Re: [A-List] US Real Estate Bubble.

["Anne Williamson" <annewilliamson@xxxxxxx>]

Sabri:  You asked if I had any comment on the RE
bubble, but I have had no time to respond due to burdensome
legal obligations/deadlines, but I think this essay of
Gary North's should be of interest to you.  The lead
is long, but he makes a very important point about
the bubble, and the probable future. -A.

                Gary North's REALITY CHECK

Issue 137                                       May 2, 2002

                THE DEBT/INFLATION RATCHET

     We are all familiar with ratchets.  A bar with a
tapered end locks into place a gear, so that the gear
cannot move backward.  Then force is applied to the gear in
order to move it in one direction.  Click by click, the
ratchet system prevents the gear from moving backward.
Click by click, the system governed by the ratchet moves in
one direction.

     This is the monetary condition of the world's economy
today.  A few items are so price competitive through
innovation that they continue to move down in price.  We
see this anti-ratchet effect in computers and computer-
related equipment.  Moore's law is actually accelerating.
The chips are now doubling in capacity every 12 months, not
ever 18.  This is not fast enough to speed up the boot-up
process of the latest Microsoft operating system.  ("Intel
giveth, and Microsoft taketh away.")  But, once booted, the
computer is faster.


COMPUTERS VS. PRICE INFLATION

     There is a kind of war between the price effects of
computerization and the price effects of monetary
inflation.  I personally experienced this dualism
yesterday.  I installed, and then removed, an ancient
Hewlett Packard Laserjet III printer.  I thought I needed
it to make a decade-old program on my computer function
properly.  I was wrong.  A Laserjet III was a real
improvement over the predecessor, which I also owned, but
at 300 dots per inch, it's not up to par today.  Most
important, it is heavy.  I mean really heavy.  I can hold
an HP 1100 (now several years old) in one hand.  It puts
out 600 dpi.  It doesn't hold a tray of paper that the
Laserjets III and IV did -- a liability -- but it is
cheaper and far more convenient.  So, I have compromised.
I reinstalled my old Laserjet IV, which holds its price in
the used printer market because of the tray.

     The improvement in desktop printers has been constant.
Prices have fallen; quality has improved.  These are
tangible benefits.  Consumers are now used to this in
printer technology.  We expect advances.  But in few other
areas of life are there comparable examples.

     Yesterday, I also experienced first-hand the other
side of the coin.  I watched a Rhino video of what was my
favorite TV show fifty-two years ago, "Space Patrol."  The
budget was low even for those days.  The sets were actually
cheaper looking than the even older "Captain Video"
program, which seems inconceivable.  (I was never a
"Captain Video" fan.)  How I could have been a fan of
"Space Patrol," yet also think that Jose Ferrer's "Cyrano
de Bergerac" and Alistair Sim's "Christmas Carol" were
great movies -- which they were -- escapes me.  I had the
entertainment aesthetics of an adult co-existing with those
of a child.

     "Space Patrol" in its TV and radio versions created
the original market for Wheat Chex and Rice Chex, allowing
Ralston Purina to replace the never-popular Hot Ralston
cereal.  The show was incredibly popular among pre-teen
boys.  It ran for five years (daily: 15 minutes), plus a
twice-a-week radio show, plus a weekly half-hour.  It was a
phenomenon.

http://www.grapevinevideo.com/space_patrol.htm

     Even more incredibly, after the show went national,
polls indicated that 60% of the audience was adults.

http://www.sundaycomicsonline.com/space_patrol.htm

     Rhino wisely retained the show's original commercials,
which are far more interesting today than the scripts.
Nestle was an alternative sponsor.  The actors came on-
camera and promote Nestle's products.  The candy bars --
Crunch, etc. -- sold for a dime.  My wife's comment was
"This will prove to our children that candy bars really did
sell for a dime."

     The product line hasn't changed.  What has changed is
the price.  Also, the bars looked bigger on-screen, which I
suspect they were.  So, the manufacturer reduced the
quantity in order to forestall price increases.  We rarely
get an opportunity to compare the same product, without
improvements, over time.  Food products are one of the few
whose formulas don't change much, and candy especially.
Taste matters, so manufacturers are afraid to tamper with
the formulas.  They prefer to reduce sizes or change
packaging.  They resist passing on price increases.  So,
when we can compare today's prices with prices a half
century ago, we can see what has happened to the purchasing
power of dollar.

     When the show first aired, in 1950, on the local ABC
TV station in Los Angeles, the actor who played "Cadet
Happy," Lyn Osborn, was paid $8 per show, meaning the pre-
tax equivalent of 80 Nestle candy bars.  I have no idea how
he paid his rent.


MARKET FAILURE OR ANALYTICAL FAILURE?

     A free market monetary system allows users of
commercial banking services to impose negative sanctions
against mismanagement.  If they suspect that a bank has
loaned out more money than the bank has immediately
withdrawable reserves on deposit, thereby increasing the
money supply and also the risk of a bank run, a bank run
begins.  The bank is forced to call in loans and restrict
the issuing of new loans.  The money supply then shrinks.

     The free market imposes restraints on the expansion of
money.  It does so bank by bank.  It imposes restraints on
individual banks, which in turn impose restraints on the
commercial banking system as a whole.  Micro-incentives to
restrict the issuing of new loans with newly created credit
money therefore impose macro-restrictions on the entire
money supply.

     This is the classic characteristic of the free market.
A positive result in the aggregate is attained by
individual decisions.  Out of the self-interested actions
of individuals emerges an unplanned system that benefits
most of the participants.  In short, "out of many, one."

     This self-regulating free market system of monetary
management has never impressed Milton Friedman, who is
famous for his attack on the gold standard and his
suggestion that what society needs is a government-run
monetary system that will increase the money supply by 3%
to 5% per annum -- a lot of flexibility there!

     This is a classic accusation of "market failure" by an
academic economist.  The free market has somehow failed to
maximize consumer benefits by providing a system that
restricts abuse.  It has failed to produce an optimum money
supply.  Yet, unlike a gold coin standard, which encourages
depositors' runs on overextended banks to get the gold they
are owed (deposits), as well as other commercial bankers'
runs on overextended banks to get the gold they are owed
(checks), Friedman's system has no independent, exogenous
(outside) negative sanctions against fractionally reserved
commercial banks' self-interested inflating of the money
supply.  The government must provide guidance and sanctions
for disobeying government guidelines.

     Friedman's brother-in-law, Aaron Director, who was
also a University of Chicago economist, took another view:
a fixed money supply with falling prices due to increased
production.  Friedman's recommendation has always had a
wider appeal than Director's among academic economists,
although no one has suggested any way to get the government
or a central bank to follow the 3% to 5% guideline.

     The result of government controls and central banking
has been the disappearance of the ten-cent candy bar.
Another result has been the creation of a debt structure
that encourages further monetary inflation.  I call this
the ratchet effect.


THE RATCHET EFFECT

     When new money unexpectedly id released into the
economy by the central bank, those who get early access to
the new money have a competitive advantage.  They can buy
at yesterday's prices.  So, new users of fiat money can buy
a disproportionate share of the economy's existing goods,
not because they have become more productive, but because
they have in their possession the newly created money.
Nice work if you can get it!

     How do you get it?  By going into debt.  The central
bank creates new money to buy government debt.  The
government immediately spends this money: checks.  Those
who receive these checks then deposit the money in their
bank, or else they cash the check and spend the money.
Banks wind up with the new money.  They lend out more
money, which in turn gets deposited: fractional reserve
banking.  So, for two groups of people -- recipients of
government funds and recipients of bank loans -- the
inflation process makes them winners.

     What we see, year by year, is an increase in the money
supply, an increase in government debt funded purchased by
the central bank, an increase in government spending, and
an increase in private debt.  All of this takes place
because the monetary system allows the central bank to use
government debt (or any other asset) as the nation's
monetary base: the legal reserve for the commercial banking
system's deposits.

     Debt produces hope for a future income stream.  People
will pay money today to buy an expected income stream.
They buy bonds: expected income streams.  They buy real
estate: expected income stream.  They buy annuities:
distantly expected income stream.  Create an income stream,
and you have created wealth.  When people bid to buy this
wealth, we call this process capitalization: the
capitalization of an expected income stream.

     These income streams are monetary.  But people's goal
in creating streams of income is the creation of consumable
income, not digits or pieces of paper with dead
politicians' pictures on them.  So, people's expectations
regarding future prices are important in establishing the
level of present demand for monetary income streams.

     If the process of monetary depreciation is slow
enough, people tend to forget what is happening to the
value of their locked-in streams of future monetary income.
I think of those Nestle candy bars.  I also remember going
to a movie on Saturday morning in 1951: 15 cents each way
for the bus, 25 cents for the movie ticket, and 10 cents
for a Butterfinger candy bar.  That bought me a day's
entertainment, 10 a.m. to 4 p.m.: a western, six cartoons,
a serial, a newsreel, and two adult features.  Plus,
previews of coming attractions.

     The Federal Reserve has acted to undermine the value
of streams of monetary income.  In response, voters have
pressured politicians to establish cost-of-living
escalators for Social Security payments.  So, the
government's statisticians do whatever they can to juggle
the data in such a way as to deflate the consumer price
index.  They prefer to include computers in the official
basket of goods rather than candy bars.  Moore's law is
their friend.

     The Median CPI, published by the Cleveland Federal
Reserve Bank, is not subject to political jiggling, because
it is not used to establish the government's official cost-
of-living estimate.  So far this year, the increase in the
Median CPI is moving at 3.7% annual rate.

     We discount the future.  Income received in the future
is not worth what the same income is worth to us today.  We
also tend to have confidence that the future will take care
of itself.  This is the right attitude with respect to the
bad things that might happen, but probably won't.  "Take
therefore no thought for the morrow: for the morrow shall
take thought for the things of itself.  Sufficient unto the
day is the evil thereof" (Matthew 6:34).  This optimism
encourages entrepreneurship.  But there is a downside to
this attitude in a world of central banking and government
debt: neglect of the declining future purchasing power of
money at the expense of looking at our net worth today.

     We look at rising prices for housing, and as home
owners, we rejoice.  We feel richer.  We do not emotionally
perceive that for every rise in our homes' value, we must
pay rising rent: the forfeited value of the income that we
could receive if we sold the home and invested the returns.
We think, "I'm rich!"  We then think, "I could be richer if
I borrowed money, bought another home, and get renters to
pay it off."  If we buy right, this is true.

http://www.johnschaub.com

     But leverage through debt is a two-way street.  The
debt meter keeps ticking even after the income stream dries
up.  If I pay $10,000 down on a $100,000 home, and I can
sell it a year later for a net return of $110,000, I have
made 100% on my investment, if I also rented it for what my
costs were.  But if I pay $10,000 down, and the price falls
to $90,000, I have lost 100% of my investment, and maybe I
could not rent it, either.  So, in order to keep from
getting hammered by the negative capital value effects of
deflation on leveraged contracts -- mortgages -- debtors
vote for politicians who promise to keep monetary income
high, and thereby protect us from the risk of default.

     In my view, the housing market is the ultimate example
of "moral hazard" that we face today.  The housing market
is too big to fail, meaning too big to be allowed to fail.
Yet the only thing that the government and the Federal
Reserve System can do to keep it from failing is to adopt a
policy of money creation.  This is what they have adopted.
The voters want it.

     Eviction for non-payment of one's mortgage is an
immediate problem.  Pension living is in the distant
future.  We look at today's wealth, or the reduction
thereof, and we make our political decisions accordingly.
We discount the negative long-run consequences of today's
political decisions.  We are willing for the Federal
Reserve System to sacrifice the value of future dollars in
order to sustain today's monetary income stream, and hence
the present market value, of our homes.

     This is the Great American Ratchet.  We have borrowed
money to capitalize our lifestyles.  We have indebted
ourselves to buy a consumer good that we pretend is a
capital good.  A house is a consumer good today -- real
income, not monetary income -- but will become a capital
good for us years from now: a salable stream of monetary
income, but not necessarily real income.  We buy real
income today by going into monetary debt.

     Because we are present-oriented, we have made a risky
exchange: real consumer income today in exchange for
promised monetary payments (a mortgage).  We justify this
because we think that the government will keep the supply
of fiat money flowing.  It undoubtedly will do just that.
But in pursuing real income now in exchange for making a
promise to pay a fixed amount of money over the life of a
mortgage, we are joining the nation's largest pressure
group for the politics of inflation.  We are undermining
our future stream of real income as retirees.  We justify
buying the home as a capital investment, yet this
investment is no better than what the purchasing power of
money will be when we finally decide to convert our
consumer good into capital.

     This is a self-reinforcing process.  It takes ever-
more debt to buy a home, and any increase in the monetary
value of the home (equity) serves as a lure for taking on
more debt.  Interest payments on homes are deductible from
gross income for income tax purposes.

     The ratchet of debt and inflation continues upward,
fueled by the public's confusion.  Home buyers do not
clearly distinguish real income from monetary income,
consumer goods from capital goods, and present real income
from future real income.  Man's inherent present-
orientation favors real income now over monetary income
later.  This favors real income now paid out of future
income later: debt.


THE MEXICAN STRATEGY

     Mexicans will do what the rest of Americans won't:
share rental space among more than one family.  While this
is illegal in most communities due to zoning laws, the
Mexicans' definition of a family is broader than the Anglo
and African-American definition.  So, they legally get away
with it.  "This is my cousin, Manuel."  His third cousin,
twice removed.  They pool their incomes to meet the monthly
mortgage payment on one house.  Thus, Mexicans are steadily
buying up African-American housing.  African-Americans for
decades in California used the block-cracking technique to
scare whites into selling at low prices.  Now Mexican-
Americans are using the multiple family technique to buy
out African-Americans.

     Block-cracking is no myth.  Almost 50 years ago, my
grandparents were warned to sell by their long-term black
housekeeper, who had cared for me as an infant for 6 months
when my parents were in Washington, D.C., waiting for my
father the be shipped out by the Army.  She came to them
and said that their neighborhood had been targeted for
transition.  How she knew, I don't know; maybe church
members were involved.  My grandparents refused to listen,
and they lost a lot of the equity in their home.  White
flight can be used against home owners by organized
African-Americans.  But family pooling of funds can be used
by Mexicans to gain their real estate goals, given the
mortgage system.

     Meanwhile, Asians are using personal productivity to
generate the income needed to buy up homes from the Anglos.

     Southern California is changing color.  About 500,000
whites left the state in the 1990's.  They are being bought
out: from below (block-cracking) and from above (higher
bids).

     The American dream is to own your own home.  It is a
worthy dream, but government guarantees have subsidized
this dream.  The dream now guarantees the decline in
purchasing power of the dollar.  The only alternative to
this scenario is a fall in real estate prices as a result
of a wave of defaults.  When monetary income no longer
allows existing home owners to pay off their mortgages, the
real estate market will break.  But will it break?  Not if
Alan Greenspan has anything to say about it.  Surely, he
does.


CONCLUSION

     The debt/inflation ratchet cranks ever higher.  The
central bank system subsidizes government spending and, by
way of funding this system, universal debt.  It has
subsidized a gigantic consumer debt market that is
incorrectly regarded as a capital goods market: housing.

     Investors say, "Don't fight the Fed."  If this applies
to buying stocks, then it is surely true of buying homes.
But we must not be naive.  The subsidized housing market is
a dagger at the heart of people's retirement plans.  The
golden years of retirement are now a myth.  A declining
dollar is going to destroy the dreams of a generation of
baby-boomers.  They will be joined in the long line of
disillusionment by their grandchildren, who will not be
able to get a down payment on the American dream.

     When governments control the money supply, you can be
sure of one thing: the long-term depreciation of the value
of official money.  The politics of now, when coupled with
the reality of long-term debt (payment tomorrow),
guarantees the destruction of money.  This is not a market
failure.  It is a government failure.  There are more
debtors who vote than creditors who vote.  Even when the
debtors (mortgage signers) are also creditors (pension
asset owners), they discount the future at the expense of
the present.  The present political power of the economic
present is far greater than the present political power of
the economic future.

     The rachet clicks upward, day by day.


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