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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

PARIS, FRANCE 
TUESDAY, 23 JANUARY 2001 

 

Today:  Mortgaging The Farm

*** Slow day on Wall Street...but the world as we have come 
to know it is disappearing! The Sahara on the march! 

*** No fall off in top end of real estate market...but 
homeowners own less of their own homes than ever before...

*** Pokemon collapses...Big Tech earnings...a 'no brainer' 
in Iceland...and cow chaos in California...

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*** Monday was a slow day on Wall Street. Not much action 
in either the Dow or the Nasdaq. The Dow fell 9 points. The 
Nasdaq fell 12 points. 

*** Dell caused a little excitement - warning that selling 
computers was not as hot a business as investors had hoped. 
The stock fell...but came back before the end of the day. 
Gateway, by contrast, lost 9%.

*** Gold rose $2 to $267. The HUI - an index of gold mining 
companies - rose 7%. Homestake climbed again...it has moved 
up 50% in the last few months.

*** Is gold a good investment now? I don't know if it is 
ever a good investment. But it might be a very good 
protection in case problems with securitization, 
derivatization, and globalization become worse than is 
popularly imagined.

*** And if books and articles on the subject are any 
indication, investor psychology may already be changing 
with regard to gold. Doug Casey: "Just as a spate of pro-
gold books were published and did well in the marketplace 
back in the 70s, the same is happening [with anti-gold books] 
now after the 21 year bear market has bottomed. People 
like to hear positive, reinforcing things at the top 
of a market; and they love negatives at the bottom" 
(See: A Literary Bell Tolls For Gold)

*** Bloomberg sees no fall off at the top end of the real 
estate market. In California, sales of million dollar 
houses rose 50% in 2000. In Manhattan, prices of apartments 
on 5th and Park avenues rose 47% - in the 3rd quarter!? 
That couldn't be right, but that's what it says. Prices in 
the Hamptons rose 41% in the 3rd quarter to an average of 
$680,947 for a single-family house.

*** Americans own $14 trillion worth of stocks and $11 
trillion worth of real estate. Even a 10% decline in asset 
values would wipe out $2.5 trillion in wealth. But people 
tend to owe a lot more money against their real estate 
holdings than against their stocks. The New York Times 
reports that homeowners have borrowed against their own 
property as never before...

*** "The borrowing has been so extensive, in fact," says 
the Times article, "that homeowners, after building up 
equity through much of the 1960's and 1970's, have let 
their ownership shares deteriorate over the last two 
decades to the lowest level on record... Now a slowing 
economy catches the average household owning less of a 
stake in its home than in any economic slowdown since the 
advent of the modern mortgage in the 1930's." More below...

*** "...The only thing that might reinvigorate the consumer 
is a replay of 1998," writes David Tice in this month's 
Strategic Investment. "That is, another refinancing boom." 
When the Fed cut rates three times in the fall of 1998, 
Tice explains, it did more than bail out Long Term Capital 
Management. In fact, the Mortgage Banker Association's 
index of refinancing quadrupled from the end of June to its 
peak on Oct. 9, 1998. Nearly 10 million U.S. homeowners 
refinanced their homes in 1998 alone. "Unfortunately, 
rather than shoring up the consumer," Tice continues "the 
refinancing boom piled on more debt." (see: Will Another 
Refinancing Boom Keep The Consumer Afloat?
)

*** Investors are now talking about the NEXT rate cut - 
expected next week. Will it be 25 bps? Or 50? But Jimmy 
Rogers is still wondering about the last one. "It is 
astonishing that they cut rates," he wrote to Marc Faber 
recently, "The Dow is within a few percentage points of its 
all time high. The S&P is only down about 12%. Even the 
Nasdaq is just back to where it was two years ago. It's 
certainly not at 10-year lows or at 16-year lows as is 
Japan. The man [Greenspan} is throwing fuel into a raging 
fire, which is going to consume him." 

*** Rogers expects the conflagration to ignite commodities. 
"We are in the early stages of the new multi-year bull 
market [in natural resources]," he writes. (see also: The 
World's Next Great Explosion of Wealth
)

*** You will remember, many of the Big Techs get a large 
part of their profits not from operations but from their 
investment portfolios. They frequently invested in other 
up-and-coming techs. Who would be in better position to 
know which new tech companies would succeed than their 
customers and clients in the industry? But Fred Hickey 
looked at Intel Capital's positions and found it held the 
same turkeys that everyone else owned: CMGI, Corad 
Communications...eToys...and so forth. The value of Intel's 
holdings fell from $5.85 billion on September 30 to $3.74 
billion on December 30. "The portfolio's decline," comments 
Hickey, "is far worse than the Nasdaq's, since Intel's 
positions are primarily in second and third tier 
companies."

*** California's two big utilities are in default on their 
loans and could be pushed into bankruptcy any day. With $12 
billion in debt between them, together they would comprise 
the biggest bankruptcy in U.S. history.

*** Bankruptcies rose 23% in Japan last year, leaving 
record debts of almost 24 trillion yen.

*** What's wrong with the Japanese? Milton Friedman says 
it's simple: they've failed to increase the supply of money 
at a fast enough pace. Maybe so. Could it be that simple? 
Not likely. 

*** My son Edward, 7, was so impressed with the Pokemon 
phenomenon that he has been collecting the cards for the 
last year and a half and decided he wanted to be Japanese 
when he grew up. Alas, I read in the newspaper today that 
the Pokemon mania has collapsed. Rare cards that brought as 
much as $375 last April can now be purchased for only $100. 
The Pokemon bubble blew up at about the same time as the 
Nasdaq. Edward, my boy, you waited too long to sell.

*** "Warming of Earth Raises New Alarm," says the front 
page headline in the International Herald Tribune. Uh 
oh...this must serious. According to the paper, an 
authoritative new report shows that "global temperatures 
are rising faster and higher than most experts feared only 
a short time ago - faster, in fact, than at any time during 
the past 10,000 years according to one climate scientist." 

*** "Some scientists say they believe that...an uneven 
warming process has already begun with the march of the 
Sahara desert into parts of southern Europe..." Wow...the 
Sahara is going to do to Sicily and Andalusia what Sherman 
did to Georgia! 

*** This winter, and the last for that matter, has been 
unusually mild here in France. The temperature has only 
dropped below freezing on a couple of nights. 

*** Steve Sjuggerud writes with what he believes is a real 
"no brainer" investment for a post-dollar, post-glacial 
world: "Here is Iceland government paper," he remarks. 
"Right now in Iceland, we can earn a yield of over 11% in 
one-year Treasury notes. This is nearly twice what you can 
earn in one-year U.S. government paper, and Iceland's 
government finances are in much better shape than the U.S. 
Over the long run, the currency of the country that saves 
is worth more than the currency of a country in deep debt. 
So in theory, Iceland's krona should strengthen against the 
U.S. dollar. In practice, the Iceland Krona is fairly tied 
to the new European currency, the euro..."

*** Steve, by the way, is leading an investment discovery 
tour on the other side of the globe... to Argentina on 
March 29 - April 8th of this year. Apart from meetings with 
high-level Argentinean businessmen and government 
representatives, the trip sounds rather enjoyable: "our 
trip will take us to the 'Paris of the Americas,' Buenos 
Aires, where we'll take in a tango, while enjoying the 
world-famous steaks," writes Steve, "... and to a five star 
hotel in a tropical rainforest on the Brazilian border - 
overlooking Iguaza Falls, the world's most spectacular 
waterfalls..." (If you're interested please see: 
Opportunities In Argentina)

*** And DR reader MK explains why cows in California are 
agitated: "The cutting of electricity and the scarcity of 
gasoline will wreak havoc with the dairy industry in 
California and the rest of the country. California is the 
largest dairy producing state in the country. I think it 
now produces more dairy and cheese products than Wisconsin. 
Cows that produce milk must be milked at least once a day 
or they stop producing. In today's industrial age, they are 
usually milked by milking machines, not by milkmaids. The 
milk must be refrigerated... and shipped in refrigerated 
trucks. Product (milk, cheese and other dairy products) 
that cannot be refrigerated will either be dumped or sold 
to the government for lower price, because the 
manufacturers cannot afford the risk of selling 
bacteria/mold-infected products. A World Net Daily article 
reports dairy farmers were dumping milk yesterday... If the 
blackouts continue or get worse, things could get real ugly 
in a real hurry, not only California but the rest of the 
country, as well, because of our dependence on California 
for food."

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MORTGAGING THE FARM

Nothing comes from nothing
Nothing ever could

The Sound of Music


"Equity Shrivels as Homeowners Borrow and Buy" declares the 
New York Times headline. 

"So what?" replies the New Era believer. "Instead of equity 
in an unproductive asset, a house, they have stocks - 
equity in profit-making businesses. Everybody is better 
off."

In most people's view of things, mortgaging the house is a 
shrewd move. At least, it has seemed shrewd. For almost 
anytime during the last 18 years, both real estate prices 
and stock prices were rising faster than the net cost - 
including tax advantages - of a mortgage. 

The shrewdest thing to do, in fact, was to buy the most 
expensive house you could possibly afford, in the most 
expensive and fashionable area...and then mortgage it at 
more than its market value. The mortgage might cost, net of 
taxes, only about 6%. But property in places such as San 
Francisco or Manhattan, Silicon Valley or the Hamptons, was 
rising at 15% to 30% annually.

What's more, by investing the mortgage money in growth 
stocks, you had a chance to profit as fully as possible 
from the last great asset boom of the 20th century. 

The NY Times reports that few people missed the trick: "The 
average home owning household owed lenders 46% of the 
market value of its residence during last year's third 
quarter, up sharply from about 30% in 1982 and 40% in 
1991... For a typical family with a home worth the median 
market value of $144,000 late last year that meant their 
equity was $77,760 while their debt was $66,240."

Gone are the days when American families celebrated paying 
off the mortgage - breathing a sigh of relief and enjoying 
the security of knowing that, even in a pinch, they would 
not be out on the street. People are so confident of 
America's economic miracle they've given up ownership 
of part of their own homes in order to participate.

What would happen if the prices of homes and stocks go down 
- as they tend to do at the end of an asset bubble? 

"In a longer recession," said Mark Zandi, chief economist 
at Economy.com in West Chester, PA, "housing prices would 
weaken and many homeowners could easily find themselves 
owing more on their homes than the homes were worth."

But in today's letter I intend to forebear from spelling 
out the obvious consequences of a bear market. Instead, I 
want to explain why the prosperity of the late '90s was a 
fraud. As you will see, the declining equity that Americans 
have in their homes is not so much a threat to their future 
wealth - as an indication that wealth has already 
disappeared. Like an illicit lover hiding in a closet, the 
fact merely awaits discovery.

The head of the household will discover it in due course - 
and in the old fashioned way. Eventually, his portfolio 
statement will reveal that his stocks have fallen. About 
the same time, news will spread that neighborhood houses 
are not selling quite as fast as they used to...and that 
sellers are getting less for them.

Even worse news could reach him, too. Perhaps he will find 
that his employer requires fewer overtime hours from 
him...or that he is out of a job altogether. Thus, will his 
clever financial strategy - which worked so well during the 
upswing of the credit cycle - prove ill suited to the 
inevitable contraction. 

But, you and I, dear reader...we cannot wait for the light 
of experience to light up our path. We have to use our 
imaginations...we have to try to anticipate these events 
before they happen so that we can prepare for them. And 
that will require poking around in the most dismal corners 
and attics of the most dismal science.

To that end, I refer to the work of Dr. Frank Shostak, an 
Australian economist, quoted at length in Marc Faber's most 
recent newsletter. "Wealth is always generated by means of 
land, labour and capital goods - i.e. tools and machinery," 
writes Dr. Shostak. 

A man with $100,000 in savings and no house can exchange 
the accumulated sweat of his brow for a house. So far, so 
good. But what happens when he then takes out a mortgage 
for the house - for the full amount - and invests the money 
in IPOs? Now, he owns the house, subject to the mortgage, 
and $100,000 worth of stocks. The mortgage company now has 
a $100,000 asset too...and companies whose stocks he bought 
also have $100,000 in cash. 

This transaction, rehearsed millions of times, brings a 
flood of cash to the stock markets - which raises stock 
prices. The investor with $100,000 worth of stocks soon 
finds that his stocks have gone up. His house, too, has 
increased in value. So he doesn't mind spending some of his 
new wealth on a higher standard of living. And the 
companies on Wall Street, flush with cash, don't hesitate 
to put it to work - hiring more people, buying advertising, 
launching yet more risky ventures.

"A pathetic side of the manipulation of credit in modern 
times," wrote Freeman Tilden in his book, A World in Debt, 
in 1935, "is that the owners of capital, especially the 
little capitalists, are swept into a pool of adventure, in 
which the actual lending of the capital is on a great scale 
and performed by central agencies alleged to be so expert 
in debt-trading that it is better to entrust all to them. 
In this way loans are made and debtors accommodated, 
representing risks that the owner of the money, were he 
lending directly, would never dream of taking. It is 
supposed that the great professional lenders are vastly 
experienced, and possess almost magical discretion. The 
truth is that these pompous egotists throw money around, in 
prosperous times, with as much abandon as though it were 
confetti." 

"When money is printed - i.e. created 'out of thin air' - 
it sets in motion an exchange of nothing for money," 
explains Shostak, "and then money for something - i.e. an 
exchange of nothing for something. An exchange of nothing 
for something amounts to consumption that is not supported 
by production. Since every activity has to be funded it 
follows that an increase in consumption that isn't 
supported by production must divert funding from wealth-
generating activities. In short, inflation, or rises in the 
money supply, creates an economic impoverishment."

America has gotten poorer in the last five years - not 
richer. That fact will be the most sensational new 
discovery of the 21st century. 

More to come...

Bill Bonner
 
 
 
 
About The Daily Reckoning:

Daily Reckoning author Bill Bonner

Bill Bonner is, in spite of himself, a natural born contrarian. Early each morning, Bill writes The Daily Reckoning—his take on the financial markets and what’s going on in the world—and sends it off by e-mail before most Americans’ alarm clocks have buzzed. Many readers say it's the first thing they want to read when they get up—not only because it's informative and thought provoking, but also it's inspiring, in its own quirky and provocative way.

Of course, there's much more to Bill than his daily market commentary. He's also the founder and president of Agora Publishing, one of the world's most successful consumer newsletter publishing companies. Bill's passion for international travel and big ideas are reflected in the company he's successfully built. In 1979, he began publishing International Living and Hulbert's Financial Digest . Since then, the company has grown to include dozens of newsletters focusing on health, travel, and finance. Bill has vigorously expanded from Agora's home base in Baltimore, Maryland since the early ’90s—opening offices in Florida, London, Paris, Ireland, and Germany.

Agora's publication subsidiaries include Pickering & Chatto, a prestigious academic press in London and Les Belles Lettres in Paris, best known as a publisher of classical literature in bilingual editions.

 

 
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Last modified: April 01, 2001

Published By Tulips and Bears LLC