Bat Meat

Bill Bonner, evading the fringe-lipped bat…

"It’s a cold, cold world we’re livin’ in."

– Percy Sledge

Pity the poor tungara frog. According to a New York Times article, the little amphibian, native to Nicaragua, lives "between a rock and a hard place." In order to mate, the male of the species makes noise – "A sliding whine followed by abrupt chucks, it sounds a bit like a little boy imitating a dive bomber. Female frogs hop to when they hear it. But fringe-lipped bats also tune in; the call is their beacon for finding frogs to gobble."

"There is a crack in everything God made," noticed Emerson. The more eager the little fellow is to mate, the more likely he is to be eaten by a bat.

What kind of world has God put together for us, dear reader? We ask the question not expecting an answer, but offering one: it is a strange world. But the weirdness of the world seems to have a pattern to it…a pattern of perversity, with cracks big enough to bury a split-foyer. When the tungara frog, for example, undertakes to whine his way to what he most wants – love and immortality – he gets what he least wants: almost immediate extinction.

Nationwide, houses have been going up in price at about the same rate as increases in the money supply…that is, about 8% per year. In certain areas, the increases have been far more resplendent, lighting up homeowners’ hearts with increases of 20% to 30% in a single year. Taken altogether, since 1997 total housing values have risen from $8.8 trillion to around $14 trillion.

Real Estate Bubble: Whining Your Way into Debt

This ‘free money’ has been so alluring that homeowners hopped over to their local banks to get at them, and then whined their way deeper into debt. The financial industry, ever ready to separate a fool from his money, rushed to the scene with the offer of home equity lines of credit that could be used "for everyday expenses, like groceries and gas."

Thus does the world’s mouth (as the U.S. has been called) gobble down its own houses one brick at a time. The homeowner, thinking he’s getting something for nothing, believes he is merely taking some of his gains off the table – like selling a few shares of appreciated stock. Little does he seem to realize, he is selling the table itself…along with the kid’s bathroom and the family room.

If, for example, his house went from a $100,000 price to a price of $200,000, he may feel he can ‘take out’ $100,000 of equity and still be living in a $100,000 house. But what he is actually doing is selling half of the house to the mortgage lender. Even if the higher prices stick, he still has to live somewhere….and now he has to ‘rent’ half his house from the mortgagor.

Another important difference between stocks and real estate is realized when the bubble finally bursts. The man who has sold off half his portfolio of stocks is actually a winner. When the other half crashes…he walks away from it.

But when a real estate bubble bursts, there are at least two losers – the borrower as well as the lender – and neither walks away easily. The borrower still has to pay his mortgage or he loses his house, and often must pay a mortgage that is higher than the value of the house. Many cannot or will not pay, which bounces the loss back onto the lender.

Real Estate Bubble: A Shrewd Financial Move?

But such is the cold, cold world we live in that the appeal of rising asset values – whether real or paper – is almost irresistible. Bats or no bats, the lumpeninvestoriat can barely wait to begin croaking.

The average house in San Jose now sells for half a million dollars, a reader tells us (below). How many people in the San Jose area can afford a $500,000 house? We don’t know. But we suspect that the number is less than the number of owners. Americans have become convinced that buying as much house as you can – even more than you can comfortably afford – is a shrewd financial move.

"Generations upon generations within the United States," writes Michael J. Burry, "believe that terrific home value appreciation is both rational and certain…The current population simply possesses very little direct experience with devastating national housing deflation. Treacherous cyclicality [price deflation] is at once absolutely certain to occur and yet implicitly, patently denied by nearly all today. For all time frames, complacency is the rule…"

People believe rising real estate prices are as close to a sure thing as anything can be. But when an investment is sure…it is surely a mistake.

"Clearly, a housing deflation would not be a pleasant experience," continues Mr. Burry. "In the more recent real estate bubbles of Britain, Japan and Hong Kong, the point was made that there was and is finite land available – which was true. Such logic formed the basis for the famous late-1980s argument that the island nation of Japan, smaller than California, was worth more than all the land in the entire U.S. But the corollary that prices could not fall due to land scarcity never proved true."

Real Estate Bubble: Replacement Costs

Another argument frequently made is that housing prices merely reflect the increase in ‘replacement cost’ of new homes. Since people need to live somewhere, it is reasonable to expect that houses will not fall below replacement costs.

And yet, every capital asset does sooner or later fall below replacement costs – including houses. We recently offered for sale one of our buildings in Baltimore – an architectural gem designed by Stanford White and built in the 1880s. Builders estimated that it would cost $5 million to replace the ornate mansion. But in downtown Baltimore today, we find no line of buyers willing to pay even $750,000.

And who, save perhaps John Templeton, is old enough to recall what happened to housing in the 1930s? Mr. Bury reminds us:

"In 1933, during the fourth year of the Great Depression, the U.S. found itself in the midst of a housing crisis that put housing starts at 10% of the level of 1925. Roughly half of all mortgage debt was in default. During the 1930s, housing prices collapsed nationwide by roughly 80%."

Earlier this year, a Harris Poll revealed that 2/3rds of investors were unaware that rising interest rates would have a negative impact on bond prices. Homeowners seem unaware that interest rates can rise at all…or that house prices can fall. And they are as unprepared for it as the tungara frog for the fringe-mouthed bat.

Your editor, Bill Bonner

October 17, 2003 — Paris, France

P.S. Below, a reader approaches the issue from a different angle. Readers are invited to replace ‘land’ with the more modern and comprehensive term, ‘capital assets.’

"I just read the commentary by Bill Bonner concerning the mystery of how equity accumulates, magically, in the normal home. Around 120 years ago, the ‘self taught’ economist and philosopher, Henry George, wondered about the same thing. In fact, Henry George could have predicted the economic circumstances that most of the industrialized nations find themselves in. The answer is simple speculation.

"….With speculators in full control, the price of the asset speculated in has no option other than to inflate. The problem is that at some point in the inflation process, land becomes so expensive that any goods and services made by the people on that land, can no longer be competitive. Gee, does that sound like the industrialized west or not?

"Here is a vicious circle for you to contemplate. Land values, after years of inflation, have the effect of reducing the competitive nature of the products made by the people that live on said land. The nation goes into recession. In order to get the nation out of the recession, policies are put into place that cause further inflation of the land, making the goods and services of these people even less competitive on the world market. Soon, all of the jobs go to countries that have not yet discovered the ‘something for nothing’ world of real estate speculation. And, the surprising thing is, everybody wonders where the jobs went.

"There are some that look at the issue from an ideological point of view. The reason that California is losing jobs at a horrific rate is not because of the workers comp system or the fact that most employers need to provide health care. The reason is that the average house price in the San Jose area is around half a million dollars. Even if, say, an engineer did not need to eat, buy a car, etc, he would still need to pay rent or a mortgage. His mortgage is more than the monthly income of the same engineer in India or China."

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the Wall Street Journal best-seller: "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).

Our lead story today comes from Sarasota, Florida, courtesy of the International Herald Tribune. There, it is reported that the Metheusela of investment mavens, John Templeton, 92, says you should get out of U.S. stocks, the U.S. dollar and ‘excess’ residential real estate.

Templeton believes the dollar will fall 40% against other major currencies…and that this will lead the nation’s major creditors – notably Japan and China – to dump their U.S. bonds, which will cause interest rates to run up, thus beginning a long period of stagflation.

The Florida reporter felt he should get a second opinion from the local brokers and fund managers. None wanted to contradict the great man directly, but neither did they want their customers to think he might be right. "It probably won’t be that bad," was the gist of their remarks. "Bush wouldn’t let the dollar fall too much," said one. Another thought she saw a way to undermine Templeton’s authority. His age, she noted, "could count against him."

Templeton was still sharp in 1999. While the financial industry hacks in Florida were urging their customers to buy more tech stocks, Templeton warned that the bubble would soon burst. He was right; they were wrong. Of course, he was only 88 back then.

He is almost certainly right again. The idea was confirmed when we let our eye wander from the on-line news story to the ads nearby. Next to a "Win Dinner with P. Diddy," which we didn’t know whether to regard as an invitation or a threat, is one that asks: "Why not try something new: Currency Trading On-Line?"

Why not? Sure, give it a whirl…The odds are better at the racetrack, but this is something you can do from home. Perfect for the millions of people who have lost their jobs since the recovery began. Sure…trade currencies until your heart breaks or your money gives out…why not?

That anyone would believe he could make money trading currencies is evidence of rampant, hallucinatory optimism. At least, you might be able to buy a decent stock paying a decent dividend…and the company might prosper…and the growth in the company and the economy at large could make it a decent investment. But currencies are a zero-sum game. They trade against each other; when one goes up, the other must go down.

But that doesn’t mean the investor has a 50/50 chance of making money. There’s also the ‘friction’ in the system…the cost of trading…the money that you must pay to the financial industry itself to support the quacks who tell you to ignore Templeton.

"There is one last point I wish to make about the gigantic financial brothel the Fed has established," Marc Faber concluded. "A visit doesn’t come cheap. We, the whores [Marc is a fund manager as well as a writer], all live very well, travel, stay and eat in style at our clients’ expense, and charge them legal, advisory, management, and director’s or trustees’ fees, and commissions. Moreover, the bordello’s furniture, maintenance, health controls, advertising, and supervision in the form of Bloomberg and Reuters machines, compliance officers, legal services, back offices, and regulatory supervision, and exchange fees add considerably to its overheads. It is inevitable, therefore, that as the financial market grows disproportionately faster than the real economy, an increasing wealth transfer between the clients and the brothel’s owners and its willing and self-interested, and mostly charming service providers will take place, which will have an increasingly significant impact on the clients’ purses."

And yet the clients practically line up to have their pockets picked. They have come to believe something that isn’t true…but it is such a comforting delusion they can’t give it up: that all they have to do is buy a house or buy stocks and that ‘equity’ will come to them like a vamp in the night.

"I don’t recall any previous time when fund managers were as ‘bullishly positioned,’" Faber points out. Quoting James Montier, he continues:

"The U.S. market is still exceedingly expensive. On the basis of a Graham and Dodd P/E, the S&P 500 is trading on a 30x multiple. Such stratospheric valuation would be fine, if investors were rationally expecting a very long-run return. However, both our model of irrational expectations and the UBS survey of individual optimism suggest that investors are still suffering a collective delusion of the likely returns from equity investing."

Marc, by the way, has made some very complementary remarks about the book we wrote with Addison. "My first reaction was that reading another investment book would be a painful waste of time," he wrote in an e-mail from Hong Kong. "But on a flight where I had nothing better to do, I started to read…and what a pleasant surprise. I could not put this book down…I enjoyed it immensely!"

Our friend the Mogambo Guru gave it Five Mogambo Stars this week. "It is a fab-u-lo-so book that I could have written, if I had any talent," says the great one. He suggests: "You should get this book, and read it, and then periodically get it out and read a few random pages every day. And read the Mogambo Guru, too. Then, one glorious day, all that stuff will suddenly click in your brain, and you will suddenly realize, in your own moment of Transcendent True Enlightenment…"

Who are we to argue? The book is once again available at

Over to you, Addison…


Addison Wiggin in the City of Lights…

– Gold is hovering around the mid-$370 range. The dollar is holding pretty steady at $1.15-$1.18 per euro. The Dow seems content somewhere around the 9800 range. The Nasdaq happily rests at 1950, and the S&P can’t shake 1050. Bullish predictions of the fabled 10,000 and 2,000 will have to hold on for another day…

– Jobless claims are at their lowest in 8 months, says Bloomberg. "Sales Feed Optimism On Growth" reads a headline in the Washington Post…setting the stage for predictions that the economy is now growing at a 3.5% rate. The High Frequency Economists are quoted in the article as pushing their "estimate for third-quarter economic growth to 7.5%."

– It seems so simple to some: "You give consumers a tax cut and they’ll spend it," says Ken Mayland, an economist in Cleveland. "That’s the way America works."

– The Fed’s Beige book came out yesterday, appearing on the surface to confirm the more bullish effects of the Bush tax incentive plan and low, low, low rates set by Mr. Greenspan and his hoary harem.

– The "Beige Book" – named after the color of cover on the report – is a survey of economic activity in the 12 regions that make up the Federal Reserve System. The New York Fed, which prepares the book, is careful to point out that the survey summarizes "comments received from businesses and other contacts outside the Federal Reserve and is not a commentary on the views of Federal Reserve officials." Still, economists, financial analysts and journalist the globe over get all hot and bothered when the book is released. Yesterday’s records business activity through October 7th.

– A quick read through the Beige Book, and you would think predictions of 7.5% growth were not only possible, but sustainable. Consumer spending "generally strengthened"…though most districts report a pull back in auto sales. Ten of twelve districts report economic activity is improving. Only Boston and Cleveland are bucking the trend. "Virtually all districts" report smoking housing markets. And financial institutions report "favorable conditions and brisk growth." Up and away we go…

– Wait, wait…what’s this? "Labor markets generally remain slack," confirms the Beige Book. And while residential real estate remains robust, that of the commercial persuasion is still characterized as "weak" in all districts…what’s more, steep declines in mortgage refinancing have been reported across the board. Prices for raw commodities – steel, lumber, plywood, and gas – are all rising sharply. Wage increases were "modest" at best, yet non-wage benefit costs, particularly health insurance, were described as "escalating" rapidly.

– What should we make of all this? Well it’s clear what the financial media and economists of the Keynesian persuasion would like you to think: The witches brew of government spending, tax cuts and low rates has gussied up the U.S. consumer enough to the point where she feels it would be a crime not to whip out the credit cards for a night on the town. "I’m looking a little to ‘hot’ to stay in tonight," you can practically hear her purring.

– Of course, as you might rightly guess, we here at the Daily Reckoning Paris hideout have an alternate opinion. Never ones to miss an opportunity to grouse and snicker, we’d like to point out a few of the specks, dimples and warts on the exposed derrière of the reflatable doll known as the U.S. economy. To begin with we remind you that consumer spending still makes up 70% of GDP. Spending your tax-break money on new barbecue implements does not a sustainable recovery make. Nor does charging your way through the gee-gaw aisle at Wall-Mart.

– Still, the Fed’s most quotable mouthpiece of late, Ben Bernanke, remains steadfast, undaunted…even a bit cocksure. "Given the rate of increase in spending and output that we are now witnessing," he blabbed to the Senate Banking Committee on Tuesday, "a reasonable expectation is that firms will need to add significant numbers of workers in the next several quarters."

– "Consumers feel supported by income-tax-relief-belief, and a strong dose of wealth reflation," writes the inimitable analyst/trader/basket-ball player Greg Weldon, "and despite bouts of confidence-shaken-confidence readings related to JOB anxiety…consumers are strutting right now." Consumers’ incomes, however, are not keeping pace with their spending habits. In fact, despite August’s widely reported increase in jobs for the first time since January, incomes dropped in September. "There have only been three instances," Weldon continues, "of no-growth in Average Hourly Earnings on a month-over-month basis. Once in 1993, once in 1994 and the other time coming just this year…meaning…that the income ‘deflation’ of 2003 is something NOT SEEN in at least a decade."

– And the ‘surprise’ 57,000 jobs increase from last week? A spit in the pan compared to what’s needed to reverse the jobless rate. James Glassman, an economist at JP Morgan, told CNN yesterday: "It would take jobs growth of 200,000 to 300,000 a month for six months or more to make a dent in unemployment."


Bill Bonner, on the banks of the Seine…

*** The LA Times guesses that "U.S. third-quarter growth may reach 6%." Bloomberg says growth in Argentina is at 7%. And in China, growth continues at more than 8%. Is this a new world-wide boom? Probably not. Every molehill of growth, particularly in America, comes at the expense of an Everest of debt. This is not like any other cyclical recovery – ever. In our humble opinion, it is a phony recovery that cannot be sustained and that will eventually end in an even worse mess.

*** Used to be, people over the age of 50 had a hard time getting mortgages. How would they ever pay them off, bankers wanted to know. But in this brave new world of ‘what’s-my-monthly-payment,’ more and more people expect to carry mortgage payments with them into retirement and die owing the banks money. Things just get better and better, don’t they, dear reader?

*** If the U.S. is going the way of the Third World…we should expect hyperinflation of the currency (eventually). We should also expect U.S. debt – state, municipal and U.S. Treasury bonds – to be marked down to junk status…and trade like the bonds of Argentina or Zimbabwe. Is it beginning already? Dan Denning sends this note:

"First Pittsburgh, what next?

"Today’s WSJ reports: ‘Standard & Poor’s dropped its credit rating of Pittsburgh’s municipal debt by five notches to junk status…The decision by S&P, announced Wednesday, affects about $879 million of Pittsburgh debt outstanding, all of which is insured, meaning any losses from a possible default would be born by insurance firms instead of investors.’

"The article added that, ‘the action nevertheless made investors nervous as it was one of the sharpest downgrades of tax-exempt municipal debt since California’s Orange County filed for bankruptcy protection in 1994.’ Nervous is just the beginning. Downright scared comes soon after.

"Of course, there’s a big difference between Pittsburgh and the United States government. But the dynamics of debt default are simple: if you borrow too much, sooner or later you’re going to pay the price in either higher borrowing costs…or the downgrading of your outstanding debt."

The Daily Reckoning