The blow to the average American’s balance sheet from the crash of the stock market has been greatly softened by the boom in housing prices…but should you continue to buy real estate? "Not to build wealth," suggests Doug Casey.

We’ve discussed property fairly often in these pages in recent years – but mostly in the context of smart speculations outside the U.S.. And I strongly urge readers to have property outside their ‘homeland’. But how about prices within the U.S.?

The Aspen Times recently ran a short note which I suspect is a straw in the wind. It seems that in Franklin Township, NJ, near Princeton, there’s a 34,000 square-foot house on forty-eight wooded acres that’s been on the market now for over a year, at $12 million.

Considering its size, location, the boom in property, and the fact that construction costs were about $10 million, $12 million doesn’t sound outlandish. In the hope of moving it, the owners put the house up for auction, but it failed to attract even the minimum reserve of $3 million.

It’s apparently an unusual house, although when something is that far off, we’re talking about a weak market indeed. Which is probably why the Aspen paper took note.

Real Estate Bust: 81612

Aspen is a town of about 6,000 people, where it’s literally impossible to buy a detached house for under a million dollars. The average house goes for about $2.6 million, making 81612 the most expensive zip code in the U.S. (with the exception of the anomalous Jupiter, FL). That’s the good news, if you already own a house.

The bad news is that there are presently about 50 houses being offered for over $5 million in Aspen, and not one has a contract. It’s the softest market in memory, and Aspen runs on real estate. Most of the people that own houses in this price range do so for cash, so they don’t have the interest clock ticking, like the average American. But prices are actually dropping.

This is strictly anecdotal evidence. There really isn’t any such thing as ‘the housing market’; rather, there are thousands of micro markets. But my question is, with mortgage rates at historic lows (perhaps 4.75% for an ARM), what is likely to happen when rates cyclically (inevitably) go back up?

Should you be a buyer or a seller of property in the U.S. today? Perhaps that’s a question best addressed to a financial planner. And long-time readers know I have little interest or inclination towards that discipline. Of course property is always going to have value (possibly unlike other popular investment classes, like stocks, bonds, futures, or even cash). And property has always been very, very good to me.

I’m favorably inclined towards real estate as an investment class. But as a means of growing wealth, the party is over, for now at least.

Real Estate Bust: Two Ways to Play Real Estate

The way I see it, there are two ways to play real estate. Either sell, and do something better with the capital; or borrow heavily against it with a fixed-rate, long-term loan. Do something intelligent with the proceeds, and count on inflation to decrease the value of the loan faster than the market can decrease the value of the property.

In a time of rising interest rates, staggering debt loads, declining economic activity, growing unemployment, and rising property taxes, real estate just isn’t a good holding. Especially at the end of a manic boom. Sure, there are exceptions, like farmland, which will be bolstered by higher commodity prices. But, except for properties I want to own strictly for personal reasons, all my stuff is on the block. I hope to buy it back in some years for substantially less, and have substantially more money with which to do it.

Remember how ugly things were at the bottom of the national property market in 1975, or 1982? Or regional busts later on in places like Denver, Calgary, and California? I suspect it could look that bad again. Could it get as bad as it did in the 30s when, believe it or not, property (including residential) dropped as much as the stock market, but was less liquid? I’m not making any predictions, except to say that anything is possible…

The property market correlates closely with long-term interest rates. Bonds correlate with them exactly. As much as I dislike property now, I’d rather own property than bonds. I’ve always considered bonds primarily a speculative vehicle. They’re a triple threat to capital as long-term holdings. They’re affected by interest rates, the creditworthiness of the issuer, and the value of the currency. Right now – although this has really been true for several years – bonds are a gigantic accident waiting to happen. The general belief is that U.S. Treasury bonds would benefit from a catastrophic deflation. Although (and I know this runs counter to prevailing wisdom), maybe not.

Even though trillions of dollars wiped out by deflation would arguably make each remaining dollar more valuable, the size of the Government’s debt relative to the economy at that point might bring the whole issue into question.

Real Estate Bust: The Inflation/Deflation Battle

But as much as massive inflation or catastrophic deflation are both possible (possibly in sequence and possibly in different parts of the economy at the same time), I’m of the opinion that inflation will win out.

The argument for deflation hinges on whether the market can wipe out dollars faster than the Fed and the banking system can create new ones. It’s an interesting problem. After all, trillions of make-believe assets have vanished in the stock market meltdown since 2000. Yet there hasn’t been deflation. That blow to the average American’s balance sheet has been greatly softened by the boom in housing prices and bond prices. So a great deal of what people have lost in stocks (assuming a reasonably balanced portfolio, which most people with assets in fact maintain), they’ve made back in bonds and property. I don’t think the housing and bond markets are going to soften the next plunge in stocks. The chances are better they’re going to aggravate its effects.

So far, therefore, things haven’t been all that bad. The problem lies with interest rates. When rates head back up, bonds will crash. Housing prices will inevitably weaken. And stocks will get even worse. Trillions more will probably be wiped off American balance sheets as a result. And the Fed is going to create more dollars, twenty-four hours a day, seven days a week.

So the question then becomes: what will make interest rates rise? The single biggest factor would appear to be inflation (used here as the rise in the general price level). And what will bring back inflation? I’ve made the argument for years that what is actually holding the whole house of cards together is America’s gigantic trade deficit, now running about $500 billion annually. It’s worth going over again. And again. And again, since people naturally just don’t think of the real macro picture. It’s theoretical; you don’t see it before your eyes every day.

Real Estate Bust: Fantasy Coming to an End

Americans export paper dollars, and import shiploads of Mercedeses, Sonys, and oil. Foreigners use many of those dollars to buy U.S. stocks and bonds, so the deficit keeps financial assets high. Many more of the dollars are held as reserves by foreign central banks, and private savings by foreign citizens. At some point, however, this moving paper fantasy must come to an end, simply because, as Fed Governor Bernanke famously pointed out, the U.S. Government can create an infinite number of dollars out of thin air.

As far back as October 2001, I came to the conclusion that the dollar was likely at a peak, and was headed down. Since then, the Australian dollar has risen 29%, and the standout New Zealand dollar 41%.

When the U.S. trade deficit turns around and becomes a surplus, inflation in the U.S. will soar, and the value of the dollar will collapse. And so will the value of U.S. stocks, bonds, and property. It’s going to be like what happened in the 70s – except much worse.

In this context, the average American doesn’t have a clue how the value of his house relates to things like foreign exchange and the trade deficit. If I’m right, he’s likely to be blindsided.

I hesitate to recommend that anyone sell their house, take the money and run. Even if it turns out to be the most remunerative thing to do. It’s by far the most important asset most people have, and everyone needs a place to live – entirely apart from the fact that they might fritter, or malinvest the proceeds. Maybe that’s an academic point, though, in that practically everyone seems to be refinancing their home. And sometimes taking out loans for an unbelievable 125% of the market value of their house when they do so. That amounts to more than selling one’s house.

What’s going to happen when rates go up significantly? A lot of people are going to have their houses foreclosed on. It will happen exactly when unemployment starts hitting serious highs…and it’s going to happen in the face of a weak market. Both the lenders and the borrowers are going to be in a lot of trouble.


Doug Casey,
for The Daily Reckoning

September 17, 2003

P.S. I really can’t think of any conventional financial assets I want to own. Stocks, bonds, property – they’re all off their highs, but they’ve just started their slide.

The way I see it, the precious metals – gold and silver – are really all you need to know for at least the next few years.

International Speculator Doug Casey has been seeking and finding incredible opportunities around the world for 25 years. Mr. Casey is the author of the best- sellers Crisis Investing and Crisis Investing for the Rest of the 90’s, as well as one of the more opinionated contributors to The Daily Reckoning.

It is all so phony…so absurd…we scarcely know what to laugh at first.

The recovery…the echo boom on Wall Street…Amazon.com at $45…the Demopublicans…the Republicrats…the Clintons…

The Clintons?

Yes, for some reason the Times of London has been doing a series on Bill Clinton. Yesterday, for example, we discovered that it was a bald-faced lie that got Bill Clinton the White House. The Clinton spin team decided to go on prime-time TV to deny Jennifer Flowers’ claim that she had had an affair with the man who was now the democratic candidate for president.

"It necessitated lying by the Clintons and collusion in such lying by the entire campaign team," says the Times article. No problem there…

And so on January 26, 1992, following the Super Bowl, a relatively unknown scoundrel from Arkansas went on 60 Minutes. "Wait a minute," said the much-rehearsed candidate to the interviewer, his wife by his side, "you’re looking at two people who love each other."

"The interview gave the Clintons the national exposure they needed, as a couple – and the result was beyond all expectations…"

We don’t know why it was beyond expectations. Nearly every president wins office by fraud of one sort or another. Woodrow Wilson promised to ‘keep us out of war,’ and then sent troops as soon as he was able. Franklin Roosevelt pledged to balance the budget and maintain the gold standard; he promptly went on a spending spree and made gold illegal. George W. Bush said he was a conservative. And though all presidents pledge to respect the constitution, the last to do so was probably Calvin Coolidge.

At least back in the days before 1971, that is, before gold was removed from the international monetary system…a president faced limits on how much fraud he could afford. ‘Guns, or Butter?’ was the question. An administration could not do both. But then, along came Lyndon Johnson, who tried to fight the war in Vietnam and the war on poverty at the same time. He lost both – at huge expense. Nixon was caught in LBJ’s trap; putting the nation back on sound financial footing would be expensive…and politically almost impossible; it would require a leader willing to tell the truth.

Instead, Nixon slammed shut the ‘gold window’ at the U.S. Department of the Treasury…and the rest is history. Ronald Reagan was able to offer taxpayers more guns and more butter than ever before – even while cutting marginal income tax rates. A huge boom began…which finally reached its ebullient stretch in the Clinton years. And now, we have reached the reign of the younger Bush and the biggest, most expensive Guns & Butter budget ever.

Every real growth spurt in the U.S. economy has been fueled by savings and a current account surplus. But now, the papers tell us the U.S. economy is recovering…beginning a great new phase of growth…with the largest current account deficit in history. In effect, the U.S. has to pass the hat among foreigners…and look under the seat cushions…to find about half a trillion dollars annually. That is the amount needed just to continue current consumption levels. Where will the money for growth come from?

We don’t know, dear reader, we don’t know.

Like everyone else…we wait to find out. Or, more likely, wait to discover that the recovery is as big a fraud as Bill Clinton.

Meanwhile, over to Eric Fry for more news:


Eric Fry in New York…

– The Fed’s inactivity, coupled with Hurricane Isabel’s hyper-activity, whipped up a gale-force buying frenzy on Wall Street yesterday. The Dow swirled to a 119-point gain at 9,567, while the Nasdaq whooshed 2.3% higher to 1,383. Gold stayed in the doldrums, dropping $1.00 to $374.60 an ounce.

– As widely reported, the FOMC governors convened in Washington yesterday, and then did…well…nothing. The governors pulled up to the Federal Building in their respective stretch limousines, schlepped their briefcases up the steps, strolled through the metal detectors and then sat around jawboning for several hours. After all that, the pinstriped FOMC governors decided to do what everyone already knew they would d absolutely nothing. They left the fed funds rate unchanged at 1%.

– Meanwhile, about 700 nautical miles southeast of the Federal Building, Hurricane Isabel was bearing down on the coast of North Carolina. As the New York office of the Daily Reckoning files this report, the category-2 hurricane is packing 105-mph winds and – to hear Wall Street analysts tell the tale – a heaven-sent bounty of economically stimulating devastation.

– "The approaching Hurricane Isabel is likely to destroy property and claim lives, but it’ll probably be a positive for the nation’s economy," a CBS Marketwatch headline declared (without the slightest hint of irony). "The storm, currently believed by forecasters to be taking aim at the North Carolina coast, will disrupt commerce, industry and travel for a few days – or even months in some cases." But fret not, the online news service counsels, "[The storm] is likely to actually increase overall economic activity in the coming weeks as individuals and businesses repair and restore their damaged property."

– Unfortunately, those of us living far from the Hurricane’s path will miss out on the storm’s devastation- induced prosperity. We’ll have to do the best we can, even if Isabel does not annihilate our homes and communities. Alternatively, we could take matters into our own hands – and contribute to the country’s GDP as well as we can – by crashing a bulldozer through our living rooms.

– "According to the National Oceanic and Atmospheric Administration, the most expensive storm to hit the United States was Hurricane Andrew in 1992, whose category 4 winds caused $35 billion in damages.

– "But when adjusted for inflation, the most expensive storm was in 1926, back before the practice of assigning names to hurricanes and tropical storms. That category-4 storm caused $87.1 billion in damages, measured in 2000 dollars, when it struck southeast Florida and Alabama.

– Of course, Hurricane George will likely be the most expensive environmental disturbance on record, costing more than $150 billion just by blowing through the Iraqi desert. Not to worry, though, Hurricane George could be even more bullish for the economy than Hurricane Isabel.

– Will the hurricane derail the stock market rally when touches down on the Carolina coast? "Heck, no," Wall Street’s finest maintain. "Storms are bullish!" Indeed, destruction in any form is bullish. The only event more bullish for the stock market than a natural disaster is a man-made disaster, like war – especially a distant war against a feeble army.

– According to the FOMC, however, the economy doesn’t need much help. "The Committee continues to believe that an accommodative stance of monetary policy," the FOMC’s post- meeting statement declared, "coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity…[blah, blah, blah…blah, blah, blah]."

– While it’s true that the FOMC left interest rates unchanged, and that it believes the economy is improving, the committee did not fail to provide one particularly riveting insight: "The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal." Funny, those odds don’t seem too much better than when the Fed first started cutting rates two and a half years ago. The Fed has cut its federal funds target rate 13 times since January 2001 by a total of 5.50 percentage points.

– Finally, after nearly two years of non-stop interest rate cuts, the economy is starting to recover somewhat. But it is recovering without pulling the job market along with it. The U.S. economy has lost 2.8 million jobs since the latest recession began in March 2001. And just last week, the number of people applying for unemployment insurance jumped to a two-month high.

– Maybe the 14th rate cut will do the trick.


Bill Bonner, back in London…

*** Eric’s comment about the approach of Hurricane Isabel reminds us that at market tops, all events are given a bullish spin. In Japan, in the late ’80s, investors were so optimistic that they bid up stocks following an earthquake in Tokyo!

*** The price of gold fell $1 yesterday. But gold stocks are doing better than the S&P.

*** "Greenspan and Bernanke appear to be willing to sacrifice bond traders for the ‘greater good’" writes Addison. "Every time Greenspan speaks, or the FOMC meets, bonds get hammered."

The following is more from Addison’s report on his luncheon with Jim Bianco and the Arbor Research crew: "According to Bianco & c ‘Since the FOMC adopted the ‘Bernanke view’ on May 6, every time the FOMC/Greenspan speaks, the bond market has collapsed. It’s a record that would make G. William Miller jealous. Witness:

‘On June 25, the FOMC cut the targeted federal fund rates 25 basis points to 1.00%. Bonds fell over three points – their worst reaction to an ease in the history of the Greenspan Fed (Since Greenspan became chairman, the Fed has moved the funds rate 77 times – 45 eases and 32 hikes).

‘On July 15, Greenspan spoke about the economy. In his testimony, twice he said: "The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance."

‘That day, bonds fell over two points, their worst reaction to any of Greenspan’s 171 testimonies since becoming Fed chairman in August 1987.

‘On August 12, the FOMC re-iterated its dovish talk of June 25. The next day, bonds collapsed over 2 1/2 points.

‘On August 29, Greenspan spoke at "Fed camp" (the Jackson Hole, WY Fed gathering). Over the next two trading days, bonds slumped almost 3 points…’"

*** Yesterday, after the FOMC decided to leave rates unchanged, the 10-year Treasury note ending trading in the red – down a slight 6/32. But if bonds follow the trend set this summer, they will fall some more today…

*** Shui Pao! Shui Pao! Shui Pao! Want proof? Look in Forbes. You will find an ad for luxury condos in Shanghai! No ads for luxury condos in Baltimore have been spotted.

*** Bloomberg columnist William Pesek: "Calls for China to let the yuan trade freely – in other words, let it rise – are about politics, not economics. The Bush administration has failed to create jobs in an economy that’s lost 2.6 million jobs since January 2001. The search for excuses has led the White House to China.

"It’s hard to keep a straight face as a nation with per capita income more than 10 times that of China tries to play the victim. Yet that’s exactly the game Washington politicians and lobbyists for companies including Boeing Co. and Nucor Corp. are playing…

"Next year, many elected officials – including President George W. Bush – will need to explain why the U.S. isn’t creating jobs. The last thing politicians are going to admit is that their efforts aren’t boosting U.S. living standards. They’re also loath to remove U.S. farm subsidies, which do more harm to developing economies than politicians may realize.

"Against that backdrop, China makes a convenient scapegoat. Corporate America used to blame the Japanese for its deficiencies. The Chinese are now playing that role. And U.S. politicians know it’s a winning strategy for them at the polls. Chances are, more than a few voters from Seattle to Miami will buy the idea that communists in Beijing are stealing their jobs…"

The Daily Reckoning