THE VALUE OF A PERSONAL ECONOMIC VIEWPOINT – PART TWO

We described the reasoning behind our current assessment of the US economy being in a fierce local deflation with simultaneous international inflation and a devaluating US dollar in our previous part one blog. We are using this personal view of the economy to develop our plan so we (hopefully) can flourish in this rapidly evolving global economy. We believe every family’s situation is different, and though our approach might work for us, it may be useless to others. We share it with the hope that it helps others to think about different views of the future to see their potential opportunities for income and happiness.

Investments

When we were employed in Silicon Valley, we created a “personal mutual fund” of stocks. We have been monitoring our stocks and some, like natural gas, have done very well while others have lost a lot of value. Our plan is to hold on to stocks in U.S. companies that are producing internationally exportable raw materials as we believe they will have expanding markets and profitability. We are reducing our holdings in stocks with less exportable products such as domestic natural gas producers because it is difficult to make it exportable (converting it to LPG) and we expect depressed prices for piped natural gas in the US for many years. We expect stocks in US retail markets to continue to decline and will exit them if there is a market rally. We only hold stocks from US stock markets due to our belief that the oversight of financial reporting in the US, though often disappointing, is still higher than stocks in international markets and investment information about US companies is more reliable than other county’s at this point.

We mentioned in a previous blog that our real estate holdings in Hawaii have been severely deflated, off over 50% and still dropping, but we will hold on to them even though we expect local deflation to continue to lower their value for the next year or more. We believe real estate in Hawaii will ultimately rise spectacularly in price as the deflating dollar makes Hawaii real estate cheap for affluent Asians and Europeans. We sold our house in California and are enjoying the freedom of mobility that renting gives us, however, if the prices for Hawaii real estate continue to plunge, it will at some point be smarter for us to buy a house or condo than to continue as renters. We are closely tracking the price of foreclosures in Hawaii County and watching in awe as the prices drop, particularly on the west side of the island.

Cost of Living

We are constantly looking for ways to cut back our expenses and preserve as much of our savings as possible. Prices of imported food, gas and materials are rising which drives us to find local replacements or live without where possible. We have dramatically changed our lifestyle from our corporate days in Silicon Valley to our laid back lifestyle in Hawaii. We eat less, exercise more, sleep more, and use less energy. We are monitoring the cost of living in every part of Hawaii County and noticed that west side prices are more deflated, particularly for rent, compared to the east side, perhaps due to the huge decrease in tourism on the west side and the growth of University enrollment on the east side. We expect deflation for local products, such as rent, services, and locally grown food, to continue as the State and County furloughs and layoffs continue to lower income in the east side economy. As we study the rents on the west side, we are considering a move to reduce our monthly expenses, though we are concerned about the intense VOG (volcanic emissions) on the west side.

Income and Employment

We have been jobless for over two years now and getting another job seems unlikely as the local and national economy continues to shed jobs. Where in the 1990’s and roaring 2000’s earning an income seemed effortless, now it seems impossible. The fact that major companies such as Sony, GM, and Citibank are struggling to make an income with their huge market share and experience, makes us feel a little better about not having a job right now.

We are viewing our future income producing activities as needing to be self created rather than dependent on a job. We are focused on developing a product or service that we enjoy and will make a valuable difference to others. We are assuming that social security and Medicare won’t be there for us by the time we would qualify in a decade and a half, so our income producing plan has to be something we can do for a very long time. We are thankful that our savings and downsizing efforts are allowing us this precious time to enjoy Hawaii and gain new skills in this rapidly evolving global economy. Though it takes time, we will constantly reassess our plan as the local and global situation changes.

We are eager to hear from others about their approach in this current economic situation and how they plan to flourish in these current times.

THE VALUE OF A PERSONAL ECONOMIC VIEWPOINT – PART ONE

We have always found the mass media view of “the economy” useless for predicting the risks and opportunities in our world. So we came up with a personal viewpoint and forecast for the global economic downturn and we have found it useful and comforting to have a view that makes sense to us and points us to where we will have the best opportunities in the future.

Our assessment of the current economic situation is colored by our experiences of the past and our view of the current situation. The 1930’s Great Depression was caused by massive speculation in stocks. Money was borrowed to buy stocks that were consistently increasing in value turning investments in the stock market into a quick way to “easy street” - a magical place of wealth and no work. When the massive speculation based economy fell apart it brought extreme deflation due to the assets that the banks had lent money on being priced far under the value of the loans. Banks could not return depositors money which caused most of them to go bankrupt. The abrupt loss of the American banking system’s assets resulted in widespread loss of jobs and wide spread poverty, where the majority of American workers had a hard time making enough money to pay for food and rent. It was not until 30 years later, in 1962, that the stocks of surviving Depression Era companies like General Electric recovered their 1929 values.

The current economic crisis looks a lot like the Great Depression scenario to us except that residential housing was the currency of speculation rather than stocks. As the bank loans for housing mortgages have come to exceed the value of the houses, the banks’ assets have fallen far below the amount of money they owe their depositors resulting in banks across the US (124 so far this year) and the world going bankrupt.

During the roaring 2000’s, the amount of global “mortgage currency” created is estimated to be about $40 Trillion. The Federal Reserve has been electronically creating an unprecedented amount of US dollars (currently between $750 Billion to $1.5 Trillion and growing) and pouring these new dollars into the banking system and global economy to reduce deflation and keep money flowing due to the head of the Federal Reserve, Bernanke, being a student of the Great Depression and working diligently to minimize the severe cash shortage and banking collapse that was so destructive in the Great Depression. Assuming real estate losses are at 50% of their value, the sudden global currency that has gone missing is about $20 Trillion, or ten times the current cash infusion by the Federal Reserve. Though the huge infusion is small compared to the global losses and has not stopped rapid deflation of things such as real estate, the response by the Fed will result in this economic contraction being different than the Great Depression.

Here is our take on the situation:
1) The huge amount of dollars being created by the Fed and the US’s massive deficit spending will continue to strongly devalue the US dollar against most other world currencies.

2) The absence of personal credit in the US due to tightened credit standards and the low rate of employment will be highly deflationary as American workers will no longer have money to buy things, even on credit.

3) The low dollar value will raise the cost of imported goods and restrict Americans access to raw materials that are in high demand by other nations.

So in summary, we are entering a deflationary period for non-exportable assets with rapidly rising prices for imported items such as computers, electronics, cars and exportable raw materials like lumber, corn, cement, oil, and steel. The strange situation unfolding is a rapidly devaluing dollar combined with fierce local deflation which will likely continue for several years. At the same time that raw materials become globally more expensive, American raw materials will have great price advantage internationally. Deflation is new to us after 50 years of inflation and it will take some time to grasp the full extent of how it will change things in Hawaii and it is further complicated by the simultaneous occurrence of international inflation.

So we ask ourselves continually, what is our smart move in a deflationary, devaluing economy with rapidly rising international raw materials prices? In our next blog we will describe our plan.

RISKS OF VOLUNTARY FORECLOSURES

We have been reading with dismay about people walking from their mortgages even though they have the income to make their mortgage payments; these are known as “voluntary foreclosures”. The motivation is to avoid paying for a house where they owe more than the current price of the house, forcing the bank to take the loss when the house is foreclosed upon.

According to Experian, a credit rating service, over half a million borrowers walked from mortgages that they could afford in 2008, double the number from 2007. These home owners are not unemployed or out of savings, they are just choosing to not pay their mortgages anymore because they see it as an easy way to make some quick cash with no long term downside. According to Citigroup one in five foreclosures are now voluntary, people with jobs and savings and able to pay the mortgage. They are using the fact that the banks are slow in foreclosing to get a free place to live for months and sometimes years before having to move out for non payment. Surprisingly, Experian found that people with high credit scores are 50% more likely than people with average or low credit scores to walk from an underwater mortgage believing that a foreclosure will be only a minor ding to their credit score.

It may seem as though they are right. After all, there has been no public outrage at this practice and there have been no stories of anyone being arrested for financial fraud for refusing to pay the money they owe the banks while still having the same financial conditions as when they were given the loan.

The US government has electronically created almost a trillion dollars to shore up the global banking system from the problems caused by borrowers defaulting on “sub prime” loans. The loss of income to the banks from voluntary foreclosures may have even greater implications to the global economy than the defaults of high risk borrowers. Deutsche Bank predicts that the number of homeowners underwater will grow from 14 million, or 27% of all homeowners with mortgages, in 2009 to 25 million homeowners, or 48% of all those with a mortgage, before home prices stabilize. Assuming that the practice of voluntary foreclosure continues unabated and 25 million Americans voluntarily walk from their mortgages the US tax payers will be left to cover the trillions in bank losses or let the global banking infrastructure collapse in bankruptcy.

In 1985 we bought 5 acres outside of Dallas, Texas during the oil boom and when the oil boom went bust, the property became worthless. When we needed to move from the area for a job, we were stuck with a mortgage for an amount that was huge to us at the time. We continued to pay the taxes and mortgage for the property until it was paid off. After 10 years the Dallas economy recovered enough for us to sell the property for what we originally paid for it. Though we lost the use of that money and the interest on that money for 10 years, we considered it our tuition in the school of hard knocks. It taught us a lot about the real value of real estate and that knowledge has been worth far more than the money we lost on that underwater property. We currently have a Hawaii property that is underwater by over 50% and dropping. Our mortgage, maintenance and tax payments are our current tuition payments in the new economic school of hard knocks. We make those payments because we promised in writing we would when we took on the mortgage and we think keeping our promises is very important. But we also believe that walking away from our property, as the voluntary mortgage walkers are doing, would be incredibly shortsighted.

Here are the reasons we believe the voluntary foreclosure walkers are making a big mistake:
1. RENTS WILL SKYROCKET: The majority of the mortgage walkers will have to live in rentals along with the massive number of Y gens (now bigger in size then boomers) and others not able to qualify for a house loan. The increased demand for rentals will cause a sharp increase in rents. As we experienced in the 1980’s, rental costs can greatly exceed the cost owning a house. The mortgage walker may find that they are never again able to buy a house on credit making them a renter for life and exposed to the ever increasing rental rates.

2. US DOLLAR BECOMES FORMALLY DEVALUED: The massive amount of US currency being created to keep the banks afloat is causing the dollar to lose value against other currencies like the Japanese Yen and Euro. In the last 3 years, the dollar has lost 30% of its value compared with the Yen. Many large currencies have fixed exchange rates with the dollar such as the Chinese Yuan and Saudi Arabian Riyal and there is growing international pressure for these countries to formally devalue the US dollar. This devaluation could happen without notice and easily be 30% or more causing raw materials that we compete for internationally to skyrocket in price. The building materials that we were able to buy cheaply in the past may make buying a new house in the future unaffordable.

3. PERSONAL CREDIT CONSEQUENCES: So far the only consequence of walking away from a mortgage that we have heard about is losing 100 points on one’s credit score. But what if Congress decides to collect the losses being incurred by the FDIC and bad mortgages being purchased to keep the banks afloat from widespread foreclosures? They have access to everyone’s IRS statements, bank statements, and IRA/401K arming them with the information they need to uncover who is really broke. What if stronger consequences are implemented by banks and mortgage walkers lose their right to credit of any kind. They may be relegated to paying for cars, college, and clothes the way it used to be done, through layaway plans, savings and cash.

The people with good credit and income that are walking away from their mortgages may be creating another economic backlash by requiring the federal government to put even more trillions of dollars in the banking system to cover their debt. This will further erode the value of the US dollar with other international currencies making the money saved by walking away from their mortgages seem insignificant. Owning real estate and a house where living costs are relatively fixed are the primary ways to financially survive the dropping value of the dollar.