The Daily Reckoning - Poor House, Part I (Bill Bonner)

verfasst von Firmian, 04.10.2003, 00:25

-->Poor House, Part I

The Daily Reckoning

Delray Beach, Florida

Friday, 3 October 2003

--------------------

*** Stocks up... bonds, gold down... US GDP growth a
shimmering, statistical mirage

*** The autumn of dollar hegemony has arrived... bulls still
footloose and fancy-free... profiting from the dollar's
decline...

*** There is no real estate market! 'Statistical
artifacts'... the U.S. Viceroy in Iraq... and more!

---------------------

Robert 'Go out and buy an SUV' McTeer sounded as though he
had been out in the sun too long yesterday. Ten-year
Treasury notes dropped sharply after the Fed governor told
the world he expected the economy to grow faster - at a 4%
rate - for the rest of the year.

But you, dear reader, know something McTeer may not. You
know that most of the growth reported in the economy is a
shimmering, statistical mirage. (In fact, we give you more
evidence below... )

Despite the grandest reflation and reliquification effort
of all time... with 13 rate cuts and the biggest Federal
budget flip-flop, from surplus to deficit, in
history... plus trillions of new money and credit flooding
throughout the world economy... there has been little or no
real growth in the American economy.

On Wall Street, this heroic reflation effort has produced a
rally. But it is only a rally that might be considered
standard for a bear market - the Dow has recovered just
half its losses. And at this halfway point, the tide of
cash seems to be drying up before it can do stocks any more
good.

What's wrong? Economists are stumped. According to their
models, lower rates and more government spending should
produce a boom. So sure are they that this must happen that
they think they see one... like the illusion of an oasis in
the desert. It is always just ahead. Just over the hill.
Just a little further.

Rather than stop to check their bearings, they trudge
along, reassuring each other that their theories are
correct."There it is, just ahead..." they say."Oh, yes, I
can see it... yes, right next to the productivity
miracle..."

If the economy real were really recovering, it would be
producing more jobs. But where are they? Perhaps they are
in China?

Still, housing prices are still rising. And consumers are
still spending, borrowing, and mortgaging. Corporations,
too, are taking advantage of this Fed-induced once-in-a-
lifetime opportunity to separate lenders from their money
at absurdly low interest rates."Corporate America on
Borrowing Binge," says a CFO.com headline.

On a hot, sunny day, if you take your hat off and
squint... it almost looks like a recovery ahead, if that is
what you are looking for. But like an oasis in the desert,
you might have to walk a long time before you reach it.

Right, Eric?

-------------

Eric Fry on the Street of Dreams... (By the way, you can
catch Eric on CNNfn's morning show,"Market Call," from 9
to 11 A.M. Eastern Time on October 8, 9, and 10. We'll keep
you posted...!)

- We New Yorkers enjoyed a beautiful autumn day Thursday.
In the early morning, your Manhattan correspondent picked
up his habitual triple cappuccino at Starbucks, then
strolled across the street to Union Square park. He found
an empty park bench and sipped his morning coffee in the
crisp sunshine. A gentle breeze escorted countless red and
gold leaves to the ground, like so many unwanted dollar
bills. Slowly, the leaves piled up on the ground like
greenbacks at the Bank of Japan. (They have to pile up
somewhere, we suppose. They can't just disappear.)

- But what happens next? If the autumn of dollar hegemony
has arrived, winter must be fast approaching. And what sort
of monetary blossoms should we expect next spring? Golden
blossoms, perhaps?

- Most stock market investors don't trouble themselves
worrying about the dollar... and that's lucky for them.
Worrying about risk when stocks are going up every day is a
very expensive attitude. Footloose and fancy-free is far
more profitable. Yesterday, the footloose bulls made
another devalued dollar or two as the Dow gained 18 points
to 9,488 and the Nasdaq added 4 points to 1,836. But
government bonds tumbled for the second straight day as the
yield on the 10-year Treasury jumped back above 4%.

- The dollar, which had tumbled to nearly $1.18 per euro in
Asian trading, managed to recover a bit during the New York
session to finish at $1.17 per euro. December gold slipped
another $1.30 to $383.70 an ounce. But surprisingly, most
gold stocks edged higher yesterday. The XAU Index of gold
stocks bounced 1.4%... Maybe the gold stocks are starting to
'smell' another gold rally in the making.

- Meanwhile, out on Main Street, the 'muddle-through'
economy continues to muddle through. Another 399,000 ex-
workers filed a claim for unemployment insurance last week
- maintaining the stubbornly high rate of about 400,000 new
claims per week. Also, orders for durable goods dropped
1.1% in August, despite hefty demand from the Defense
Department. Excluding the 37% increase in orders for
defense capital goods, total orders fell a whopping 1.7% -
which is one more indication that the manufacturing sector
will be slow to revive.

- Hmmm... seems like we may need to clip another 20% to 30%
off of the coin of the realm. The lower the dollar falls,
the more competitive our manufacturing industries
become... or so the gang on Capitol Hill believes. We
needn't make the dollar bills physically smaller, of
course, just functionally smaller. For example, a couple of
years ago, 265 dollar bills purchased one ounce of gold.
Today, an ounce of gold costs 383 dollar bills. And on the
day that an ounce of gold costs 1,000 dollar bills, our
manufacturers will have become so competitive that they
will be exporting firecrackers to the Chinese... or so the
gang on Capitol Hill believes.

- We don't believe it. We believe we will all be poorer for
embracing the idiocy of 'competitive devaluations.' How can
we be so sure that devaluing the dollar is idiotic? Well,
truth be told, we cannot be absolutely sure. But let's
consider the evidence: Alan Greenspan, most of the FOMC
governors, Treasury Secretary Snow and President Bush all
favor boosting economic growth by devaluing the dollar... We
rest our case.

- Lately, Strategic Investment editor Dan Denning has been
spilling a lot of ink over the sorry state of the U.S.
dollar - even going the extra mile for his subscribers by
instructing them on how to profit from a dollar decline.
"What is the easiest, least expensive way for you to
profit?" Dan asks rhetorically."First, there is obviously
gold, both gold stocks and physical gold, coins, or
bullion-based trusts like the one in Australia, in which
shares are redeemable for actual gold."

- A more direct - albeit short-term - approach would be to
buy put options on dollar index futures."The U.S. Dollar
Index," Dan explains,"trades on the New York Board of
Trade under the symbol DX. The index measures the market
value of the dollar versus the trade-weighted geo-metric
average of six currencies (although 17 countries are
represented in the index because there are 12 counties
which use the euro).

-"Here are the six currencies and their most recent
weightings: Euro 57.6%, Japanese yen 13.6%, UK pound 11.9%,
Canadian dollar 9.1%, Swedish krona 4.2% and Swiss franc
3.6%.

-"Why these countries and these currencies? These
countries constitute most of America's international trade
(excepting Mexico and China), and have relatively well-
developed foreign exchange markets. Most importantly, the
value of these currencies are, with the exception of
central bank intervention, freely determined by market
forces and market participants (central banks are market
participants, too.)

-"Because the exchange rate of each of the currencies that
the dollar is measured against is determined by the market,
the index should, at least in theory, tell you what the
market thinks of the strength of America's economy as
represented by the dollar. Strong economy, strong dollar.
Weak economy with chronic debt, structural employment
problems, and a pathological consumption addiction... weaker
dollar."

--------------

Back in Delray Beach...

*** Down here, the conversation often turns to real estate.
Florida is one of the best real estate markets in America.
Delray Beach is one of the hottest areas in the state.

"You can't really talk about a real estate market," said a
canny friend over dinner last night."There are hundreds of
different real estate markets. You have to look at each one
separately. But if you look hard enough you can make some
money. Because it's not like buying a share in Microsoft,
where you don't really know what is going on and... in any
case... you can't possibly know as much as the insiders... so
you can never really have an advantage. But down here, I
know who is building... who is buying and selling... what
areas are hot... Down here, I'm an insider. And I can do
deals with such a wide margin of safety that I will be the
last person to get hurt.

"Frankly, I'm convinced that real estate is in a bubble,
generally speaking. I think a lot of these properties are
going to fall in price. And if there is a serious economic
decline, a lot of people are going to have to downsize.
They've over-reached and they're not going to be able to
keep up with their payments. So, I'm buying the apartments
that they are going to downsize towards. I get a good
return on my money now... and when the collapse comes, I'll
still have demand for my units at a reasonable rent."


*** Ah ha! We've said the recovery was a fraud. So is Alan
Greenspan's 'productivity miracle.' They are 'statistical
artifacts' - the results of crunching numbers into such
grotesque shapes that even their own mothers wouldn't
recognize them. The following note was sent by our friend
Martin Spring:

"My thanks to Sjoerd Schalekamp who forwarded the link to
this highly informative article by V. Anantha Nageswaran
for The Business Times (Singapore). For those interested,
this is too important to miss, so I have reproduced it in
full. [You can read Nageswaran's article on the DR website:
The Truth Behind Much-Vaunted U.S. GDP Growth
http://www.dailyreckoning.com/body_headline.cfm?id=3461 ]

"My view - I'm not in a position to either confirm or
refute all the statistics quoted by V. Anantha Nageswaran.
However, the overall theme - that the U.S.'s method of
economic reporting overstates GDP data, is certainly
familiar to me... There seems little doubt that a more
conservative method of reporting, not least regarding the
nominal value of IT spending rather than the quality-
adjusted hedonic reporting described above, would show a
much weaker economic performance by the U.S..

"So why the hedonic spin? I suspect because it makes the
government look better, which hopes that its innovative
data will boost confidence, leading to more real GDP
growth. The growth story spin also helps to attract foreign
investment in the U.S., necessary to fund the current
account deficit.

"How will it all end? With disappointment. Being somewhat
more optimistic than V. Anantha Nageswaran, I maintain that
the U.S. economy will grow faster than Europe over the next
9 months, due to its additional boost from record monetary
expansion, record fiscal spending, exceptionally low
interest rates and a soft dollar. I also maintain that this
growth is unsustainable. A denouement is likely to occur
following the U.S. presidential election in November 2004,
when both the Federal Reserve and White House will attempt
to rein in the deficits."

*** We don't know anything about Paul Bremer. But the U.S.
Viceroy in Iraq, currently engaged in an historic effort to
'transform' the nation with 100,000 troops and a budget
vastly greater than anything the Iraqis ever spent
themselves, must either have a sense of humor or a loose
connection. He complained recently that Iran was"meddling
in the country's internal affairs."

--------------------

The Daily Reckoning PRESENTS: Your very own home, on
trial...


POOR HOUSE, Part I
by Bill Bonner

We begin today's reflection with a shocking illumination:

It is a mean, mean world we live in.

Americans believe their favorite and most reliable assets,
their homes, are making them rich. But could the contrary
be true? Will they be trading down soon... from their split
foyers, neo-colonials and desert contemporaries directly to
the poorhouse?

Could it be that the same roof and four walls that seem to
give shelter actually expose their denizens to a world of
cruel and unforgiving elements? In an effort to improve
their financial health, Americans have slathered on
mortgages, lines of credit and home equity loans as if they
were sunblock. What a disappointment it would be to
discover that they didn't really stop the harmful rays,
after all!

Many are the reasons given why real estate prices must
continue to rise. On the other hand, we immediately see one
reason why they might all be wrong: everyone believes them.
As they say on Wall Street, when everyone thinks the same
thing, no one is thinking.

And so we began to think... and came to a disturbing
conclusion. The average house, we believe, is a dangerous
place for your money. But since this little aperçu is
completely at odds with the entire corpus of modern
household economics, clearly the burden of proof is on us.
Fair enough.

We begin our case with an examination not of the house
itself, but its contents - what are known in the modern
lingo as its 'peripherals.' To be precise, we ask the
refrigerator and washing machine to come to the witness
stand.

We invite you, dear reader, to examine these appliances
closely. You will notice that neither is the simple device
it appears to be. Merely turning a dial or pushing a button
produces a complex variety of reactions involving centuries
of accumulated knowledge of metallurgy, at least 200 years'
worth of progress in mechanical engineering, about 100
years' worth of trial and error in making household
appliances and electrical engineering, and half a century
of electronics.

These machines might rightfully feel proud, mightn't they?
Do they not represent the accumulated wisdom and technical
knowledge of generations? For the purpose of keeping food
cool or getting the dirt out of clothes, are they not the
best machines that mankind has ever built? Couldn't it be
said that they - at least in speaking of household
appliances - are the crown of modern creation?

We thought you would agree with us there, dear reader, so
let us move on.

But suppose you buy one of these marvels. Suppose you pay
$1,000. And suppose, a year later, you decide to leave the
country and need to sell it. How much do you think you
could get for it?

Five hundred dollars? Seven hundred? We don't know, but it
would be unlikely that you would get as much as you paid.
Instead, you would rightly expect to lose money on your
appliance asset. And, setting aside art, antiques,
collectibles, and the gold coins you have hidden, isn't
that true of the entire contents of the house? Does a one-
year-old couch have the same value as a new one? How about
a one-year-old trash compactor... or a one-year-old baby
stroller? We could go on, but you take our point.

And so we take it one step further. What about household
furnishings as opposed to furniture? Do you expect your
carpets to rise in value after you have spilled a few
bottles of beer on them? Do your drapes go up in price
after they fade?

Here we invite readers to inspect the house itself. Take a
look at the lighting fixtures. How much have they gone up
in value in the last 10 years? And now let your eye wander.
What about the light switches? And the paint on the walls,
surely that must go down in resale value rapidly, once it
is applied to the walls. And the wallboards? The 2 x 4s
behind them? The wires and pipes and cinder blocks... if you
called in a crew and had the house deconstructed... what
would you get for it? Wouldn't you see that every single
element had deflated dramatically....that, reduced to its
component parts, the entire house had a 'break-up value' of
less than, say, 10 cents on the dollar?

But suppose you did not break it up or knock it down.
Suppose you merely picked it up, put it on a flat-bed truck
and sold the whole thing to a friend in a nearby state.
Would you make a killing? Or suppose, you notice that the
averagish house in Southern California sells for $350,000
and the averagish house in southern Arkansas goes for less
than half that much. Could you make money by buying in
Arkansas and shipping it to the coast? Have you ever heard
of such a thing, dear reader?

"Well, actually, it's a good business down here," said our
friend at dinner."People buy a lot with a house on it.
They want to build a new house. So they give away the house
to anyone who will take it away. A friend of ours got one,
loaded it on a barge and floated it up the intra-coastal
waterway and put it down on another lot. It was beautiful.
And she saved a lot of money."

"But she got the house for nothing, right?"

"Right."

Isn't it true, then, that it is not just the appliances,
the furniture, the furnishings, and the building materials
that lose value over time....but the entire house itself?
And isn't that what you would expect? Over time, all
physical things wear out. Metal corrodes, plastics warp and
fade, fabrics weaken. Even granite turns to sand and
dust....worn by wind, rain, sun, and cold... eventually.

And we, dear reader. We are no exceptions. We turn to dust
too, don't we? And wouldn't it be an affront to all the
world if we didn't?

But before we move on to our next point, we would like to
call our first surprise witness: the célèbre architect Le
Corbusier.

It will be a surprise to us if the man actually comes to
the witness stand, for he has been dead for over half a
century. But we would like ask him some questions anyway.

"Please just answer yes or no," we begin."Isn't it true
that you are... or were... one of the world's most famous
architects?"

"Yes," answers Le Corbusier's ghost.

"And isn't it also true that you designed many houses
during your career."

"Yes."

"And so it might be said that you were an expert on
domestic architecture.

"Yes, that is right."

"And in your expert opinion, which you expressed whenever
you had the chance, a house really was nothing more... and
here we quote your exact words... than 'a machine for
living?'"

"Yes."

"In other words, in your opinion, a house is just like a
dishwasher, or a refrigerator... or an automobile... isn't
that right...?"

"Yes."

"And since a house is no different from any other
machine... isn't it logical and correct to think that it
will wear out..."

"Yes."

"And since it will wear out like any other machine... isn't
it logical and correct to think that its price will
fall....JUST LIKE ANY OTHER HOUSEHOLD APPLIANCE OR
MACHINE....?!"

At this point in the proceeding, the opposing attorney
rises from his chair...

"Counsel is asking the witness to speculate about things he
knows nothing about..."

We take the point. Neither the world's most famous
architect, nor even we, can say what will happen. So, we
content ourselves to direct your attention, dear reader, to
what has always happened: Over time, almost all things man
creates depreciates. Even the tax code recognizes
it... allowing a taxpayer to write off the value of a new
building, even a house, over a few decades. At the end of
the period, the building is presumed to be worthless.

But let us move along. Next witness! We call Mr. Hubert
Homeowner.

"Mr. Homeowner," we commence,"you are the owner of an
averagish house, wouldn't you say? Well, just stop us if
we're wrong... we're just reading from the dossier...

"Your house has risen at nearly double-digit rates for
about the last 8 years, isn't that right? And you have
cleverly taken advantage of that, isn't that right? Isn't
it true that you've refinanced your house 3 times in the
last 5 years, partly to get a lower interest rate and
partly to get some extra cash? And isn't it true that you
used some of that cash to build a new sunroom on the house
and upgrade the kitchen?

"Now, you consider yourself a smart man. Those improvements
to the house certainly improved your enjoyment of the
property. But would you describe them as good investments?

"You would. Because the house itself has been a very good
investment for you, hasn't it? You only put down $15,000
when you bought it 8 years ago. The return on that
investment has been spectacular. And so, you feel that
improving the quality of the asset is a good investment
too, right?

"But you've listened to the testimony so far. In light of
what has been said about the normal depreciation of a house
and its contents, how do you reconcile the two points of
view? Isn't it perhaps more true to say that the new
kitchen was a lifestyle improvement... which you could
afford because the house itself has gained value?

"Okay... yes... maybe that is a better way to put it. And,
yes... of course, these things make the house easier to
sell. But then, isn't it also true that if you don't make
these sorts of upgrades, your house will be harder to sell?
So, in fact, you really have to make them, don't you... if
you want to maintain the house's value?

"Wait, I can see you're struggling with that idea... because
all houses have gone up in price, haven't they? Even some
of your neighbors who didn't make these improvements have
been able to sell at higher prices, isn't that correct? So,
at least in this market, the improvement may not be
necessary. If property prices were stable, on the other
hand, do you think you could get away without making
improvements? Hard to say, isn't it? But certainly you'd
have to replace the roof from time to time. And paint. And
put in new carpets. And, yes, probably upgrade the kitchen
and so forth.

"So, isn't it safe to say that owning a home actually
imposes some costs on its proprietor? Even if the house is
not going up in value?

"Yes?

"Still, you consider your house your major asset, are we
right about that?

"Yes?

"But it is a funny asset, isn't it? You get to live in it,
which is a bit like a dividend or interest coupon. But you
also have to take care of it... and spend money on it... if
you want it to hold its value. And, all things considered,
the physical thing - the house itself... if you could
separate it from the ground that it is on....would
naturally lose value over time, right?

"Strange asset, isn't it.

"And yet, you say that your house has gone up in value -
dramatically - over the past 8 years. Not only that, but
almost every house you know about has done the same. That
is real money, isn't it? We mean, you can take the equity
out if you want. You refinance your house to get it. And
then you can take it and spend it just like any other
dollars you get. We see here in your dossier that you
bought all kinds of things, including a new bicycle for
your boy, Huey.

"Can you tell us where that bicycle was made?

"China?

"How about that. You were able to take out this 'equity'
from your house and trade it for a bicycle that came all
the way from China. It's a remarkable world, isn't it? We
mean, you didn't have to work an extra minute for that
bike, did you? You didn't win it... no one gave it to
you... you didn't have to save for it or start a business or
make a profit. It came almost like magic from the 'equity'
buildup in your house.

"Amazing.

"Well, what do you think about this stuff called 'equity?'
What do you think it really is? Where does it come from?
How come the Chinese guy didn't take the equity out of his
house and buy the bike himself?

"Your house is worth about $200,000 if we have our
information correct. Let's see, if prices in your area were
rising at about 10% per year, that would be an increase in
your wealth - tax free, we might add - of about $20,000 per
year. Not bad. That's about 10 times the average income in
China. And you get it without lifting a finger.

"And... let's see... your household income is about $80,000
per year. Or, about $60,000 after you've paid taxes. And,
well... don't you think it is remarkable that you get
another $20,000 to spend... equal to a third of your
disposable income... without doing anything for it? How is
that possible? Where does the money come from?

"Yes, it comes from an increase in the value of your
house... but how? How is it possible, that after all we've
heard about the depreciating value of your house and all
its contents... that YOUR house seems to go in the opposite
direction? Everything else - even natural stone -
deteriorates, degrades, deflates, depreciates... but your
house! Your house gets better... more valuable... more
desirable... more fetching and more appealing every blooming
day. Your wife doesn't get better looking every day, does
she? We mean... looking at the matter objectively, of
course. But, somehow, your house does. How is that
possible? It seems almost to violate a law of nature... it
almost seems an affront to God himself, doesn't it? He made
the world and everything in it to decline with time... and
your house stands like a beacon out of time and space... out
of this world, almost... somehow resisting all His efforts
to take it down... to reduce it... to make it bend to His
laws. HOW IS IT POSSIBLE?"

"Objection, counsel is badgering the witness."

"May I be excused?" asks the homeowner.

Yes. And so may you, dear reader. At least for now. Tune in
next week, when we call our star witness: you.


Bill Bonner

"It's not that simple," explained our friend."Houses go up
in price because the lots become scarcer and the houses
themselves become more and more expensive to replace.
Building codes, zoning restrictions, environmental
rules... delays... paperwork... they all increase the value of
a house, even if the house itself, physically, is
depreciating. Here in Florida, for example, you can't just
replace a window in your house. You have to buy an very
expensive window that has been approved for hurricanes. So,
in effect, all the existing windows in your houses get
marked up to the value of the replacement."

More to come....

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• The Daily Reckoning - Poor House, Part I (Bill Bonner) - Firmian, 04.10.2003, 00:25