Ryland Taniguchi

When long-term low rates cause the global economy to overheat and over-invest, the world produces more than it consumes and inevitably prices will dramatically decline. Falling prices create a vicious cycle of lower consumption, lower corporate profitability, bank failures caused by non-performing loans, and higher unemployment. Economists call this deflation.

WHAT IS DEFLATION?

Deflation is a negative inflation rate. Price drops give dollar holders strong incentives to save rather than consume or invest.

Depressions usually evolve from deflation. In our fractional reserve system, banks magically create money when they create loan ledgers. When you deposit $1000 into Wells Fargo at 3%, your bank can turn around and loan $10,000 (10 times the cash reserve holding requirements) at 24% in the form of a credit card loan. When debtors start defaulting on promises to pay, it can snowball into credit compression, cause massive bank failure, and create deflation. As asset prices drop for the underlying collateral of loans, banks typical see an increase in their non-performing loan portfolios.

CAN’T YOU SIMPLY PRINT MONEY TO PREVENT DEFLATION?

Not necessarily. Printing excessive money devalues the currency and causes import prices to increase without a corresponding increase in export prices. Even when interest rates hit zero, consumers and businesses will not borrow if they do not expect to earn profits or wages that exceed the interest on the loan.

The Fed stimulates the economy through credit expansion. To increase the money supply, the Fed Open Market Committee (FOMC) purchases assets (such as US Treasury bonds) from banks to increase their liquidity. Theoretically, banks should be able to jump start the economy by increasing their loans to consumers and businesses. As seen in 2010 and 2011, lending does not necessarily increase during a financial crisis because 1) the banks focus on eliminating their non-performing portfolios 2) loan eligibility falls as consumer and business credit and income decreases and 3) the demand for loans by consumers and businesses diminishes.

For over a decade, the FOMC kept interest rates at historical lows with all indicators signaling low levels of inflation. Despite record levels of credit expansion, low-wage labor from countries such as Bangladesh, Vietnam and Mexico drove down import prices and kept inflation in check. Through modern advances in manufacturing and logistics, global corporations now have unlimited access to $4/day labor around the world. In other words, global wage deflationary pressures tricked the Fed into believing that we were experiencing low inflation.

As a result of the FOMC’s decision to sustain long-term rates, this “easy money” led to asset price overvaluations in both the US stock and real estate markets. Asset price hyperinflation (as argued in prior blogs) resulted from global trade imbalances with the US running massive account deficits and China running account surpluses. As consumption in America decreases due to economic anxieties (especially for retirees) and labor contractions, the trade gaps will continue to widen unless the dollar falls comparative to America’s trading partners. As a result of these trade account deficits, the resulting foreign capital inflows fueled the bullish trend of the US stock market in the last twenty years. Unfortunately, what goes up must come down.

The global economy will soon enter a deflation-induced depression similar to what Japan has experienced since 1990. Technical analysis of the Dow Jones (in the graph below) shows a historical “M” pattern called the “Kiss Goodbye,” which forecasts the coming of a huge market crash. I’m forecasting that the Dow Jones will crash to 5,000 in 2011 or 2012. Unfortunately, millions of Americans will lose their retirement savings held in 401(k)s and mutual funds. Governments will try to jump-start the economy through fiscal stimulus but this time they are handcuffed by unsustainable national debts.

Even if fiscal and monetary stimulus comes to the rescue during this crash, the result will be an even bigger bubble that will crash more severely in the future. In some nations, running the currency printing press to fight deflation can cause the possibilities of hyperinflation similar to that experienced in Indonesia after the 1997 Asian Banking Crisis.

These blog posts sound pretty gloomy but these are exciting times for investors who know how to profit from the upcoming events. If you need a no-nonsense real estate and business broker (with connections to private money sources) who will help you with your real estate investments and/or business, please contact me at 206.832.9590. If you’d like to get my updated blogs, please like my “Like” my page at www.facebook.com/zempower.

History shows that powerful nations manipulate global currencies for their own domestic advancements. In light of this propensity, nations have resorted to gold standards as a self-correcting mechanism for leveling out global trade imbalances. A Gold Standard creates an interdependency of currencies, smaller balance of trade gaps, and lower worldwide inflation.

After World War I, the US hoarded gold to bolster its own domestic economy. The US held 27% of the world’s supply of gold in 1913 and increased their holdings to 38% of gold supplies by 1931. Reasons for the accumulation of gold stock include conservative Fed policies (money and price levels remained unchanged from 1925 to 1929) and restrictive protective tariffs such as the 1930 Smoot-Hawley Act. During World War I, the European nations went off the gold standard to allow for deficit spending and saved their gold for the purchase wartime materials from America.

From 1914 to 1924, the US dollar was the only currency convertible in gold. In 1924, Germany went back to gold to stop hyperinflation, and England and France soon followed. These four nations created excessive demand for gold and started the deflationary process that evolved into the Great Depression. By 1931, France and America owned 60% of world gold supplies.

During this time, Britain could not maintain its balance of payments as their gold drains worsened, and by September 1931 the Bank of England could no longer maintain the convertibility of the Pound. Britain went off gold in 1931. After Britain abandoned the Gold Standard, speculation that America would get off gold led to massive foreign withdrawals from US Banks and a rapid outflow of gold. In the six weeks ending in October 28, 1931, the gold stock of the US decreased by 15%.

In an effort to combat gold outflows, the Fed raised its discount and acceptance buying rates to attract foreign capital inflows. Because of the Fed’s lack of gold reserves (they were required to maintain gold reserves equal to 40% their notes or reserves of either gold or “eligible paper”), the Fed’s failure to offset the gold and currency outflows suffered by the banks accelerated the process of money contraction. By 1933, gold and currency outflows forced Franklin D. Roosevelt to declare a Bank Holiday to suspend gold shipments. France abandoned gold in 1936.

Interestingly, in 1930 and 1931 the Fed opted to preserve their commitment to the Gold Standard over the expedient short-term benefits of suspending reserve requirements to infuse cash into the economy. These Fed members were “liquidationists” who believed that depressions and corrections were healthy for the “long term vitality of capitalistic markets.”

The inflows of gold to America from 1914 to 1929 created the credit bubble now called the Roaring Twenties. Foreign capital inflows have the same “easy money” effect that occurs when the Fed purchases securities. Bank lending averaged 16% annual growth from 1916 to 1920. As a result of the hyperinflation of asset prices caused by gold inflows, the credit bubble exploded, caused massive bank failures across the US, and started the Great Depression.

The key to wealth is simply the ability to foresee and invest in asset bubbles in their early and middle stages and the discipline to sell your holdings during their late stages. If you’d like to get my updated blogs, please like my “Like” my page at www.facebook.com/zempower. If you need a no-nonsense real estate and business broker (with connections to private money sources) who will help you with your real estate investments and/or business, please contact me at 206.832.9590.

The 2007 real estate bubble was caused by global trade imbalances. When the US runs a trade deficit with China, the following options become available to China:

1) Convert the dollars into their own currency which weakens the dollar and thereby makes Chinese exports less competitive in the US marketplace.

2) Hold dollars in a vault with no return on investment.

3) Earn interest by purchasing US denominated-assets such as treasury bonds, mortgage-backed securities, corporate bonds, or stocks.

Because China has become dependent on exports to the US to drive its economy, option one falls off the table. Option two defies past experience. By default, China will pick option three and purchase US-denominated assets.

Essentially, the US gets a two-for-one. The US gets more goods and services that it gives. The US also procures foreign capital inflows that push interest rates lower and lower and push up stock and property prices.

Foreign capital inflows enable and fund the securitization process that we’ll explain here in more detail. Access to “easy money” and increased collateral values create a self-reinforcing paradigm for Wells Fargo to issue more loans. Furthermore, Wells Fargo pools a group of loans and sells them to Goldman Sachs, who acts as special-purpose vehicles (SPV). This gives Wells Fargo the ability to collect fees for originating these loans without the risks of holding onto these loans. Goldman Sachs diversifies the risk, takes on the risk of default (although they’ll pay a premium to receive “default coverage insurance” from a credit-default swap issued by AIG) and packages the asset-backed security into a trust. The trust is sliced into segments called “tranches” that come with different risk ratings and sold to investors such as pension funds and mutual funds. The SPV hires Deutsche Bank (as Trustee) to manage the trust on behalf of the investors.

In 2008, homeowners, consumers, and corporations owed an estimated $25 trillion. Banks owned $8 trillion in traditional mortgage loans. Bondholders and other traditional lenders provided another $7 trillion. The remaining $10 trillion came from the securitization markets. The securitization markets started to close down in the spring of 2007 and nearly shut-down in the fall of 2008.

Blame the lack of an international monetary system such as Bretton Woods or a gold standard on the 2007 “Mortgage Mess.”

For a no-nonsense Realtor who will give really help you with your real estate investments, please contact me at 206.832.9590. If you’d like to get my updated blogs, please like my “Like” my page at www.facebook.com/zempower.

Global trade imbalances over the last two decades created an overvaluation of asset values in both the US stock and real estate markets. We’ll explore how trade imbalances exploded the process of credit expansion and created bubbles that eventually burst.

Recent history has been strongly influenced by trade imbalances. In the 1970s when oil prices tripled, huge trade deficits by oil-importing nations were balanced through debt instruments and this had a hidden effect of causing double-digit inflation. In the 1980s, New York bankers redirected petro-dollars (caused by trade imbalances) in the form of loans to South America and Russia and created the International Banking Crisis.

The 1997 Asian Banking Crisis foreshadowed the US Banking Crisis in 2007. After World War II, the US dollar became the defacto reserve asset of the world. During the 1980s and 1990s, the “Asian tiger” economies accumulated huge amounts of reserve assets through current account surpluses. In other words, more money went into these Asian countries than the money leaving these nations. The excess credit liquidity through the bank lead processes of credit expansion created the Asian Bubble that eventually burst.

As shown in the Wikipedia graph below, the US (dark red) runs the largest current account deficits and China (dark green) exhibits the largest current account surpluses. The concept of current account deficits remains a very difficult one to grasp. A current account deficit measures a country’s decrease in foreign net assets (as relates to transactions in goods and services, income and current transfer between countries).

The Bretton Woods system was created so that countries could not devalue their currencies to procure advantages in trade. It is widely believed that currency manipulations during the 1920s (such as the US hoarding gold to gain trade advantages) were one of the primary causes of the collapse in international trade that lead to the Great Depression. In recent times, China has devalued their currency to gain trade advantages and if they continue these manipulations they could destroy international trade and plunge everyone into a global depression.

For a no-nonsense Realtor who will give really help you with your real estate investments, please contact me at 206.832.9590. If you’d like to get my updated blogs, please like my Fan Page at www.facebook.com/zempower.

Reading through many realtor blogs this week, it would seem that the real estate market has hit bottom. Consumer spending improved dramatically and the DOW climbed up 78% from its low point in March 2009. The self-serving claim by the real estate community is that it's time to purchase a home. Lets look at why they maybe wrong.

The Federal Debt Ceiling set limits on deficit spending for the Federal Government and some estimate that the US will reach its deficit spending limits by Spring 2011. The Obama administration argues that the Congress needs to raise the debt ceiling or risk defaulting on government loans. The Republicans state that they want to cut government spending at a time when economic recovery need fiscal stimulus.

Any default on government loans would shake world confidence in US Treasury bonds and the US Dollar and the result would be 12 to 17% interest rates similar to the 1970s. The easier but more insidious route would be to expand the M3 money supply. In 1980, M3 ranged around $1.8 trillion US. In 2010, the M3 expanded to $14 trillion US or a 700% plus increase in our money supply.

We'll hear mixed messages from economists. Some worry about deflation as occurred during the Great Depression. In our fractional reserve system, banks magically create money when they create loan ledgers. When you deposit $1000 into Wells Fargo at 3%, your bank can turn around and loan $10,000 (10 times the cash reserve holding requirements) at 24% in the form of a credit card loan. When debtors start defaulting on promises to pay, it can snowball into credit compression and cause deflation. With the collapse of our credit markets, we see huge deflationary pressures. Ben Bernanke, renown for his speech about dropping money from helicopters to stop deflation, believes that we need to print our way out of deflation.

As a result of current FED monetary policy to combat deflation by expanding the M3 money supply, I believe we'll see rampart inflation similar or worse than the 1970s. During inflation, the depreciation of the value our money gives the price of real estate, commodities, oil, gold, silver and other hard assets the appearance of skyrocketing valuations. Inflation benefits debtors and harms creditors.

THE PROS AND CONS OF BUYING REAL ESTATE IN 2011

CONS
1. The market has not bottomed. In Washington State, capitalization rate trends show that the income from rents point to an overvaluation of real estate prices. I believe the market will bottom out around 2014 or 2015.
2. If market values continue to fall, it would be a risky time to invest in capital gains strategies such as flipping houses, fixing up houses, or other short term strategies.

PROS
1. Interest rates will never be this low in a very, very long time. If either we default on our government loans, if the US dollar value collapses or the if US keeps expanding our Federal Debt Ceiling, the results of these scenarios all point to 12 to 17% interest rates during this decade.
2. It's a great time to purchase cash flow properties because inflation will cause home values and rents to increase in the next 7 to 9 years AND decreases the real cost of borrowed money. Because the banks now have strict income requirement verifications, you'll need very high incomes or cash flow to get a 20% down payment loan on a cash flow property. You will have to search very hard for a good cash flow property because homes are still overvalued.
3. Land values have bottomed out. It's now possible to purchase a lot of land for $50,000. This is a rock bottom price because it costs around $40,000 to build the entitlements (permits, zoning, utilities, land usage, etc.) for the land. With capitalization rates around 6% in the Greater Seattle Area, you'll earn a higher return on investment now by purchasing land and building an apartment building than buying an existing apartment.

If you believe my 2011 Inflation Analysis above, holding dollars or investing in mutual funds/stock would be the worse investment you could ever make. For smaller investors, you may want to consider purchasing some silver bullion or purchase commodities such as oil. For cash rich investors, the best investment now is purchasing land at rock-bottom prices and building in two years for high capitalization rates and cash-on-cash returns.

For a no-nonsense Realtor who will give really help you with your real estate investments, please contact me at 206.832.9590 or email me at rylandtaniguchi@hotmail.com. For more of my blog posts, visit zempower.com