubble, but thousands of marriages too. Families were never forced to cut back on spending – they merely refinanced their houses. This new bubble has a feminine side, Duffy thinks. Mortgage finance companies have been targeting women. Men may make the final decisions when it comes to the nest egg, but it is women who make the final decisions about the nest.

Every time we turn on our computer, we get another opportunity to mortgage our house. This morning, Ameriquest offered a "Click to Refinance" link. We had several choices, but "Cash Out" was highlighted. But many people are using the refinance link in order to leverage their real estate speculations – taking the cash out of their primary house in order to use it as a down payment on a second.

"Second home market is surging," says an LA TIMES headline. Second homes are going up even faster than first ones – because they tend to be in more desirable, high-growth areas, such as beach communities. The result is that the homeowner increases his leverage, while also notching up his lifestyle. If he has $50,000 invested in a house worth $200,000…a year later, in California at least, he might have a $250,000 house, with no additional investment. Then, he could take out $50,000 in ‘equity’ and use the money to buy another $250,000 vacation house. Now, he’s still got $50,000 invested…but he’s got a half-million worth of real estate. If the property market goes up another 20% this year, he would make $100,000 – probably more than he would make in his job. But why should he stop there? The following year, he could buy yet another house – again, without a penny of new investment. Pretty soon, he’s a real estate mogul, with millions of dollars worth of houses, all resting on a measly $50,000 original investment.

All up and down the West Coast the story is the same. From Seattle, the word on Media Street is that house prices are increasing at a "frantic pace" – which sounds remarkably like the final year of the NASDAQ bubble.

That this bubble will burst we have no doubt. As to when and how, we have only opinions. But when it does, this time it could be the entire economy in the doghouse…and not papa familias. When the NASDAQ rose, women were suspicious, says Duffy. They guessed that the tech stocks might be a passing fancy. There was no rush to spend their husband’s profits; it was "only on paper" for most people.

But the bubble in real estate is different. Our observation – based only on personal experience – is that women have far more faith in property than in stocks. Some instinct seems to drive them to want to own the nest, rather than just occupy it. Our own wife – even after hearing our warnings of a real estate bubble – still urges us to buy. "It may go down for a while," she says, "but it won’t go down for long. Besides, it’s better than making rent payments each month." She is referring to an apartment in Paris, where your editor has declined to buy for the last five years – while prices rose nearly as fast as those in California.

Will they continue to go up? We are not so sure. But we are sure that rising residential property prices is something that families have come to believe in, count on, and profit from. People have become accustomed to paying for vacations, new kitchens, and new cars from the Bank of Everlasting House Price Increases. When that bank fails…so do a lot of other things: retirement plans, marriages, and the U.S. economy.

More news, from our currency counselor…


Chuck Butler, reporting from the EverBank trading desk in St. Louis:

"Amazing isn’t it? When Europeans feel that the economy isn’t up to standards, they hunker down, and save. When we experienced a recession in 2002, what did we do? We went out and used our houses like ATM’s and spent like there was no tomorrow!"


Bill Bonner, back in Paris…

*** If the U.S. economy is going to fail, it’s going to have to wait. Stocks are going up. Oil is going up. U.S. bonds are going up. What isn’t going up? The dollar.

Warren Buffett says the dollar is going down further.

"The evidence grows," says the Sage of The Plains, "that our trade policies will put unremitting pressure on the dollar for many years to come." His company, Berkshire, made more than half of its 2004 pre-tax profits from betting against the dollar. Buffett thinks there is more money to be made selling the dollar:

"There are deep-rooted structural problems that will cause America to continue to run a huge current-account deficit unless trade policies either change materially or the dollar declines to a degree that could prove unsettling to financial markets….

"Our country that is now aspiring to an ‘Ownership Society’ will not find happiness in – and I’ll use hyperbole here for emphasis – a ‘Sharecropper’s Society.’ But that’s precisely where our trade policies, supported by Republicans and Democrats alike, are taking us."

*** The trade deficit last year came to $617 billion, up from $495 billion the year before. It is rising as fast as the money supply…and as fast as California houses. Alan Greenspan told Congress that this represented no "crisis," just a "serious problem." He is right. It is a serious problem on its way to becoming a crisis. Greenspan hopes it doesn’t get there before next January, when he leaves office.

Like so many of the other things that Greenspan tells the politicians – the Fed chairman’s remarks on America’s trade/current account deficits were carefully crafted to deceive. He told the pols, for example, that even though deficits must be funded from overseas, it makes little difference if foreigners or Americans themselves lend the nation money. It makes little difference to God, we suspect. But it makes a big difference to Americans. If we borrow $50 from our children, the family’s net financial position is unchanged. But if we borrow it from an outsider, the family has a $50 obligation beyond the family itself. Each time we make an interest payment, the money passes to outsiders and we are that much poorer.

Likewise, he says we needn’t worry about the deficits because America’s economy is so "flexible" and so able to "deal with shocks." He must know, but does not mention, that its flexibility is only in its credit joints – which stretch remarkably. Each time the country is threatened with an economic shock, since Greenspan has been at his post, the reaction has been to stretch credit. The shock has not really been dealt with; it has only been made worse, and postponed. The crisis will still come; it will be even more severe because people owe more money.

*** From colleague, Dan Ferris:

"A quote I came across that might appeal to you guys watching the real estate bubble. This, from Chief Flying Hawk who died in 1911:

‘The Tepi is much better to live in; always clean, warm in winter, cool in summer; easy to move. The white man builds big house, cost much money, like big cage, shut out sun, can never move; always sick.’

"That about sums it up, doesn’t it?

"Of course, where would Fannie Mae be if we all lived in teepees?"

Well, if we all lived in teepees, Fannie Mae might now have gotten into such a pickle…even more severe accounting problems have been uncovered at the mortgage giant, raising their total of estimated losses up $2.8 billion to almost $12 billion dollars!

This is starting to seem more and more like Enron, Part Deux everyday…