The real estate blog.

Excuse me as I put on my tinfoil hat today to discuss some of the economic calamities the United States is currently experiencing.

We’re hearing news today with such headlines as Housing starts, permits plunge and More price drops, more layoffs. The dreaded “recession” word is being talked about a lot more often. It sounds like things could get real bad, real soon.

I was referred to an article this week that I read with interest. It starts out -

The many parallels between 1924 Germany and present-day United States are cause for concern. Though the U.S. has not yet reached the depths to which Germany descended in that era, few can look at the constant depreciation of the dollar since the early 1970’s and fail to be alarmed. It seems contemporary America differs

from 1924 Germany only in the duration between cause and effect. While the German experience was compressed over a few short years, the effects of the American inflation have been more drawn out.

Up until recently, the United States enjoyed a strong world-wide demand for its government paper. Thus, the negative affects of government deficits have been subdued. Now, with consistently low interest rates, and a growing fear globally that U.S. deficits may have run out of control, foreign support for the U.S. bond market has faltered. In the absence of international buyers, the Fed could be forced to monetize an ever larger portions of the debt — the modern equivalent of printing money.

I didn’t want to ruin the twist by publishing the link to the article earlier. The article in question was written in 1970 and the foreword quoted previously appears to have been written in 1999. The parallels remain uncanny especially in today’s economic environment. Inflation in America has continued to increase.

The decline of the dollar over the past few years and the past few weeks in particular should have Americans concerned. But most are not. Why? Excessive levels of debt. If you borrow at a fixed level of debt and then have your earnings inflated, while the debt remains the same, inflation doesn’t matter initially.

First, it would be wrong to think that everyone was opposed to inflation. Many big business leaders accepted it cheerfully. It wiped out their debts. They knew how to protect themselves and even profit–by speculating in foreign exchange, by converting money into goods and fixed plant, by borrowing money from the bank and using it to buy up cheap stocks and competing companies. Their wage costs, in true value, decreased, swelling their profits. Yet many workers also thought that they were benefiting, at least in the earlier stages of the inflation. Their wages were increased, and it took time before they recognized that, with prices soaring even faster, they were actually suffering a cut in true income.

Does this sound familiar?

Now before we get too caught up into this, let’s remember that Germany had lost World War 1, was paying reparations and its business district was occupied by French forces. That’s a lot different than America where we’re paying foreign nations trillions of dollars a year to service national debt, we’re fighting a very costly war in Iraq and we’re not very popular on the international scene. It’s not quite the same as post WWI Germany, but there are similarities.

The sad thing is the first stages of this destructive hyperinflationary period looked like success.

Under the forced draft of inflation, business was now operating at feverish speed and unemployment had disappeared. However, the real wages of workers dropped badly. Unions obtained frequent increases, but these could not keep pace.

Inflation created speculation in all kinds of markets like food, clothing and other consumable goods.

Businessmen began to abandon their legitimate occupations to speculate in stocks and in goods. Thousands of small businessmen tried to eke out a living by speculating in fabrics, shoes, meat, soap, clothing–in any produce they could obtain. Each fall in the mark brought a rush to the shops. People bought dozens of hats or sweaters.

Contemporary America is full of speculation as well. Real estate, stocks and the Internet have made commodities accessible to anyone with extra money, even people without money. We’ve seen the consequences of the real estate boom, which followed a stock and new technology boom. The next boom? Internet companies again.

Internet companies with funny names, little revenue and few customers are commanding high prices. And investors, having seemingly forgotten the pain of the first dot-com bust, are displaying symptoms of the disorder known as irrational exuberance.

The surge in the perceived value of some start-ups has even surprised some entrepreneurs who are benefiting from it. A year ago, Yahoo invested in Right Media, a New York company developing an online advertising network. Yahoo’s investment valued the company at $200 million. Six months later, when Yahoo acquired Right Media outright, the purchase price had swelled to $850 million.

What changed? According to Right Media’s co-founder Brian O’Kelley, very little, except for the fact that Microsoft and Google were writing billion-dollar checks to buy online advertising networks, and Yahoo felt that it needed to pay any price to keep up.

“I have to say I giggled,” O’Kelley, 30, said of Yahoo’s acquisition, which earned him $25 million. “There is no way we quadrupled the value of the company in six months.”

I’m not saying the American economy is going to collapse like Germany, but the similarities are ominous.

However, similarities don’t mean a self fulfilling prophecy has to occur. Remember, the bulk of the article I’m referring to was written in 1970. The world was a chaotic place then, just as it is now. The 70s saw some difficult times, oil shortages, double digit interest rates, inflation and high unemployment. But the nation didn’t collapse. During this time period home values continued to increase except for one year and more Americans became homeowners.

It wasn’t easy to avoid hyperinflation. The article post script explained -

Only the very strict monetary policies of the Federal Reserve Bank during the 1980’s kept the nation from sliding into the hyperinflationary abyss, and those years became a period of relative calm. The profligate fiscal policies of the United States government, however, continue unabated. The overall national debt has grown to enormous proportions.

It’s important to note, this Federal Reserve Board was run by Paul Volcker, not Alan Greenspan. Some people have claimed Greenspan simply postponed the consequences of the late nineties stock bubble by lowering interest rates which created a real estate bubble that we are just seeing the effects of. Greenspan’s successor, Ben Bernanke, appears to have taken a similar tack by lowering interest rates last month when the true effects of the housing downturn became more apparent.

Since that rate cut, the dollar has lost value with even the Canadian currency surpassing it and the Euro charting record spreads. The Fed’s course of action in the 80s was to raise interest rates. The 30 year conforming mortgage peaked in 1981 at 16.63%, ten percent higher than it is now. Bernanke has a tough decision in front of him on October 30-31. With inflation rising, and jobs higher than first reported in August, a rate cut is out of the question. A rate hike is probably the best course of action, but it could cause panic on Wall Street. I expect rates to hold through the end of the year.

Let’s get to the end of the German economic crisis story. How did it end and why? I’ve said that consumer sentiment affects so much of our economy. If people don’t feel good about their finances, they put off major purchases, rent instead of buy and repair instead of replace. Real estate is reeling right now due to negative sentiment caused by a few changes in that landscape.

1923 Germany was no different. The article continued -

In November 1923, a currency reform was undertaken. A new bank, the Rentenbank, was created to issue a new currency–the Rentenmark. This money was exchangeable for bonds supposedly backed up by land and industrial plant A total of 2.4 billion Rentenmarks was created, and each Rentenmark was valued at one trillion old paper marks. From that moment on the depreciation stopped–the Rentenmarks held their value; even the old paper marks held stable. Inflation ceased.

To understand this, we must recall that the real value of the money circulating in late 1923 was small–equal to a mere 168 million pre-war gold marks. The continued depreciation at this point was due to utter lack of confidence–to the belief that the printing presses would run indefinitely. But actually there was a great shortage of and need for money. New money could be introduced without price inflation if only people had confidence in it.

Consumer sentiment saved Germany and I believe it will save 21st century American real estate. The market won’t change until prospective homebuyers think they’re getting a good deal on the price. When will that happen? Nobody knows. Some parts of the country are seeing sentiment turn. Others, like Salt Lake, haven’t begun to go down yet.

I know the concepts introduced in this post are pretty scary, especially coming from a real estate bull like me. It is very important we remember the differences between 1920’s Germany and the present day. They are significant, though similarities do abound. It’s also important to remember that America is in a state of near full employment. Inflation is a serious concept that can have disastrous effects. Keeping our politicians in line and fighting inflation will cause it to become more costly to borrow and more beneficial to save. The costs of fighting inflation are great, but the costs of ignoring it are much greater.