The Myth of Home Ownership as Investment in the Casino Economy

It only takes two eyes and a short memory to realize that houses in the U.S. just keep getting bigger and more ostentatious, especially over the past five to ten years. Families are getting smaller yet the average home keeps getting bigger. Millions of Americans have been taking out home equity loans and second, or even third, mortgages to buy a bigger home or add on to the existing one so they can compete with the neighbors who are doing the same thing; it’s ridiculous. One of the main reasons is this pervasive belief that owning a home is a sound ‘investment’ so the more money the ‘investor’ dumps into it the better. It’s practically taken as fact within American culture that owning a house is a great investment and anyone that doesn’t play along is just throwing money away on rent.

Certainly this belief has become very big business for the banks and mortgage companies dealing out the loans, for the real-estate agents selling the properties, for the home improvement stores like Lowe's and Home Depot (the other Wal*Marts), and for the construction contractors, but not so much for the (often illegal, mostly Hispanic) immigrant laborers who end up doing all the arduous construction work. Even state and local governments have a vested interest in perpetuating private home ownership because property taxes are a major source of funding for government services at the local level. So you can see that bias towards home ownership is systemic and thus it’s not too surprising that so much hype and myth about personal home ownership as a prudent investment emerges from this situation.

Hypothetically if you stay in the same house for 30 years you can pay off your mortgage and own the home but it's fairly rare for that chain of events to actually occur. Most people move into a different price market, refinance their mortgage and extend it out for cash up front or do something else that extends the payments beyond the standard 30 years for a typical home loan. Even if someone manages to pay off their entire mortgage loan the payments don’t stop entirely, you’ve still got to pay for maintenance, insurance and taxes. And the taxes in some places are pretty steep, so steep that many retirees on fixed incomes are forced to sell. So where’s the gain? The bank owns the house because they hold the loan, so where’s the personal ownership?

Investment or Liability?

One of the standard lines used to justify buying a house is that it’s not just a bunch of sticks and plaster, it’s an investment. Everyone needs some kind of domicile to live in but If you can’t sell it then it’s not really an investment it’s a liability because you must preserve it. If you own two homes then one can legitimately be considered an investment but the one you have to live in is still a liability. If, like the vast majority, you only own one home then you have one liability.

The proponents of home ownership argue that it increases in value over time, but so what? The entire housing market increases in price so even if you sell your one house you just have to buy back into it at around the same price to get the same quality and quantity of house! Because prices rise along with your own you just end up paying more in taxes. Plus all the maintenance time and cost associated with keeping a house functional and at a level where it can be sold just for a break-even price. And then there’s the mortgage. The money paid on a 30 year mortgage consists of about half or more in interest paid to the bank, rather than the principle. The loan holder doesn’t actually pay on the equity until about two thirds into the 30 years! So the majority of the loan time is just paying interest to the bank that lent you the money. So much for actually owning the house!

Truth is, banking and finance has a higher profit margin than any other sector of the economy, better than oil even; and why not? Everyone else does the work for them. For example, Citigroup has a 25% yearly profit margin while Chevron only has 10%. Every single month millions of Americans send a major portion of their personal income to the mortgage holder, creating a mammoth industry. And now they're paying more than ever because they believe the marketing hype telling them it’s a smart investment. Yeah it’s a real profitable investment – for the banks! 'And the more you buy the more you save!'

Total outstanding home mortgages in 1999 were US$4.45 trillion and by 2004 this amount grew to $7.56 trillion, most of which was absorbed by refinancing of higher home prices at lower interest rates. When Greenspan took over at the Fed in 1987, total outstanding home mortgages stood only at $1.82 trillion. On his watch, outstanding home mortgages quadrupled. Much of this money has been printed by the Fed, exported through the trade deficit and re-imported as debt. From: Why the US sub-prime mortgage bust will spread to the global finance system, by Henry C.K. Liu, March 16, 2007.

Home Ownership as Pseudo-Equity

Owning only one house means you have to trade it for another one and you can’t sell it and walk away with the proceeds like you could from selling stock or cashing in a bond. Buying a house makes for a poor investment strategy for several reasons not least of which is the relatively high transaction fees and the continual expenses associated with maintenance and value competition within the neighborhood and regional market.

How does this [investment] compare to housing? Costs vary significantly by location, but for urban areas, annual property taxes are typically between 1% and 2% of the current property value. Annual maintenance costs can add another 1% of the property value. If your down payment is less than 20%, you will also usually have to pay private mortgage insurance. Add property insurance, and the annual expense ratio associated with homeownership can easily reach 3% or more.

The big hit, however, arrives when you sell a property. Real estate agents will collect 6% of the selling price, while, lawyers, inspectors, title companies, and banks will collect additional fees. These fees appear as though they will remain stubbornly fixed for years to come. If you flip properties as though you are actively trading stocks, the only folks getting rich will be real estate agents. Meanwhile, transaction fees for stocks and mutual funds have plummeted in recent decades, to the point of falling below $10 per trade at several discount brokers. From: The Worst Investment Ever, by Robert Aronen, Yahoo! Finance, May 18, 2007.

If you still believe that by buying one house and living in it you are ‘investing’ your money, think about this:

For any time period longer than the past few years, residential housing prices fall far behind these returns. Perhaps the best measure of housing-market appreciation is the S&P National Home Price Index. This index represents the actual appreciation of the same house over time, whereas a portion of overall housing-price increases occurs because new houses are generally much larger than old houses and people frequently spend substantial money upgrading and expanding their houses. Looking at the index, from 1987 to 2006, we see that the overall average appreciation in the U.S. was only 5.6%. Even cities showing huge gains during the final years of the housing bubble -- including San Diego, Las Vegas, and Washington, D.C. -- showed gains slightly above only 7% for the 19-year period. If we adjust these returns for inflation, we end up with real returns on housing in a range of 3%-5%. Subtract our annual expense ratio of 2%, and the return gets pretty thin.

This index is relatively new, and the data ends at the top of the final eight years of the biggest housing boom in U.S. history. Longer-term data paints an even less encouraging picture. Piet Eichholtz studied records on home sales in Amsterdam's premier Herengracht neighborhood from 1628 to 1973 and found an inflation-adjusted return of 0.2%. There were periods of rising prices and periods of falling prices, but not a continuous march upward with spectacular returns. …

Those who think renting is "throwing money away" should consider that mortgage interest, maintenance, taxes, and insurance are also "thrown away." Having a place to live costs money no matter what, and a rational evaluation of your local market should let you know which one is a better value. [ibid]

Home ownership is only an investment if you are able to acquire more than one house or if you plan to bequeath the house to your descendants and you’re thinking in the long term, i.e. over 30 years. For most everyone else home ownership as an investment is a nifty scam that sustains the economic elite by creating the illusion that the average guys can get a piece of the action for themselves by buying a home and turning it into a mansion. In reality the price inflation only makes the rich richer through rampant speculation and at best everyone else treads water. One way the banks have successfully perpetuated this trick is through home equity loans. Home equity is the difference between a home’s current value and the remaining mortgage balance. Banks will give the home owner a loan based on the differential between the current inflated house price and the total cost of the remaining mortgage. As long as the average house price continues to rise rapidly this is usually financially sustainable but if the price falls, as in the collapse of a speculative bubble, then the home owner is stuck in a negative equity trap – they owe more to the bank or loan company than the house is worth.

Housing is a primary human need, so along with food and clothing shelter is a public good. Fulfilling the primary need for housing shouldn’t be a burden for anyone working full time or more. Yet that is exactly the situation today in many places around the world, not just the U.S.A. Indeed, unaffordable housing is a worldwide problem. Guangzhou in southeastern China is typical of the rapidly developing parts of the world.

In Guangzhou, the average price of housing rose from 3,888 yuan per square meter to 7,729 yuan in February, up 100%. [1 US Dollar is equal to about 7.6 Yuan]

In China, skyrocketing housing, education and medical-care costs have become the three major sources of growing public discontent. In Guangzhou, even middle-ranking officials have begun to complain about high housing prices.

Ding Jianhua, deputy chief of Guangzhou's Tianhe district, openly said at a government meeting on January 21 that he rented an apartment in Guangzhou and didn't own his own home because he could not afford one. "Civil servants can hardly afford to buy housing on their regular incomes," he said. From: Guangzhou aims to cool property market, by Sally Wang, Asia Times Online, April 12, 2007.

With loads of hot money, rampant real-estate speculation and rising demand many would probably be surprised at how much urban eastern China is beginning to look like the United States. With few investment options available to them Chinese are plowing their wealth into real-estate and building ever-bigger mansions for their families American style.

Buyer Beware

Price inflation isn’t the only concern for home buyers. Once you mortgage the rest of your life away as a home owner you usually have little recourse for purchasing poorly constructed homes or getting stuck with a house built on polluted ground.

Home sellers are generally supposed to reveal environmental hazards to buyers. The specifics vary from state to state, but owners who find surprises in their new homes are often out of luck.

Crude Awakening In the early '90s, Trendmaker Homes built houses atop an old oil refinery in Houston. Residents complained of skin and respiratory problems, their dogs dropped dead, and sludge seeped from their lawns. Some owners who took the builder to court in 2002 were forced into arbitration and won nothing. Another lawsuit is pending.

All Wet

In the mid-'90s, the buyers of a Florida home built on stilts learned the hard way that most of their land spent four months of the year underwater and infested by alligators. They sued, but the judge told them they should have seen it coming.

This Old Dump

When garbage oozed out of the ground, an Alabama man discovered that he'd built his new house an top of a landfill, He sued the site's previous owners. In 1991, the state supreme court told him that the doctrine of caveat emptor, or "buyer beware," meant he was on his own.

Bombed

KB Home built a new subdivision on a former Navy bombing range in North Texas in 1999. In 2005, 260 bombs were removed from owners’ lawns. Residents have been stuck in an arbitration process that in Texas tends to favor the developer.

Driven Batty In 1999, an Ohio family had its new house inspected before moving in, but failed to check far bats. After they unpacked, the critters began to screech and scratch inside the walls at night. Dead bats clogged the basement drains. Too bad for the owners—they’d bought the house "as is." From: Not in Their Back Yard, excerpt by Josh Harkinson, Mother Jones magazine May/June 2007.

Money, Money Everywhere

There’s a huge amount of loose capital sloshing around in the global economy, much of it due to the inflationary financial policies of consecutive Presidential administrations that use the Treasury and Federal Reserve as political tools. Sound finance this does not lead to. Free capital naturally seeks the highest return and the housing market is just another gambling table in the worldwide casino economy, so not surprisingly prices have skyrocketed in most major markets around the world. The federal government in the U.S. has little if any real desire to protect the public from speculative pressures because they are too influenced by the wealthy elite and the banking industry to do anything to slow it down or regulate it.

If the rich want to gamble then let them do it in Vegas or on the stock market – not with a public necessity like housing! But too many big players are getting rich off of the global casino and then using their wealth to buy political influence to see anything get fixed before it crashes, just like the financial authorities charged with protecting the public and the integrity of their economy won’t do anything about the explosion of derivative-based schemes, the ones that Warren Buffet calls “time bombs” because too many hedge funds are making billions of dollars for already very wealthy investors with black box cash machines operating on magical money making formulas hidden inside. With many hedge funds averaging 30% yearly returns nobody wants question the (mostly) Jewish wizards in charge, nor to look inside the black box to find out what’s really going for fear for of what they might find!

The derivatives market has exploded in recent years, with investment banks selling billions of dollars worth of these investments to clients as a way to off-load or manage market risk. But Mr Buffett argues that such highly complex financial instruments are time bombs and "financial weapons of mass destruction" that could harm not only their buyers and sellers, but the whole economic system.

Derivates like futures, options and swaps were developed to allow investors hedge risks in financial markets - in effect buy insurance against market movements -, but have quickly become a means of investment in their own right.

Outstanding derivatives contracts - excluding those traded on exchanges such as the International Petroleum Exchange - are worth close to $85 trillion [in 2003], according to the International Swaps and Derivatives Association. Some derivatives contracts, Mr Buffett says, appear to have been devised by "madmen". He warns that derivatives can push companies onto a "spiral that can lead to a corporate meltdown", like the demise of the notorious hedge fund Long-Term Capital Management in 1998. From: Buffett warns on investment 'time bomb', BBC, March 4, 2003.

"Large amounts of risk have become concentrated in the hands of relatively few derivatives dealers ... which can trigger serious systemic problems." - Warren Buffett

The Sub-Prime Mortgage Debacle

The current sub-prime mortgage debacle is a classic example of this spreading 'screw-over the little guy' attitude. Thousands if not millions of homeowners that took high-interest loans just to get on the escalator to riches along with everyone else in the housing boom are losing their homes to foreclosures amidst rising interests rates and rigged, onerous payment plans that inevitably crush the loan holder if they lose their job or have any kind of financial difficulties, like a sudden medical problem and associated expenses. The elected leadership has basically done nothing for these people while the banking sector does all they can to downplay the risks of billions in bad loans to their own bottom line and the wider economy.

Ignorant people are easy to exploit and manipulate

Consumers continue to make foolish decisions because they take their information from a mass-media created by and for corporate interests, like the banks and loan companies, then they compete against millions of other people in the rest of the nation making similar ill-advised decisions! Both consumers and government spend more than they earn, leaving only corporate profits to drive most investment in the United States today. Consequently corporate values are being replicated throughout the country as they spend and build based on their own image. Welcome to the United States of Enron, a country governed by a venal leadership trapped in a corrupting system and directly influenced on a scale measured in dollars. This creates a national government that actively aids and supports predatory capitalists, eventually forming a self-fulfilling, dysfunctional culture of greed and short-sightedness where everyone is desperate to make a few dollars for themselves regardless of the consequences or who gets burned along the way.

America is descending into a predatory culture based on theft and subterfuge, where individuals seek to morally justify anti-social personal actions through whatever insubstantial rationalizations they can concoct, unaware and unconcerned with the unseen forces driving their behavior. We must not ever have a government where outside money equates to internal power and influence, just as a government that no longer works towards serving the welfare of the public majority it rules over has lost its mandate to rule over anyone. The U.S. government is becoming an illegitimate regime, not a democracy, not even a Republic, but a plutocratic oligarchy, and this oligarchy is manipulating public competition to serve interests largely antithetic to the electorate. 02.06.07 

The financial speculation that has created a massive real-estate bubble in the United States, fueled largely by low interest rates, is currently in a state of slow-motion collapse. Although home owners are in a bind amidst rising interest rates and declining house prices, the situation for those who rent their homes is looking much better as the glut of unsold houses are being converted in rentals thereby pushing down rent prices. 03.05.07

Nationwide, 2.8 percent of houses for sale were unoccupied in the first quarter, the highest since the Census Department started collecting the data in 1956. Unsold properties on the market totaled a record 3.45 million in 2006, according to the Chicago- based National Association of Realtors.

"Unsold properties being turned into rental units are creating a shadow market that's driving up the vacancy rate and slowing the growth of rents,'' Chandan said in an interview. "Areas that saw the most speculative investing, particularly in condos, will see the biggest pressure on rents.''

In markets such as South Florida, Nevada and Arizona that led the country in speculative buying, owners who can't rent their properties may default on their mortgages, Chandan said.

"A bigger supply of units for rent means fewer opportunities for speculative owners to cover their mortgage payments by renting,'' Chandan said. "It has the potential of placing further stress on mortgage performance that has already deteriorated because of subprime defaults.''

The Center for Responsible Lending in Durham, North Carolina, said in a December study that as many as 2.2 million borrowers are at risk of losing their homes, at a potential cost of $164 billion, from subprime mortgages originated from 1998 through 2006.

The drop in [housing] construction will help shave 1 percentage point off economic growth this year, the homebuilders said. The U.S. gross domestic product will expand 2.3 percent this year, slowing from 3.3 percent in 2006, the trade group said. From: Rents Peak in Housing Glut, by Kathleen M. Howley, Bloomberg news, May 2, 2007.

Private capital tends to become concentrated in few hands, partly because of competition among the capitalists, and partly because technological development and the increasing division of labor encourage the formation of larger units of production at the expense of smaller ones. The result of these developments is an oligarchy of private capital the enormous power of which cannot be effectively checked even by a democratically organized political society. This is true since the members of legislative bodies are selected by political parties, largely financed or otherwise influenced by private capitalists who, for all practical purposes, separate the electorate from the legislature. The consequence is that the representatives of the people do not in fact sufficiently protect the interests of the underprivileged sections of the population. Moreover, under existing conditions, private capitalists inevitably control, directly or indirectly, the main sources of information (press, radio, education). It is thus extremely difficult, and indeed in most cases quite impossible, for the individual citizen to come to objective conclusions and to make intelligent use of his political rights. - Albert Einstein, 1949

What is China? Capitalist? Communist? Or something in between? Is it a benign rising power or a regional, even worldwide, threat? Here are some insightful thoughts on that issue taken from a new book on China by Will Hutton, The Writing on the Wall:

In short, the party state is at the centre of a spiderweb of control of the economy, radiating out from the tight ownership and direction of the 57 sectors the party considers the economy's strategic heart like steel and energy to a more relaxed stance the less important the party considers an enterprise's activity - such as packaging or hairdressing. Even they can be controlled if need be. The general rule is that the more politicised and controlled a Chinese enterprise, the lower its productivity and performance. Thus the performance of China's State Owned Enterprises (SOEs), which control two-thirds of industrial assets, has hardly improved during 20 years of reform. One in three of their employees is estimated to be structurally idle. SOEs are on a financial edge and barely profitable. According to one influential estimate, even the tiniest upward movement in interest rates or the slightest decline in sales would mean that 40%-60% of their enormous bank debts would not be serviced, rendering the entire Chinese banking system bankrupt. They are commercial and business disaster areas.

Even large private companies, although better performing, are still affected. Davin Mackenzie, managing director of iVentures, which is based in Beijing, says that almost no private company, however well run, wants to leave the opaque, informal world of guanxi personal relationships in which the main aim is to hide revenue, cash, and profits from potential political direction. The vast majority, he says, run themselves out of the "cash box in the back of the Mercedes". Most private Chinese companies have three sets of accounts - one for the banks, one for the tax authorities, and one for management. Most do not last long; the average duration is three years. The law of the jungle prevails: you do what you can get away with. China is the counterfeiters' paradise, where intellectual property rights are neither respected nor enforced. Between 15% and 20% of all well-known brands in China are fake; two-thirds of the imports confiscated by US Customs as fakes were made in China. Counterfeiting is estimated to represent 8% of GDP - eloquent testimony to Chinese business strategies and the ineffectiveness of the legal system.

…

But none of this can happen if individuals are not free and capable of being involved - and having the capacity, through the independence that property ownership, education, trade union membership and citizenship confers, freely to challenge and change individual policies, whether they are those of the government or the company they work for. These social processes work best the less social distance there is between people. The more inequality and the more social distance, the less well these processes of pluralism, capabilities and accountability can function. And the less well capitalism then functions. So China leads to an unexpected insight. Capitalism works best the more inequality is capped - and the more and better developed its democratic institutions.

From: Power, corruption and lies, The Guardian (UK), January 13, 2007.

Here are some official economic statistics, plenty of material for a  scary bed-time story:

Households are simply not saving anything. Real average weekly earnings of production and non-supervisory workers - over 75% of all us payrolls - have been stagnant since the mid 1970s. If we use 2005 dollars and the CPI-U (consumer price index for urban consumers), average weekly earnings decreased by about $1 per week over the 30-year interval 1975-2005. The folks have thus stopped saving and have taken on massive amounts of housing and consumer debt.

A look through the Federal Reserve's Flow of Funds Accounts of the United States, or Z1, released in September 19, is a traumatic experience. It reveals the contours of America's debt disaster in stark statistics that grow worse with each passing quarter. In 1999, total outstanding household debt was $6.4 trillion. As of the end of the second quarter of 2006 total outstanding household debt was $12.3 trillion.

Household debt has increased by almost as much since 1999 as the sum total of all debt accumulated by all households across the preceding 220-year history of the US. In 1999, household mortgage debt stood at $4.4 trillion. At the close of the second quarter of 2006 it had more than doubled to $9.33trillion. In 1999, consumer credit outstanding was measured at $1.6 trillion. From: Hard US lessons, harder landings, by Max Fraad Wolff, November 21, 2006.

It looks like the American middle class is headed for the classic debt-trap amidst rising personal debt and declining income against inflation. Apparently the working class of Americans is already written off entirely. 23.11.06

Now it can be sold: the truth about commoditization

February 2006

Capitalism Profits From the Commercialization of Artificiality

Under capitalism any natural product that can be made into an artificial substitute will be mass-produced to replace the natural original because the artificial substitute can turn a profit whereas the natural one is (hypothetically) free to everyone and therefore not commercially viable for purposes of private gain. Everything from grass to culture has been turned into a marketable commodity, packaged and sold. Everything that can be commercialized within an under-regulated, or non-regulated, capitalist system will be.

The Forbes effect, or the sycophantic glorification of distorted wealth

I was reading the ‘Forbes 400’, a list of the richest people in the world, and I noticed something interesting, nearly all of them are men and nearly all of them are either White or Jewish. So not only is the wealth narrowly concentrated in the hands of a small fraction of the population but it is narrowly concentrated by race and sex too! What percentage of the world population do you think White and Jewish males compose?

But how exactly do these people get rich in the first place? Many are simply born into a wealthy family and gain billions of dollars for life without doing anything for it. Most started out wealthy to begin with and combined their already sizeable chunk of capital with their own capitalistic efforts to get even richer. A few began poor and worked even more to create the classic, stereotypical, and extremely rare, rags to riches story.

But what vehicles and established mechanisms do the rich use to get richer? From the Forbes list it is clear that one common mechanism creating extreme wealth is the government operated patent and copyright system. Interestingly enough the government earns nothing from this system, except perhaps through the possibility of increased taxes somewhere on down the line, yet it enriches thousands of corporations and private citizens practically in perpetuity in many cases. Think of the patents on new drugs granted to pharmaceutical companies like Merck or Eli Lilly, or copyrights that support business juggernauts like the Disney Corporation.

Other common methods of getting rich, that are legal, include retail sales. The Walton family of Wal*Mart fame are clearly the reigning monarchs of this method. Retail wouldn’t be in business without the public infrastructure created by state and federal governments that brings customers to their stores every day. Yet how much in taxes to major corporations actually contribute to the public coffers with their creative accounting, teams of tax lawyers and lobbyists drafting new tax exemptions and loopholes? Not much, certainly nothing proportional to their size and impact upon society.  How do they get away with it? Tax breaks are needed to improve the productivity of the 'free-market' and give people jobs, and so on and so on.

Another method is brute force investing, people like Warren Buffett and George Soros who start out by using highly leveraged capital funds, usually that of other investors, to make calculated bets on stocks, bonds, commodities and so on, and get rich in the process. Yet none of this speculation would be even or consistent in operation, or sustainable at all if it weren’t for government regulations and oversight through agencies such as the Securities and Exchange Commission (SEC). Indeed the gambling, excuse me, ‘gaming’ industry is the same story. Corporations are notorious for breaking the rules if they can make a quick dollar doing it. Without government regulation there would be no ‘free-market’ as people use the misnomer today, it would be just a series of scams and con-artists traveling around trying to rip-off someone before they flee to the next town.

Let’s take a quick look at some of the characters investing, or formerly investing, in highly regulated capital markets in order to get even richer. Check out George Soros at #28 with $7.2 billion, everybody’s favorite “Hungarian” immigrant (and if you really believe that he’s Hungarian I’ve got a bridge I want to sell you). First he plunders the world’s financial system and trashes entire countries with his predatory monetary system investment ‘strategies’ and now he’s a philanthropist out to save the world. What made him see the light? Amazing how much easier it is to have a political agenda when you have the billions to push it. Or what about former junk bond baron and inmate Michael Milken at #133 with a only paltry $2 billion, now there’s an all-American hero for you that worked his way up from the lower east side. Amazing how concerned he is about finding a cure for cancer and donating to charities instead of predatory finance after being diagnosed with the disease himself.

Philanthropy isn’t part of the attitude of these people, it’s clearly not an effort that has characterized their lifetime efforts before they were rich or even while they were getting rich, greed is the motivating factor, pure unbridled, totally selfish personal aggrandizement of wealth and prestige even at the expense of anyone and everyone else. After they get it all then they need to insulate their character from public challenge so then they become philanthropists. Philanthropy is just a retirement hobby to pursue after you’ve plundered the world and siphoned off your billions into your own bank account and personal charity funds are just a convenient tax-write off to keep government and the public from gaining control of your wealth

An interesting comparison is that of Linus Torvald of Linux fame versus Bill Gates of Microsoft infamy. Linus Torvald has philanthropy as an attitude, or at least a strong initial consideration, because he single-handedly created a computer operating system and gives it away for free! Yet is Linux admired by the apologists for capitalism, or reviled? Mostly they hate it but increasingly they are warming up to it now that they realize they can make a profit off of it.

A disdain for the public welfare is emblematic of what the capitalist admirers are really admiring, it’s not what the rich have done but rather what they own that makes them so fantastic in their minds. The Forbes 400 list of the wealthiest in the world is about rank, after all, how much practical difference exists between being rich with $10 billion or with only $9 billion? How many inventors and scientists toil away in company labs and never earn a dime from the patents and discoveries they generate for their employer? How many of them are on the Forbes rich list? Here’s a hint: zero. The point to take home is that the reason these people are rich is because of the rules that government has created, they play the game and come out winners, but they would either have nothing or wouldn't be able to hold on to it without the legal order that protects the winners and their wealth. Communism under the Soviet Union, for instance, did the exact same thing just with a different set of rules! Instead of the winners being defined as those with the most money they were the Communist party members with the best insider connections.

No matter what system of artificial rules are established and enforced we will see a group of winners and a group of losers, that’s really not the core issue. The critical matter is how much turnover do we see within that system? What level of opportunity is open to the public for upward mobility within any given set of rules? This is why the permanency granted to copyrights, for instance, is so pernicious, it creates perpetual winners and by corollary perpetual losers. Drug patents are a perfect example but look at Disney - an entire financial machine built on a rule backed by government edict that allows the company to retain sole rights to a cartoon image! And no one else anywhere can use that cartoon image without Disney getting paid for it. How is this promoting creativity or innovation? What if it wasn't a cartoon mouse but something more serious? Copyright rules were originally created to expire after a certain number of years for just that purpose, to allow new entrants into the marketplace, but every time the expiration date comes up Disney just sends its horde of lobbyists to Capitol Hill and buys and extension from the lawmakers. 04.12.05

Part I: A Vicious Cycle

Money supply is measured in three ways, M1, M2, and M3. Basically, M1 is money in circulation, M2 is M1 plus money in savings, and M3 is the aggregate total of all of it – all of the national currency. M3 is the most significant in the sense that it clearly indicates the size of the overall money supply and by corollary the economy as a whole. When measured over time these money supply values indicate the size and direction of change, and just as the chart I created here shows, the M3 aggregate money supply has not just inflated but hyper-inflated, especially over the past several years.

In the case of the United States, the Federal Reserve expands the money supply by printing Federal Reserve notes, i.e. cash. This action is driven by numerous factors from political considerations to bailout cash injections, to trying to boost the economy out of recession, and so on. Although cash can hypothetically be destroyed, in practice the money supply only goes in one direction – up. Rapid expansion of the money supply creates several simple but nonetheless quite pernicious problems. One problem is price inflation because in any given market of fixed supply as the amount of money in circulation increases so does the price charged for those products. If consumers have more money to pay for a product then the seller will, logically, increase their asking price to take advantage of the market. This effect is related to another serious problem, financial speculation and bubbles. Bubbles have been ever more frequent in the United States economy just over the past decade. The Internet and tech stock inflation bubble that occurred in the late nineties is still being felt today as the massive debt that was racked up on unrealistic speculation of fantastic growth perpetuating indefinitely is slowly being digested by most of the technology industry.

Another serious price inflation bubble is occurring right now in many housing and real-estate markets across the United States. The west and east coasts particularly are experiencing ballooning prices for houses and property to the point that in some markets new home buyers have been forced to turn to “unconventional” loans such as ones where the monthly payment is only the interest on the loan and no principle is every paid off!

As the government expands M3 through the Federal Reserve printing money, it creates massive quantities of new cash injected into the economy. This ‘hot money’ has to go somewhere and with interest rates at historic lows it doesn’t make sense to stash the cash in a bank because the investment return is negligible. Similarly, after the stock market burnout when the tech-bubble popped, the markets aren’t that great of a destination for money either, although 2005 has seen somewhat of a resurgence, even if perhaps only temporarily. Right now real estate offers the best return for speculation investment and that’s why housing prices have soared. Clearly this bubble can’t last long, they all pop eventually, and when it does the Federal Reserve will be forced to conduct another bailout of the economy, lowering interest rates or printing and injecting more cash or all of the above and more. Meanwhile M3 continues to expand at an ever more frenetic pace and the hot money of speculation returns with greater vengeance every time. 09.08.05

Part II: National Debt

The raw numbers are impressive but the chart speaks for itself: this is the gross federal debt for the United States government from 1939 to the present, in trillions of dollars; click on the chart to view the numbers I used to create it. What’s especially interesting is a comparison of gross federal debt and the M3 money supply, for they are nearly the same. Indeed the aggregate money supply measured by M3 is composed mostly of the gross federal debt because the money printed by the Federal Reserve is created through the issuance of debt. The United States’ money is debt. The irony is that the federal debt is not a loan that can realistically be paid back; it can only be extended and recycled with new loans replacing old loans because this debt is the money supply. Under our present monetary system if the federal debt were eliminated then the cash to pay for anything would be eliminated as well!

The United States is a country living on credit because federal expenses far exceed federal revenue, and the more debt accumulated the more interest has to be paid on those loans as a fixed expense in the budget. Indeed a vicious cycle.

For all practical purposes this monetary system is doomed to hyper-inflation because, by its very structure and when combined with domestic political forces, it can only expand exponentially. Once the global market for the United State’s debt is saturated then interest rates will have to massively increase in order to entice the debt holders not only to just hold the paper they already have, but to take on even more debt which is necessary to keep the current American economic system afloat! Gold and silver are starting to look like a very smart investment destination right now.

Looking at the chart once more, the time period from about the year 2000 to the present is the most alarming. As a self-proclaimed proponent of smaller government, President George W. Bush has done just about everything possible to expand the national debt at an incredible rate and to an unprecedented quantity with his administrations profligate spending policies and seemingly irrational federal revenue reduction maneuvers. It looks like Bush is piloting the country the same way he ran all of his businesses: straight into the ground. 20.08.05

The Amazing Self-Destructing Economy

The federal debt limit under the Bush administration's watch has increased by around 2.4 trillion dollars in just his first four years of office, anyone care to estimate how much more he will add in another four years? This is not an idle issue, two trillion dollars is hardly an irrelevant sum. This is borrowed money and the American taxpayer will continue to pay increasing amounts in interest payments indefinitely as it’s also worth noting that no one is seriously considering the possibility of actually paying off the principal of the debt.

The United States is a very large economy and can continue the current trend of massive deficit spending, for decades even, but what is disturbing is the structural qualities of the political spending system for not only does it not reward responsible behavior but it actively rewards irresponsibility. Elected politicians that waste money are the most likely to get re-elected! There really isn’t anyone in the elected leadership willing to stick their neck out to do something about the ballooning deficit and there won’t be anytime soon even though the budget deficit reached a record of $413 billion for the fiscal year that just ended. The federal spending deficit, the amount tacked onto the national debt, is simply a non-issue in terms of current political debate. The spending cap was recently increased by $800 billion to a total of $8.18 trillion without any hesitation because the alternative is unthinkable – a federal default! So even though the elected leadership may try to halt spending by setting limits, those limitations are meaningless!

Presently around 2 billion dollars a day in extra funding is needed to support the American economy and its gap between savings and spending.  Foreigners have already become the primary buyers and thus supporters of American debt largely because the domestic market can’t support the volume being issued anymore, like it once did. Even Fed Chairman Greenspan himself has started warning of the fact that since Americans don’t save their money others that DO save their money are now supporting the country and further that this state of affairs is unsustainable. This can’t go on forever because eventually buyers of American government debt will themselves run out of funds or more likely simply demand higher interest rates before they continue to accumulate more federal bonds.

Signs of Trouble

The first sign of the consequences of uncontrolled spending will likely be a fall in the American Dollar because the trading value of any given currency on the open market is a direct reflection of investor confidence in the health of that economy.

Interestingly enough the United States Dollar is rapidly falling in value right now largely as a reflection of the above mentioned deficits and total lack of political willpower to address the financial fundamentals. For the most part America is not overly concerned with a weaker Dollar because it makes exports more attractive to foreign buyers and will in the short term improve production rates in the domestic economy. But if the Dollar continues to slide it may become a free-fall and then foreign investors will begin to dump American equities as they lose relative value and perhaps stop buying or even start to dump government bonds even as they are already choking on the volume of federal debt flooding the world market now.

The second sign of trouble is higher interest rates. The Federal Reserve has been steadily raising interest rates for the past several months in response to rising inflation, largely due to the inflationary nature of higher fuel costs, but also in response to the obvious need to put national debt at a return level attractive enough to hold buyer interest; two percent isn’t much but it’s still enough for now. The problem with higher interest rates is that it makes consumer debt more costly and this in turn decreases economic expansion so a healthy economy can sustain higher interest rates and still grow but a weak or stagnant one will have problems. These are the two boundaries the Fed is trapped within – the need for higher interest rates but while the American economy is still anemic at best.

While Bush & Associates have made it their mission to cut taxes any way and for any reason that they can, none of this loss in federal revenue has been matched by a concomitant reduction in federal spending. In fact quite the contrary has occurred. So while France, for example, is taking advantage of high gold prices to sell 600 tonnes of their supply to pay down their deficit, what is the U.S. Treasury doing? Nothing. While France isn’t paying anything to fight a war (besides a few minor civil-unrest problems such as the Ivory Coast), the Bush administration is busy pouring hundreds of billions of dollars into an extremely messy and brutal counter-insurgency/occupational war in Iraq and a ‘War on Terrorism’ that is as limitless in cost as it is in length. Currently the American military is buying (expensive) new armored vehicles to replace those lost in Iraq at the fastest rate of production possible. Socialist France is far from a model of restrained government spending but anymore it is in comparison to the United States! Not surprisingly the Euro continues to climb in value while the Dollar falls. The Euro zone economies cringe at the prospect of losing export share but the higher currency value is nonetheless still a vote of confidence in their macro-economic management policies. The Bush Administration (with plenty of help from Congress) has already burned up an average of 500 billion dollars in extra debt per year over four years; at this rate in another four years America may well be in the financial intensive care unit hooked up to life support.

Fading Empire

History has shown that the long-term substantive gains go not to the debt-accumulating profligate spenders but to the prudent savers. Britain lost its empire fighting a war against Germany during World War II having borrowed itself into oblivion from the savings accumulating nation of the United States. Today the United States appears to be following the same path as the British Empire. This is pause for thought when considering that China is one of the major sources of foreign buying of American debt.

The Bin Laden Factor

Even more unnerving, this is all completely in line with Osama bin Laden’s asymmetrical financial warfare strategy against the United States government - specifically its Israel-biased Middle East foreign policy. Bin Laden claims that each dollar spent by al-Qaida in attacking the United States has cost his opponent $1 million in economic damages and increased military spending. Whether Osama bin Laden is ever captured, alive or dead, is irrelevant at this stage because he’s already proved the effectiveness of the strategy. The source of America’s real problems aren’t external, they aren’t the French, they aren’t even terrorists because they can only exploit pre-existing weakness, they can’t make them. America’s problems are internal. America has a self-destructing politico-economic system that is a product of an extremely distorted political system that makes eventual and unavoidable national bankruptcy preferable to short-term spending control; a system so disproportionately influenced by special interests and lobbyists that it prefers self-destruction rather than a fair and objective foreign policy. 21.11.04

Bond Snapshot

"The benchmark 10-year T-Note (US10YT=RR) shed 1-16/32 in price to yield 3.91 percent after hitting an earlier peak of 3.96 percent. That was its highest since May 6, when yields plummeted after the Fed highlighted the dangers of disinflation.

Yields have not shown such a big percentage change on the day since October 1998, in the aftermath of the LTCM crisis, when the losses of a major U.S. hedge fund rocked financial markets and the Russian economy spiraled into recession." From: Deflation-Deficit Double-Hit Scalds Bonds, By Amanda Cooper, Reuters July 15, 2003.

"We had the equivalent of three months of moves compressed in one week,'' said Christopher Low, chief economist at FTN Financial in New York, the biggest underwriter of bonds sold by mortgage finance companies Fannie Mae and Freddie Mac.

An investor who bought $10 million of the notes at the closing yield of 3.63 percent on July 11 has lost about $294,000. The yield may rise to 5.5 percent by the end of 2004, according to analysts at Bear Stearns & Co., the world's sixth-biggest securities company by capital." From: Treasuries Poised to Extend Biggest Weekly Drop Since March, Bloomberg news July 21, 2003.

This is important to everyone because home mortgages and many other consumer interest rates such as those on some  credit cards are pegged to the 10 year treasury rate. Treasuries have had a fairly continuous rally (meaning lower interest rates) for over three years and so the current level was mostly unsustainable hence the sudden and severe correction sparked by Greenspan's recent, otherwise blasé comments. Perhaps more interesting is the quantity of new government debt being unloaded on the market now to support the massive federal deficit set to be near $500 billion for the year. Consequences? Unlikely to be serious as demand for all debt remains very high but nonetheless any sudden and extreme action in the financial markets can sometimes generate dangerous and unexpected side-effects, derivatives being the most likely culprit potentially initiating a catastrophe. 21.07.03

22.07.03 Here We Go Again...

15.08.03 Wow, look at this one (red dotted line is previous day's close):

Last Hope - Why the June 25th quarter point cut may be the last chance the Federal Reserve gets.

The most recent action seems to raise more questions than it answers and the Fed's comments only restate what everyone already knows anyway, clarifying nothing and pleasing no one with a mere quarter point rate cut.

It seems likely that even though a half point would be better, setting interest rates that low would create chaos in the money market funds in the sense that they are barely making a profit now and low interest rates are seriously impinging upon their viability. This would be a bad thing because it would upset the current financial order and shift funds in a potentially unpredictable way. Also cutting a half percent would send the statement that the economy is in bad shape which would roil equities more than the mechanistic benefit of lower rates would confer. So although a half point cut made the most sense as a kick start from a technical perspective it would have sent the wrong message.

Whatever the case at this stage we're in uncharted territory because no one really knows where it will lead or what to do and everything tried so far to get the American economy out of the tank has not worked, or if it has only very slowly. Characteristic of the bizarre situation is that both bond and stock markets were disappointed by only a quarter percent cut instead of a half (bonds and stocks are reverse investments, like the opposite sides of a coin). The bond markets, being pessimists, wanted it because a half point cut indicates a faltering economy and the stock market, being optimists, see that a quarter won't boost the influx of new funds as much.

So if bonds aren't happy and if stocks aren't happy, where to invest? If the answer is nowhere then everything is out the window, game over. And this is the crux of the matter and in this regard the Fed seems more dejected and unsure of themselves than ever before. The Fed should be talking up the economy but instead spout dry rhetoric and day old news. This is why today's rate cut may well be the last real shot they have and they had better hope that it either works or just on its own the economy picks up by the end of the 2003. They've already cut over a dozen times in a short period and have yet to see any meaningful response although hints have emerged that decent economic growth may arrive by the fourth quarter. It seems the fundamental belief here is that if things don't get worse (and Bush doesn't start another war) then they must be getting better, which is not unreasonable just speculative.

The nightmare scenario for the Fed, America and the world economy is that people will stop spending and investing money; this is why upsetting the money markets was almost too dangerous to justify the needed rate cut. If people see that a bank is no better than a mattress or a jar in the basement for stashing their savings then the whole system will collapse. Money as far as the Fed is concerned is worthless if it is not in circulation.

The problem with the Federal Reserve is they've only one tool they know how to use and it's like a big hammer and now they are being asked to repair a car engine - they can't do it. Japan had the same experience and look where they are now - you can't fix a car engine with a hammer just like you can't fix the present economic problems with interest rates alone.

Bush & Associates are fairly shrewd at least when it comes to getting re-elected and they know that the economy is key to that plan. They've made a reasonable effort to do what they can to get the economy back on its feet by enacting policy and legislation to free-up cash for people to spend, mostly through tax refunds, but this is both a delayed effect and of limited benefit too.

If things get much worse the Fed is faced with employing unconventional, often convoluted financial measures of various forms but they all center around the basic need to inject cash (liquidity) into the economy and convince consumers but mostly business' (the current weak link) to invest it. Unfortunately, America is starting to look more like a replay of the situation in Japan. The equity markets are about the last hope here. If the stock market is not perceived as a viable place to invest now then it's difficult to see any part of the economy picking up pace soon at least in a symbolic manner. If this is the case consumers will slow spending without jobs and industry will cutback due to a lack of demand and it all spirals downward and the Fed is left without ammunition and the modern macroeconomic rule books have no answers. 25.06.03

It is through the hustle of commerce and the arts, through the greedy, self-interest of profit, and through softness and love of amenities that personal services are replaced by money payments. Men surrender a part of their profits in order to have time to increase them at leisure. Make gifts of money, and you will not be long without chains. The word "finance" is a slavish word, unknown in the city-state. In a country that is truly free, the citizens do everything with their own arms and nothing by means of money; so far from paying to be exempted from their duties, they would even pay for the privilege of fulfilling them themselves. I am far from taking the common view: I hold enforced labor to be less opposed to liberty than taxes. From: On The Social Contract by Jean-Jacques Rousseau, 1762.

Economists along with their fallible science are the modern equivalent of the sawbones doctors of medicine 150 years ago. Regardless of whether they kill the patient or accidentally save a life the public is compelled to seek their services for lack of a superior alternative.

<ON TO PAGE 2>