How long does a condition last before people generally consider it permanent and adjust their behavior to accommodate it?
Credit inflation created by Federal Reserve Bank policy has been uninterrupted since prior to World War II. How permanent is that, and what kinds of perverse behaviors does such an assumption of permanence foster?
For one, people no longer save. Permanent inflation destroys the value of any savings held in dollars so people rapidly adopt actions that avoid this invisible tax. People immediately spend whatever money they have, before the cost of what they want inevitably rises (actually, before the value of their dollars declines in the sea of fresh dollar credits).
What, then, do we all do with the excess productivity our division-of-labor economy yields?
To me, saving is setting aside something with no expectation of gain, simply holding onto what I have. Speculation is involves risking something of value in order to gain more than that risked.
Holding Federal Reserve Notes under the mattress in an environment of inflation is to accept a guaranteed loss, year in and year out. Not such a great deal.
Instead, we have mutual funds. We have hedge funds. People can invest in precious metals, mining stocks, and for those willing to take even more risk of loss, options contracts and futures contracts that allow the control of large blocks of value but require only a small percentage of "down payment." We even have options on futures contracts to satisfy the gambler’s gambler. But what about those who don’t wish to gamble?
I hear people all the time say they are saving in their 401(k) plan at work. They tell me they don’t invest in stocks; they have mutual funds.
They’re speculating…and they don’t even know it.
Do you know any real estate speculators? No, I don’t mean the neighbors who bought five Florida condos planning to flip them. I mean anyone who put 20 percent or less down on a house and is paying off the mortgage over fifteen, twenty, or even thirty years.
I was a real estate speculator. Chances are, you are too. Lots of folks never plan to pay off their homes. The speculator’s rule is that once capital appreciation has raised your equity in your investment enough you use that to leverage up to a higher priced asset. In this case you buy a bigger house, often restarting the term of the loan.
Why not? Homes have experienced almost uninterrupted price inflation, and inflation is the speculator’s friend. You "invest" a small amount but enjoy capital price gain on the value of the entire property, even the part you don’t actually own. A 10% down payment followed by a 10% gain in property value yields a 100% gain on your investment.
Why, it’s magic! The joys of leveraged speculation without feeling the fear of loss that usually comes with speculation. What’s to fear when price inflation is guaranteed by our friends at the Fed?
We’re a nation of speculators. The Fed provides the whip to drive the herd into speculation, and decades of experience lull us all into a sense of comfortably complacency. The process invisibly impoverishes people and keeps them hanging on political promises from Washington DC and the local state legislature, so politicians absolutely love it.
All these behaviors have gone on for a long, long time but there’s no way that our times are in any way normal. Credit cards and home loans have been around for decades, but recently people became so complacent that both were practically thrown at persons with little capacity to manage and no history of servicing the payments on their debts.
This zenith in wild speculation coincided with governments at all levels going on their own spending sprees, paying for global wars and nation-building, promising public employee unions king-sized retirement packages — nothing was too extravagant.
While the length of a trend tells us nothing about its remaining lifespan, it’s been said that things that can’t go on forever, don’t. One day, perhaps soon, we will experience a phase change and what was deemed permanent simply…ends. I know lots of people think this stable inflation will end in hyper acceleration, but what if that’s wrong?
What would it look like if the seemingly permanent trend of inflation reversed? First and foremost we should see a widely owned asset class convincingly reverse from wildly overpriced amid a speculative mania to decline amid evidence of a contraction in credit availability.
The dominant belief is that significant or protracted contraction is impossible, yet how else should events in the real estate market be described? It remains to be seen if the contagion of credit contraction spreads and grows. I suspect it will, but have no proof.
Prices for things are high because of a deluge of credit-based liquidity, but clearly that flood is draining out from under home prices. Switching metaphors, visualize that prices for myriad goods and services are supported on the back of a dirigible of Hindenburg proportion, the hydrogen analogous to a vast balloon of credit & debt. What might an economy so supported look like if the fire spreads?
If no one remembers what the absence of inflation is like, consider how unprepared is a nation of speculators for a conflagration of its opposite.
November 26, 2007