Tuesday, February 9, 2010

Losing Credibility

Losing credibility is much easier than gaining it. Trust is fragile and takes time to grow. A secular credit contraction is a time of distrust. So much bad paper issued, it seems impossible in retrospect. That paper made the last bull market in real estate and its affiliated industries, particularly finance.

How much was that piece of property at the peak? The loan-to-value ratio was greater than 100% at the time of initial purchase? You mean no money down AND you walk away with cash at the closing? A 1% teaser rate? HELOCs for six figures only a year after you moved in using a "no-money down" mortgage?

And now all that paper is bad and stuffed deep into the bowels of the U.S. Government, which has been de facto running the mortgage industry by backing 90% of new mortgages over the last year. Right. This is a smart move - I don't know why the private sector doesn't do it any more. Because we cannot let the mortgage industry deflate. We must sustain an unsustainable bubble at all costs. Why, if you're nice or it's right around election time, we might just quintuple the tax credit for a new home purchase. Or, whatever - would you prefer some other resource-wasting scheme? Americans deserve to have artificially inflated home prices. It's for their own good!

At least the National Association of Realtors knows its real estate. We need to listen to their wisdom to find our way out of this mispricing problem in real estate. This problem's pull is powerful and exposes a lot of naked swimmers. It is also just a symptom of a larger syphilitic disease, that of credit excess. Ask the credit card companies. Or the auto loan companies. Or the home appliance loan companies.

When prolonged, massive debt expansion turns to contraction, price-extended assets fueled by the boom crumble. Housing is done. Kaput. The psychology change is entering its middle phase. Trust in the "home as wealth and investment" concept is leaving and it will take a generation to come back.

Using the government till to combat such a situation assumes resources that don't truly exist. This is a massive undertaking. It will fail. And the more "stimulus" that is wasted in trying to stop what must occur (a bubble bursting), the more credibility and confidence will decline in the currency/debt.

Part of this cycle is about the current central planners and financiers losing credibility. As unpayable debt from the private sector is transferred to sovereign government balance sheets, where are the governments going to get the money to pay these debts? They can only take it from their citizens, whether through currency debasement and/or taxation. If we don't come up with the money through taxes, a more direct confiscation (i.e. your 401(k)/IRA) may be needed. Otherwise, they might break our knee caps!

Gold is good money going into hiding. Gold will survive this financial storm with its value significantly enhanced relative to other asset classes. Gold loves monetary extremes. I can promise we are headed for more of these. Gold senses when the monetary system is losing credibility. Precious metals are the most likely asset bubble to develop over the next speculative cycle. Their bubble will be fueled by the monetary blast(s) accompanying any one or more of a number of potential targets in the next few years that can't be adequately funded with current tax revenues:

+ Fannie Mae and Freddie Mac (no, I mean AGAIN!!!)
+ State bankruptcies
+ Social Security
+ Pensions (government employee pensions in particular)
+ "Stimulus/job creation/infrastructure improvements"
+ Continuing, expanding or starting a war
+ "New" health care plan
+ Medicare (yes, health care again...)

The Dow to Gold ratio will likely reach 2 and could go below 1 this cycle. That's a big move in this ratio given a current level above 9. Many more people will lose faith in debt paper and move into Gold. Gold's biggest move in this ongoing secular bull market of almost a decade lies ahead, not behind.

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