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Thursday, April 05, 2007

Provident Living: Soon To Be Forced Upon Us?

The Church has been trying to teach its members for years the importance of provident living - staying out of debt, spending less that we earn, preparing for cloudy days ahead, etc. So far, millions of Americans have had the luxury of choosing whether they live frugally or not. Soon that luxury may be gone, and provident living will be the only option for many as economic reality catches up with the United States. Are you ready? Are you preparing?

Peter Schiff's April 5 commentary, "No More Legs to Stand on," offers succinct analysis about the economic troubles we are now facing. Here's an excerpt:
As investors and market strategists sift through every new economic tea leaf for clues about the health of the U.S. economy, I am reminded of a group of railroad engineers discussing the structural qualities of the track bed while an overloaded fright train careens around a sharp turn. For those not lost in the inconsequential minutia, a severe recession is an outright certainty, regardless of what current statistics might indicate on a day-to-day basis.

Since the bursting of the dot.com bubble, the U.S. economy has been fueled by an enormous consumer spending spree. This largess has been artificially propped up by the largest real estate bubble in U.S. history. In fact, housing has acted as a three-legged stool upon which American consumers have been precariously perched. Those legs are: 1) home equity extractions; 2) adjustable rate mortgages; 3) the wealth effect.

First, rising real estate prices allowed Americans to routinely borrow against home equity and repeatedly refinance loans of any stripe (be they mortgage, credit card or automobile) at lower rates. If the home equity was turned into cash, or used to pay off other debts, the result was additional spending beyond what consumers could have afforded based solely on their incomes.

Second, adjustable rate mortgages, especially the "negative amortization" or the "interest only" varieties, allowed Americans to enjoy temporarily low mortgage payments despite accumulating bigger mortgages. The difference between those temporarily low rates and the normal rates, to which these loans would ultimately reset, was available to be spent by homeowners.

Third, as real estate prices rose, homeowners felt wealthier, which has been shown to be a stimulant to spending. In addition, the pervasive belief that home prices would continue to rise indefinitely led many Americans to make false assumptions regarding their financial circumstances and their need to save to meet future obligations and retirement goals. As a result, money that would have typically been applied to savings was spent.
Consumer spending must dry up, and yet as the prices increase due to a weakening US dollar, the Fed will probably not be able to cushion the landing by decreasing interest rates. Rather, to try to keep foreign investors from dumping the US dollar as it weakens, they will have to increase interest rates to compensate. All this could create a crushing economic burden for the US economy.

Ladies and gentlemen, it's time to get out of debt now and start saving in ways that will still have value when the dollar tanks.

14 comments:

Jakob said...

The way I understand it, a weakening dollar doesn't cause higher prices; inflation weakens the dollar. Similarly, foreign investors divesting themselves of the dollar will cause it to weaken, not vice versa. A weakened dollar will cause increased exports, though, as China has proven by their tight control of the yuan. The same article you quote says that we will have excess savings which should take the place of foreign investment. So we have increased exports on one hand while Americans are saving more; what's wrong with this?

My point is that these doomsday scenarios often don't explore every possible area of the economy and see how other more positive effects could occur from this problem.

As a side note, I notice that a lot of your economic analysis comes from Kitco. It might be a good idea to diversify your sources of information on our economy.

Joe Shmoe said...

Your columnist has a vested interest in making gloom and doom predictions - he is trying to sell gold. You hear ads from companies like that on fringe nutjob radio shows like Art Bell. Mainstream financial organizations like banks and brokerages advertise in real media.

I agree with getting out of debt, but if you want to live your life like Chicken Little, that's your prerogative.

Mormanity said...

Don't discount the commentary from Kitco, but there are plenty of other sane sources. Take one of the world's most famous economists of the past, Henry Hazlitt, whose book on inflation is still terribly needed today. It's a short but extremely valuable book, available at http://www.mises.org/books/inflation.pdf. He explains clearly the dangers we face by not being on a gold standard.

Folks, you can say "everything is just fine" and ignore those who warn of economic difficulty, dismissing their analysis as "chicken little" doom and gloom. Would it be doom and gloom for me to point out that your US dollar has lost over 90% of its value in the past century? Is it doom and gloom to point out that the current creation of new fiat dollars at enormous rates must lead to further devaluation of the dollar? Is it doom and gloom to point out that value of the US dollar is no longer backed by any intrinsic value since we went off the gold standard, and that if China and other nations decide to get out of US treasuries, the dollar will quickly lose a large portion of its value?

It's not just crazy people warning of alien abduction of the economy or something. It's simply looking at what has already happened and understanding where our boat is heading.

Or have you not noticed that your cost of living is increasing year after year, and that money in the bank buys less this year than it did last year?

Mormanity said...

And Jakob, yes, inflation is a manifestation of a weak dollar - or rather, an excess of fiat dollars printed up. As productivity increases and technology gains, our dollars should become more valuable - but the fact that they are being printed and dumped at insane levels into the economy robs us all with a hidden tax that makes our money worth less, not more, giving politicians billions more to spend. This has created the easy credit and the housing bubble and has been a driver for heavy consumer spending that has propped up the economy, but this bubble cannot be sustained.

So when the dollar collapses, will that increase exports? Perhaps - but everything will cost vastly more, and the cheap goods we important that help hold down the signs of inflation will cost much more, and we cannot be better off. If all the money in your 401k were now worth half or 1/10 what it is, you can kiss your retirement good buy. You will have to work the rest of your life for less and less, and even if other nations are buying up more and more of what we have - exporting, say, New Jersey - that will be poor compensation for what we have lost.

Debasing the currency of a nation has happened over and over in history. It occurs when governments get out of control and start creating worthless money, not backed by real value. And when it happens, it leads to social chaos. to incredible poverty, to instability and the collapse of nations. Rome, the Weimar Republic, the Kirtland Bank (sorry, but there's a tragic story there), Zimbabwe, etc. Runaway inflation is the last thing you need, trust me.

Jakob said...

The Federal Reserve actually has a vested interest in keeping inflation low: it's composed primarily of bankers, who hate inflation. However, severely limiting the money supply by going on a gold standard would make the debt that almost every consumer is in almost impossible to pay. So you can't have it both ways. Either we have inflation or everyone and their dog goes bankrupt.

The problem with basing a monetary unit on a limited commodity is that it makes it very hard to adjust the money supply. There is a finite amount of gold in the world. Given the current size of the US economy, it would be extremely difficult to acquire enough gold to back our money supply.

I'm not sure that dollars are being "printed and dumped at insane levels." Do you have a source for this? Are these rates historically any different than we've seen before? Are the bills that are being printed actually ever reaching consumers?

Increases in the money supply don't have to be inflationary; you're assuming that both the velocity of money and the real value of all transactions stay constant. Those two (especially the value of transactions) drive economic growth.

There are reasons to have some inflation: one is the stickiness of wages. Since most of the time, salaries don't go down, inflation allows businesses in tough spots to save money by not issuing raises. But since it's very hard to lower wages, they couldn't do the same in a situation of deflation.

It is irrelevant how much the dollar was worth 100 years ago. Inflation is something that happens, and at about 3-4% (which is considered a fairly normal percentage) it adds up to a lot over 100 years.

China will not suddenly decide to get out of US treasuries because their economy depends on keeping the price of the yuan low. If they suddenly sell all their dollars, prices of Chinese goods (mainly purchased in the US) will go through the roof. China's economy depends on a weak yuan.

Debasement is actually a slightly different thing than you seem to think; you can tell debased money apart from non-debased money. That's why it's a problem: people spend the debased money and keep the "good" money. This kind of thing happens on a small scale with things like state quarters. People collect the state quarters and spend the regular old ones, leading to a surfeit of the old quarters. Inflation, which you're talking about, happens to all money in an economy. Debased money still has value, just less than the older money.

Mormanity said...

Irrelevant how much the dollar was worth in the past? Jakob, do you really mean this? Inflation is not an inevitable law of nature - it's the direct result of monetary policies that governments can choose. They can be wise and protect their currency, or they can be profligate and debauch their currency and destroy their long-term future. It's a choice. Whether we are facing 3-4% official reported inflation or 8-10% actual inflation, in either case it means that what people save for their retirement or their children rapidly becomes worth less. Inflation deprives everyone of the value of what they have earned and saved - it especially robs people of their retirement income. Maybe you mean that you don't plan on living 100 years, but what about 30 years from now? If your 401k gets worth less each year in spite of putting al you can into it, doesn't that worry you? Seems pretty relevant to me.

The economic difficulties that our burgeoning money supply and grotesque indebtedness will lead to don't require mystic psychic powers to see. Look at what's happening right now in the subprime area. The easy lending systems that allowed so many people to turn their homes into ATMs and allowed many unqualified people to buy a home, fueling the housing bubble and consumer spending in the past decade, are already drying up. Big companies that were doing the lending are going bankrupt. Lending rules are being made tighter. The juice behind the housing bubble and the vast consumer spending it drove is drying up already. Diverse data sources show economic slowing. Will it slow so severely that there is a recession? That's the debate. But the potential for much greater losses in the dollar, coupled with economic slowing, point to a need to make adjustments in our personal economic lifestyles now.

Bottom line: get out of debt and get some of your savings in vehicles that can withstand high inflation. Silver, for example, was six dollars an ounce a couple years ago, and is now approach $14. The potential for 20-30% appreciation in its price per year is very high. Ditto for gold. Do your own due diligence, but those are two vehicles to consider. And food storage!!

Anonymous said...

Instead of listening to hucksters trying to sell gold or wheat, perhaps listening to people like Clark Howard or Dave Ramsey or Ben Dover would be better ways to learn how to manage money.

dp said...

I thought this video might be relevant to the topic:
http://video.google.com/videoplay?docid=-2757699799528285056&hl=en

It's a graph of US home prices since the late 1800's adjusted to inflation.

Corey said...

Is it hopeless? http://infohype.blogspot.com

Mormanity said...

Clarh Howard is a tremendous source of sound financial advice, like "get out of debt and live providently". Lots of fine tips. I used to listen to him in Atlanta before he became so famous. Always enjoy his show when I get a chance to listen in. In fact, he's coming to Appleton, Wisconsin in a couple weeks and my wife is going to his show here. I'm a little worried that she might become a groupie or something.

Jakob said...

I reiterate that some inflation is necessary to keep a healthy economy. You should read up on other opinions of inflation than the nonstandard economics you seem to be using. A good place to start would be the Wikipedia article: http://en.wikipedia.org/wiki/Inflation.

I'm also not sure how you're arriving at your 10% "actual" inflation rates. Given the substitution effect, it's likely that the "official" inflation rates are somewhat low. You complain that housing and transportation are not included, but housing is not a routine purchase, and major changes in transportation prices are not generally caused by government policy.

Governmental policy is not the only thing that can cause inflation. Expectations of future inflation can cause inflation. A vicious circle of wage and price increases also causes inflation. Are you sure that this 10% inflation you cite is actually caused by the Federal Reserve? What possible motive could they have for this? After all, their constituents (bankers) make money from a low inflation rate.

Mormanity said...

From mainstream economist Alexander L. Wolman of the Federal Reserve:
"According to standard monetary theory, optimal monetary policy involves slight deflation." (See http://ideas.repec.org/a/fip/fedreq/y1997ifallp1-21.html.

I fully agree.

And if you want a more international perspective, try the International Monetary Fund's research paper on the harm of inflation to growth: http://www.imf.org/external/Pubs/FT/staffp/1998/12-98/ghosh.htm.

Now regarding that 10% (or 8%) number: have you checked M3 recently? Or estimates of M3? What would the CPI be if energy and other key things were included, and if we didn't massage all the numbers downward with hedonic factors and other fudge factors to make inflation seem as low as possible?

And why would Central Bankers and governments want to inflate the money supply while keeping officially reported inflation low? Follow the money! Who benefits from deficit spending? Where are the billions of dollars of interest going? Who gains power from massive spending and deficit creation? Why does every corrupt government seek to inflate their money supply and devalue the currency? It's arguably what led to the downfall of the Roman Empire. Why were they doing it? Darn good reasons! Hint: it wasn't to help their subjects have more freedom and self-sifficiency.

Anonymous said...

So, if I understand you correctly, that would be Jimmy Carter's reign that answers your question, "Why does every corrupt government seek to inflate their money supply and devalue the currency?" Or were you trying to condemn the Bush administration again? You are so transparent.

With that said, I love you man! Keep up your insightful LDS blogs. Your website is the best one I have seen to explain our beliefs and your sense of humor always gives me a good laugh. We do have some things in common.

Jakob said...

I apologize for using an ad hominem attack in my previous post. Of course it isn't relevant whether your economics is mainstream.

One of the articles you cited notes that "At very low inflation rates (around 2–3 percent a year, or lower), inflation and growth are positively correlated." This was my original point.

M3 is not a very accurate measure of our money supply. It's not very liquid and thus represents very little of the money that sees day to day use in our economy.

Furthermore, inflation (regardless of your definition thereof) only affects consumers when prices actually rise. Simply increasing the size of the money supply does nothing if the economy also grows.

Interestingly, the CPI between February 2006 and February 2007 is actually smaller if you include energy and food, which have volatile prices that don't accurately represent long-term price increases. So keeping something out when it actually decreases the reported value of inflation is trying to fool people into thinking the inflation rate is lower than it really is? See http://www.bls.gov/cpi/.

The problem with your analysis of motivation is that the Federal Reserve does not gain power or influence from deficit spending. It is an independent body.

And why would Central Bankers and governments want to inflate the money supply while keeping officially reported inflation low?
In the US, Central Bankers and governments are two separate entitities. Bankers of any sort would lose from using artificially low inflation statistics. If money is becoming less valuable at a faster rate than they obtain interest, they are losing money. While the executive and legislative branches may desire inflation, they have very little to do with the actual money supply.

Who benefits from deficit spending?
Pretty much no one, but that's not the point. If the government borrows money, it takes away the opportunity for businesses to borrow money, so there is still the same amount of borrowing happening. Deficit spending alone does not cause inflation.

Where are the billions of dollars of interest going?
To the banks, but if inflation is happening faster than the interest, the bankers lose anyway.

Who gains power from massive spending and deficit creation?
The government currently in power; it's pandering to the people.

Why does every corrupt government seek to inflate their money supply and devalue the currency?
This is a rather hard proposition to prove - does every corrupt government seek inflation?