We’re not sure whether to call it a guest editorial or a soapbox, but in either case we’re handing plugged-in reader Satchel the mike.

Thanks for the questions regarding how I can be predicting deflation when everyone else seems to be saying inflation (and some price measures are pointing that way). It does seem contradictory, but it’s really pretty straightforward when you take it step by step. Apologies to anyone who finds this pedantic or useless. And of course for some of you this will be very obvious. But maybe some of you would find this interesting? As usual, it is long…

First, real wealth is not the same as monetary value (prices). Real wealth (sometimes called real assets) consists of things like real estate, useful goods (like, say, a nice handmade guitar or maybe a store of grain) and control of the factors of production (people typically think equities, but it’s really much broader – intellectual capital, the ability of a mother to teach her young children in their earliest years, small unlisted businesses, etc.). Most real assets are assigned a monetary value or price, especially if they are to be exchanged. This is obvious with real estate or equity prices. But think out of the box. Think about how people sometimes say, “I need to monetize my idea” or “monetize my time”. Wealth is a pretty broad concept.

Real wealth grows slowly, and is correlated with productivity growth, which is a small number, and, although the tech guys will not like to hear this, is actually today lower than pre-WWII. Lots of debate, and no real reason to go into it here, but suffice it to say, we’re talking gains of roughly 1-2% per year per capita. So, real wealth grows slowly, and if too much government gets in the way, it can turn negative (think USSR post- about 1980). (Please guys, don’t tell me about the recent uptrend in trend productivity. I’ve seen the NY Fed data – they’re wrong as far as I can tell, because they’re derived from a deflator that is understated; I guess this is arcane, but for those of you who understand this, you’ll also understand why the government has a systematic bias in favor of understating price inflation measures for obvious reasons.)

In a fiat system, money is debt. Simple as that. Money is literally borrowed into existence. Think about when you buy a house in SF in 1999. Its monetary value then was $1MM. In 2005, say, its monetary value is $2MM. The real value (or wealth) inherent in the house has not increased (technically, there is a slight increase or decrease, but people are already complaining about the bandwith I use, so forgive me if I skip that wrinkle) because it is the SAME house. Same utility. Same wealth. Same real value.

Now, if you borrow $500,000K against it, you get money. Where did that money come from? It was borrowed into existence. That’s how it works. In the old days, before Dr. Greedscam, the amount of borrowing available was limited by reserve requirements, so that the Fed could control the rate of growth, at least somewhat (not that they really did). Following 1991, these limits gradually disappeared, as securitization took hold. In its most extreme and current iteration, one could literally create money out of nothing. All you needed was a willing investor (hello silly Asian savers and Eurosclerotics) in a SIV (or conduit, or ABS tranche, or CDO, or CLO, get the picture?), and you could always find a willing American Debt-Serf. By now the fed had basically relinquished all control over borrowing, especially as it was unwilling to disappoint the masses who were increasingly tricked into thinking debt was wealth (and this confusion was a very happy happenstance for the banks and corporations BTW). Nominal debt (and derivatives) EXPLODED – literally into the hundreds of trillions of dollars, although some of these net against each other. Wall Street siphoned off a little bit every time they created one of these things, then took a little more every time they traded, and for good measure even bought them and traded against the infinitely less sophisticated public officials, pension funds, money market funds and, yes, even homebuyers (through excessive fees siphoned off by brokers, re agents, etc). It was literally a slaughter.

Following the example, after you create the $500K of money, you are no more wealthy. This is important. You have exchanged your future earnings (with interest of course) for the newly-created money. In other words, you have exchanged part of your FUTURE wealth (your earnings power and productive capacity or your ability to consume in the future) for current wealth. (You might sometimes hear people throw around the term “Riccardian equivalence” which is basically this idea.) There is an illusion of increased wealth, because of all the money flying around, but wealth is the same on a net basis (across time), increasing slowly as it does. Actually, you take a hit to your wealth – LOL! That’s why all the hedge fund guys are buying yachts and mansions!! – but you won’t realize that until later, if ever. Where do you think Wall Street got all the hundreds of billions in bonuses in the last 6 years while equity markets returned approximately 0% (excluding the fraudulently small dividends received)? Now that return was for the broad S&P. If you happened to be invested in tech stocks generally…..well, you know it was a(nother) slaughter. Hmmm, BTW, where did all that money go?? I’ll let you figure that out, but I’ll give you a hint – drive around Atherton or, even better, Greenwich, Connecticut for some clues…..

Back to your questions now. I think your confusion about inflation is that you are only thinking about it as prices. Think of it as money (credit) supply. As the credit supply is expanded (through borrowing) it is inflated. As it contracts, it deflates. Inflation/deflation. That’s it.
But think about the effect on monetary values (prices) of things when credit inflates. The extra money created “chases” some asset prices and goods/services up. Generally, these items are what amateur trader/economists call “houses and haircuts” – that is, fixed assets and services that cannot be arbitraged. You can’t get a haircut from China. You can’t get a house from China. And you can’t eat out at a restaurant in China on a Staurday night and still be home for bedtime. So that created money tends to flow here, raising prices for houses, haircuts and restaurant meals. For things that you can get from China, well, you know the story. Price deflation, which is what you would expect because as productivity rises things become cheaper to make (in real terms).

There’s no real reason prices should go up in the aggregate, absent credit creation. In fact, before we had a fiat money system (basically prior to 1913), you might be surprised to learn that a house in 1780 cost basically the same as it did in 1900! Imagine that. Real estate didn’t go up over a 120 year period!! Well, of course that makes sense, because the REAL VALUE doesn’t really change too much. It never does, not even today. (This is of course super oversimplified, but you get the idea.) Incidentally, over this period, living standards and real income increased dramatically, as many prices fell (through increased productivity), freeing people up to enjoy the fruits of their increased productivity.

Sometimes when credit is expanded recklessly, and under apparent mass psychology conditions that no one can really figure out, the public’s attention is turned to a particular asset or asset class. It could be tulips in Holland, could be land in Florida 1925-26, equities in the 1920s, railroad stocks in the 1840s, a crazy company that no one really could figure out what it was supposed to do (except somehow exchange stock for newly created government debt) in the 1720s England, the twin Japanese real estate and stock bubbles of the late 1980s, the NASDAQ in the late 1990s, or, most unfortunately for some of us, what looks to be the biggest bubble of them all, the (almost) global housing bubble. Although no one wants to admit that SF suffers from it, it would be strange for it to sit out the party, don’t you think, since it is usually on the cutting edge and all??

We’re getting to the good part. What happens when there is deflation? That is, when money/credit is destroyed? And what effects will this process likely have on asset prices, and can certain consumer prices (like food or oil, for instance) still rise in an environment like this, or its variant, what is often thought of as stagflation?

I’ll post more tomorrow. If anyone appreciates this at all, or wants me to absolutely stop, either way, put up a comment, and I’ll try to be a “people pleaser” – as I’m sure you can tell, something that does NOT come naturally to me!

Editor’s Note: We’re not all that interested in lowest common denominator thoughts, so please don’t worry about trying to be a “people pleaser” on this post. And as always, thank you for plugging in (and provoking thought).

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Comments from “Plugged-In” Readers

  1. Posted by SurveyKid

    Satchel does a nice job and uses the helpful notion that the intrinsic or long-term value of real goods doesn’t change that much, and if at all, appreciates slowly over time. While that is of course subject to lots of variability, by using this idea as a constant Satchel is then able to make a point that is salient, and worth learning.
    Here is the problem for the USA, however, as it faces a period of widespread deflationary pressure, as the housing bubble bursts: unlike Japan, the US has no net savings and may even have negative savings. So, whereas in Japan, deflation meant that Yen’s purchasing power strengthened, that may not turn out to be the case here. In short, the USA is more at risk of an Argentina style deflation, than a Japan style deflation. Which is to say we could see inflation in lots of things that one needs, and deflation in other things. There is some risk of pricing chaos.
    My main point therefore, following on Satchel’s fine post, is that while the housing bust will introduce an inflationary **pressure** into the US economy, that does not seal the deal on making widespread Deflation. More likely is that USA living standards in total are about to go down. Think: falling prices for houses that people still can’t afford, yet persistently high oil prices, high food prices. Sadly, the dollar’s purchasing power may be the central victim in the years ahead.

  2. Posted by Satchel

    SurveyKid,
    I think that your idea of dollar purchasing power is a very plausible and perhaps even likely scenario. I will develop a little different approach in my future continuation post (hopefully by tomorrow), centered around the idea that the notion of the greenback as a reserve currency will die hard, just like bubble myths. As credit deflates, real currency (as a store of value) becomes scarce, and is therefore chased. Gold is money too, and is likewise chased. Perversely, the currency of the most reckless debtor becomes the most sought after scarce good. For me, this is the primary takeaway from Japan’s early 90s experience.
    You are dead on that the US is practically certain to undergo a radical reduction in living standards, barring an upside black swan or something more sinister. As is often said, when the money is gone, then come the guns. Think Rome, or Weimar, for those of you who are historically inclined (there are numerous other examples). Remember people, to the extent that China grows into a real competitor (it is nowhere near there yet, but watch out), it may become an adversary….
    As for your idea that US savings may be negative, I think that is virtually certain, if you believe the data. As you know, the current account deficit is the excess of gross domestic investment over domestic savings (public and private). Note that foolish consumption items (like granite kitchens) are counted as “investment”. So are MILLIONS of surplus housing units that were foolishly built because the bubble sent the wrong price signals. “Savings” include phony plug items like depreciation allowances and retained earnings (notice any big writedowns lately? Does GM’s $39B(!) “noncash charge” ring a bell??) You know the rest.
    BTW, you write much better than I!

  3. Posted by enonymous

    First of all, kudos to you, Satchel, for an intelligent and well thought out post. It is obvious that you have a stronger grounding in economics than the average ‘bear’ (but not necessarily the ‘average Socketsite reader?’).
    Your thinking is rather well-reasoned, and I generally agree that we are entering into a deflationary period (in real terms, not necessarily in absolute terms). Ultimately, this is the impetus for the sudden reversal in Fed Policy, i.e., increasing liquidity and decreasing the fed funds rate. Inflation has run rampant over the past 7-10 years, and the cycle must reverse. Inflation as measured by the powers that be and real inflation are two very different things, mind you, and when a house doubles in price (but not in value) over five years, you have inflation, plain and simple.
    The deflation that occurs, especially in places like San Francisco itself, will be insidious though. Housing prices in areas such as San Francisco will tend to flat line, for years, even decades. The rapid decrease in price that some might hope for, or predict, will not materialize (barring natural calamity) here in SF proper.
    Why? For the same reason that old adage location, location, location exists. All of the money that was created out of thin air went around and around and chased real estate in preferential locations. As the free money dries up, what remains of it will chase progressively more attractive locations and residences. With fewer dollars chasing, even the perfect properties and perfect locations will flat line in price eventually. This process takes years, not days or months.
    But even as this is happening, the dollar is getting devalued (why, because if the fed does nothing and allows the dollar to remain at its current value, the deflation is visible, and deflation laid bare is brutal ugliness and pain which could cost many a high ranking official their prestigious position of power), making your more price flexible commodities (food, gas), much more expensive. What you have, on net then, is deflation on a macro (U.S.) scale, yet it occurs so imperceptibly, and so slowly, and is so muddied by inflation in your everyday purchses, that it goes unnoticed.
    But unnoticed and unfelt are two very different things.

  4. Posted by John

    “Inflation” means different things to different people. If you modify its definition to your own liking, it could be anything and you can reach any conclusion.
    According to the official term and method of measurement, there will be inflation, and maybe even a strong one. However, that’s not what people see and feel.
    Why? the official “inflation” use rent, but not RE prices for housing cost.
    So, for the last few years, the official inflation was tame. However, I would say there was a strong hidden inflation (due to the RE prices).
    Fast forward to 2007, with the RE bubble popping, there is a strong price decreasing in the RE market. However, does it show up in the official inflation number? No, because (again) it uses rent instead of RE prices. So, the Fed sees inflation pressure, while we can buy more with our money due to the housing pricing going down.
    By Fed’s definition, the inflation was low for the last few years (they loosened the credit for a long time) and they think the inflation pressure is high right now (so they are reluctant to loosen it right now too quickly).
    By my definition, the inflation was high for the last few years (meaning the Fed should have tightened the credit), and we will face a deflation (or 0 inflation), meaning the Fed should loosen the credit right now.
    See, it all depends on what your definition is.

  5. Posted by Satchel

    John,
    “‘Inflation’ means different things to different people. If you modify its definition to your own liking, it could be anything and you can reach any conclusion.”
    I agree. You **could** define something however you like it. But I propose that if you accept my definition (most of you will no doubt recognize my formulation as a monetarist one, sort of Milton Friedman meets Von Mises, if you will), you are more likely to get the intuition right and make better investment decisions, and generate real wealth. What do you have lose?
    You guys are all really smart, and I will try to work in some of this in what I am writing up for later. But a few more hints to develop the ideas.
    First, the fed is a bank. It’s private. It holds **paper** assets, not real ones. Do you think they want inflation?
    Second, it’s comforting to think that the Fed controls the supply of credit. While I sometimes sloppily fall into that fallacy, it is really more accurate to say that the Fed manipulates the price of credit in order to induce **lenders** to create credit (I take it as a given that there is always a willing American Debt Serf to take the other side of that transaction – “Serf’s Up” all the time I guess, especially in Cali). What happens when the lenders do not want to lend because the borrowers are insolvent? What happens when those insolvent borrowers are consumers generally in a 72% (by [phony] GDP) consumer economy?
    Third, the Fed has the option to inflate the money supply (called all sorts of things – quantitative easing, usually) but they haven’t, and they are not, even with the crisis raging? They are actually running a **tight** policy, and there hasn’t been any appreciable loosening since the crisis began? You can see this in the adjusted monetary base numbers published by the fed every week. I can tell you about 5000 Wall Street and hedgie bond vigilantes are all over that, practically in real time. I would suggest that the moment the Fed atempts a real quantitative easing or hints at monetization, interest rates will spike and cause a collapse of the credit complex the likes of which the world has never seen. Instant wipeout. If you really want to be scared of what would follow, scare up a chart of U.S. historical Debt/GDP ratios (Ned Davis has done a nice one – and that’s the service the best macro hedge fund guys have historically used, at least when I was doing that 10 years ago).
    Last, if you think that genealized price inflation (your definition) lies ahead, why does the long end of the yield curve disagree so ardently?
    And BTW, the BLS certainly manipulates the CPI and deflator, and exactly as you say. But watch for a change in formulation to overweight owner’s equivalent rent and the other housing components as housing collapses (yes, rents will go down too, that’s what happens when you have a fundamental oversupply of housing) so that published inflation figures track lower, offsetting increasing energy and food prices. I would suggest that this has no real effect on the markets (maybe the equity guys – they’re a little dim, but that’s mostly because they’re main business is selling stuff to unsophisticated retail and pension investors). The credit guys see through all this and see it for what it is: a cynical sleight of hand designed to shortchange social security recipients, mostly.

  6. Posted by SFGuy

    Magnificent and very educational. I can’t wait for part II. Thanks.

  7. Posted by vox

    Oh wow! An Austrian monetarist!

  8. Posted by Tipster

    Your piece was a big buildup, but merely hinted at the reasons behind what I thought was the topic: will there be inflation or deflation.
    Correct me if I’m wrong, but your theory is that: money is created as a result of debt, and as money is created, if more money chases the same assets, the price of those assets goes up. When debt is destroyed, the prices of assets goes down because money is destroyed. I assume that you believe that when debtors walk away from their obligations, which has started happening and is believed to continue to happen, debt is destroyed.
    But what happens when the debt destroyed is debt held by foreign investors? It isn’t OUR money. Do I care? If China held a lot of it, and their productivity is raging as it moves from primarily agrarian to industrial, can they take the hit in money and no one will really notice? What does it do to exchange rates?
    The money that was lost was used to purchase lumber from Canada and fixtures from China. That stuff is staying here. Only the debt in China is going away. How does that alter your equation?
    Or what happens if the money that disappears is held by 45 year old teachers in their retirement accounts, and the money lost was money that wasn’t going to be spent for 20 more years. Can we say with certainty that we’ll see deflation any time soon as a result of the dollars that were not going to be used any time soon not chasing goods?
    I think your analysis is a good start, but that there are so many interrelated factors, it is very difficult to say what the outcome will be.
    It certainly is fun watching this all unfold. How much longer it remains fun is a different question.

  9. Posted by WhatNow

    Given that, should I invest in guns and bullets?

  10. Posted by peanut gallery

    What happens when they start printing money and forget to stop? How is this money accounted for? Is that the US loaning/giving money to ourselves?

  11. Posted by anonyman

    Someone’s going to have to explain to me how real estate in desirable locations doesn’t increase in real value over time, which seems to figure very heavily in this analysis. I mean, I understand the idea that you’re basically living in the same house and in tangible value of it doesn’t change if you add up the cost of the construction, property, etc., but if I can remember my Economics 101, we don’t live in a Marxian world where the price of a diamond is the cost it takes to pull it out of the ground and polish it. And in the real world, the intangible value of a desirable piece of property goes up when more people want to live there.
    So saying that a piece of property is not getting more valuable in terms of living standards, and that the lack of affordability based on the purchase power of a dollar diminishes results in effective deflation (if not actual deflation as it is usually defined) — this seems to me to miss the point entirely. If I had bought an apartment in SoHo when it was a shithole in the 70s, are you saying that it has the same real value today that it did thirty years ago?
    And if the intagible value matters, aren’t we just talking about moving debt around to pay for it and who’s paying the bill when it comes due?
    I’m just probably just showing off my ignorance, so feel free to put me in my place.

  12. Posted by anonyman

    I mean, no offense to Satchel, but to me this post is basically a really complicated way of saying that inflation (which we all know is happening) lowers our standard of living, which Satchel is saying is effectively deflation in real terms (i.e. purchasing power).

  13. Posted by Satchel

    anonyman,
    “If I had bought an apartment in SoHo when it was a shithole in the 70s, are you saying that it has the same real value today that it did thirty years ago?”
    Sorry, anonyman,thanks for pointing this out. Of course, over long periods of time, certain areas will show real appreciation, largely dependent in my view on the growth of productive labor and ideas (and, sure, “attractiveness” as a place to live – that’s a good that might be considered a form of consumption item I guess). But I would just caution that the real value increases slowly. On the order of a few percent a year. While that sounds nonintuitive, remember that 3% real compounded growth can produce extraordinary results! Think of how – in just two or three generations at most – we went from basically a bicycle that flew (Wright Flyer) to the Apollo space program!
    But let’s not get too cocky, and imagine that suddenly an area (hmmmm, say SF, suddenly changes the trajectory to a permanently higher “productivity plane” such that 5% or even (gasp!) 10% real appreciation becomes sensible when you figure out what to pay for the asset (in tis case, the SF house).
    Your Soho example is excellent! I grew up in NYC, and I was in elementary school when the “Ford to NYC: Drop Dead” headline ran, and murders were approaching 2000 people a year and entire heighborhoods were burning down. Who would have guessed that Soho would have turned out as it did? Anyone who bought then sure was lucky, but were they smart? Maybe some foresaw what would come.
    Now, think of areas where trend real productivity has arguably gone down. I like to use the example of Detroit in the 1960s (incidentally, MUCH more expensive then SF or even NYC for comparable properties). I like to think the people must have thought like SFers today – how could anything go wrong. Well, if you paid those prices, you quite literally suffered a (for all practical purposes) 100% real loss. Were those people buying then stupid? Or just unlucky? If someone happened to sell in Detroit and move to Silicon Valley to be an apple farmer, all his friends would have thought him an idiot. Same thing, in reverse, for the famer who landed a job at GM when they were sucking in everyone they could find (tech industry 1999 anyone?)? Would his friends have thought he was a genius?
    Repeat these exercises for Buffalo in 1900. Everything looked pretty good. Shenzhen (China) 30 years ago – hmm, sort of a poor fishing village. Who would have guessed? There are hundreds of other examples. Just look around – history is literally right there before your eyes! (My personal favorite is Butte, Montana. Skyscrapers in Butte in the 1920s – I wonder what a party that must have been!)
    By comparison with Detroit and Buffalo, you might be surprised to discover that the housing stock of SF historically is actually sort of meager, and reflected a prosperous, but nothing really special city.
    My point is, don’t trade all your future wealth for an SF house. You can rent it (ok, maybe not that particular one, but one similar enough) for 1/4 to 1/3 the cost. (Apartments will be a little more expensive.) Invest the savings in some portfolio that is likely to have higher real returns with diversified risk. Don’t be fetishistic about four walls. Your real wealth (actual or potential) almost certainly lies elsewhere.
    If you have the accumulated wealth, and you don’t care whether you lose 50-80% of it (in real terms) then by all means buy something. For you, pay cash. It’s a consumption item, like a car. Somehow, I don’t think that is what is happening, except maybe in Noe Valley right now.
    Last point. I sometimes get people to agree with my ideas about trend productivity and real asset growth. Then they give me an argument that goes something like this: you don’t understand that in today’s GLOBAL marketplace, glamour cities like SF have the ability to arbitrage productivity differences in a perfect marketplace even across places with entirely different cultures, laws, forms of government, etc., like China! That is usually right after they finish telling you how prices in Livermore or Antioch or even Daly City could crash and burn but that would never affect SF valuation. Nahhhh. No “arbitrage” there.
    Sloppy thinking. Every bubble is the same.

  14. Posted by Satchel

    peanut gallery,
    “What happens when they start printing money and forget to stop? How is this money accounted for? Is that the US loaning/giving money to ourselves?”
    Good question. Only the Fed can really start the printing press. But would they? What would happen?
    Imagine the city of SF opens the floodgates. Any developer can buy any SFH or lot and throw up a condo tower. They start “printing” condos.
    Bitter renters rejoice! Condo debtors who have to repay their loans with real $$ while the price of the condo is crushed… Well, they’re not so happy. The guy who paid for his condo cash. Well, tough nuts. Absorb the loss, and move on.
    Now the Fed and the banks basically own a lot of condos, and only they can green light the development order (ie, start the printing press). The American Debt Serf rejoices! Now, seriously, how likely is this one?
    I keep telling people, it ain’t gonna happen. The Fed owns dollar assets (actually claims on future wealth created through productivity by the American Debt Serf). There’s no magic bullet. No printing.
    I challenge anyone to show me an example of a developed (or even semi-developed country) that has turned on the printing press **before** suffering a deflationary wipeout, just to please the serfs.
    If we get a wipeout, which I think is becoming increasingly possible but of course don’t really know (they are after all very rare events), all bets are off afterwards. But not unless we get a wipeout first.
    No central bank hyperinflates voluntarily, and I would sincerely ask anyone to show me a counterexample because I’ve been looking. It always happens (when it does, and it’s rare) after the gubmint takes back the reins.
    Remember Bush’s $300 cash gift after the tragedy of 9/11? That’s about the closest thing the American Debt Serf gets to free money. Sorry about that.

  15. Posted by peanut gallery

    I may be missing your point, but one thing about your SF condo example, it is not “free” to build condo’s in SF. We can discuss the developers cost per square foot but it is certainly not free…And the Fed does not have to get Sue Hester’s blessing to print $s, they just turn them on. You know the numbers and history better than me, but the US has significant debt and the Treasury would benefit by paying it off with less valuable $s. Just like all those jumbo and subprime mortgages that have to be paid back as well, would be nice for the borrowers to pay them back with less valuable $’s as well (as long as their income went up). Surely wages would rise with the printing presses fired up, and the rest of the prices in society would catch up to our “over valued” real estate (some RE is coming down, but I really don’t think the FED will let the the US market crash). As you know, the inflation kills the bond values, so they are going to try to hide the inflation for as long as possible (50 inch TV now the cost of a 30 inch 2 years ago-deflationary)…I always thought the printing presses would be the last resort, kinda an insurance policy, especially now that they are much sneakier about reporting money supply. BTW, I am somewhat confused why the 10 year is back near 4%? If the market thought we were going down this road, those rates would soar. I will keep watching, but have not discounted this possibility.

  16. Posted by satchel watcher

    By comparison with Detroit and Buffalo, you might be surprised to discover that the housing stock of SF historically is actually sort of meager, and reflected a prosperous, but nothing really special city.
    Not sure I buy this statement – from its founding, SF has always been a boom and bust town. From the gold rush to 1906 to dot com, I’m not sure there’s another town that has risen so far only to fall so low shortly thereafter. The fact that SF has never fallen completely down says quite a bit – to me at least.

  17. Posted by Satchel

    peanut gallery,
    I totally accept your point that condos are not “free”. Not the best analogy, but my point is if you take all the development restrictions and zoning requirements completely away, you could see how the “cost” of development would fall pretty fast, and so would prices for condos. Bad example – I was just trying to be relevant.
    Now, on to the more substantive insight.
    “but the US has significant debt and the Treasury would benefit by paying it off with less valuable $s.”
    You’re right. But remember. The Fed is not the government. They are private and they are controlled by the banks, who most assuredly do not care whether it is easier for the U.S. taxpayer to pay off the debt. The government can take back the reins, of course, but I doubt they will unless things get really really bad. Even then, doubtful. Deflation is painful, but in deflation government grows and controls more of the economy as the people go for “easy fixes”.
    Incidentally, that’s what happened during the Great Depression. Government power and control expanded exponentially. That’s when FHA, Fannie Mae, and the mack daddy of all crazy programs to “control” the population, Social Security, got their starts.
    Hyperinflations lead to revolutions and change of government. Think Weimar and the handover to the Nazis. Russia in 1991, and again in 1996. Watch what happens to Zimbabwe shortly. Government doesn’t want this. So neither the Fed nor the government wasnts this. If the American people really understood the implications, they would not want it either, but that is too much to hope for!
    In fairness, some people do think the Fed can engineer modest inflation, through controlled depreciation of the currency and rising expectations of future price rises leading to higher equilibrium wages. I don’t think you can do that, given the enormous debt overhang that cannot be serviced. It’s either/or IMO. The debt is destroyed leading to credit deflation and liquidation of assets (and attendant lower equilibrium asset prices – values of course stay the same). Or the debt is repudiated through printing worthless little green squares, coupled with capital controls to prevent all the smart people from sending all those squares overseas a la Argentina, leading to a currency collapse. I don’t see a middle ground, with debt/gdp at 350%++ of GDP, leading to the obvious conclusion that the debt cannot be serviced. I’ll try to think a little more.
    About the fact that the Fed is private, this seems the time to highlight the genius of our Founders, who realized all this. Read this in the context of how difficult it is for most Americans to “stretch” to buy a house, while it seems so easy for some (GOOG and Wall Street, mostly):
    “If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.”
    - Thomas Jefferson
    Now, honestly, can you imagine any politician saying this today? Or even understanding it? Look what we’ve been arguing about. From what I can tell, only about .01% of the population today understands what inflation and deflation really are, and only .001% has any intuition what money really is (but that is much harder question – not so sure I’m part of that .001%! :) ).
    No question we are stupider today as a people. That’s one of the reasons why trend growth in productivity was so much faster in the 19th century BTW….

  18. Posted by reader

    Can you increase the font or something? You would not believe how hard it is to read these posts on the train ride home.

  19. Posted by M

    This discussion is fantastic. I feel like I’ve stumbled upon an encampment in the forest of like minded individuals where I’ve been on a long lonely journey. And to think it’s SF centric.
    For those of us that have taken the red pill and are just trying to figure out how to try and protect what we have against the ravages of our government’s irresponsible fiscal policies these are very trying times. Inflation? Deflation? I can’t see how we don’t have a little of both at least for a little while. I can see arguments for both directions but am hopeful deflation is the route only because I’m an “ant” but unfortunately our government keeps instituting policies that favor grasshoppers. For those of us that are armchair economists and work outside of the financial industry constantly worrying about this is quite a drag on productivity. All gold? cash? all non-USD investments/currencies? Looking forward to reading further discussions and hopefully I can add a thing or two.

  20. Posted by GunsAndBullets

    Could be an interesting study.
    12/19/2007
    ===========
    SWHC $5.80
    AAMU $ .07

  21. Posted by joe shmoe

    I’m sorry, but the dollar does not exist in isolation. I do not see how deflation can coexist with the pressures that will keep the dollar falling until the fed raises rates.
    The pursuit of this neo-platonic idea of real value seems fruitless to me and essentially a rejection of markets.
    It seems to me as if we talk a whole lot about monetary and real estate history without any data on this site so most of it is just talk. Some of satchel’s post seems tainted by paranoia and conspiracy about who’s making money and why.
    Sure the CPI is not accurate as many have noted, and inflation has been with us for a while. But great deflationary periods are few and far between and a result of mistakes by central banks like curtailing liquidity abruptly.
    I think one thing that is lost about interest rates is that the real borrowing costs that people incur are likely a better indication of the presence of inflation. Real interest rates (including service fees) reflect the real conditions of the economy and the debtor (Only money center banks, governments, and people and businesses who don’t need the loan get great rates).

  22. Posted by John

    Satchel, you were renting in SF since 1999?

  23. Posted by Satchel

    John,
    Only since 2002. And if I sense the tone of your question, no, I don’t regret it in the least. I’ve made a good deal of money from that decision. At some point I may actually share the real numbers with our comment crew! (I have a very good feel for the true appreciation and costs in my chosen location, because the house rightnext door to mine – basically the same house I rent – sold a number of times during or shortly before this period.)
    If you share with me the dates and dollar numbers for the house you obviously own, I would be happy to give you an estimate of the rate at which you “consumed” your housing, and whether ithas been a good investment fro the point of someone who really understands finance. It very well may be! For my part, buying the house I live in would have been a very poor choice investment-wise for me, not that it would have mattered much though to tell you the truth to my overall net worth. Rent, while not a rounding error for me, is pretty close. Buying the house for cash would have been a pretty large investment, but again nothing that would have affected me too much.
    By the way. Ahh, what the hell. 3000 square feet, 4 bed, 3 bath. Rent $3100. Never gone up. Very nice area of SF. Unobstructed ocean view from all windows.
    Price 2002: Good estimate $1.3MM. Price 2005: $1.6MM. Pretty confident about that. Price today: $1.45MM. Perhaps slightly lower (there is a similar house languishing near by that was just reduced from $1.6MM, to $1.5MM and now $1,224M. Still not sold. Vacant. The house right next to it just went up too. That house started at $1.98MM. Just reduced to $1.7MM. Languishing. Vacant. The guy who owned it took all his cash out and put it down on a “mansion” in the East Bay! LOL! What. A. Moron. To buy as the crash is beginning, and before you’ve sold your existing house…. I can tell you, all of us here at the Satchel household are literally laughing our a$$es off, even the dog!
    Now, John, if you can’t see how much I’ve made by renting, you quite simply are hopeless. My experience with renting in SF has been great!
    Missionite, if you are reading, can you run the spreadsheet?? My tax rate is low (around 25% – thank you Bush tax cuts, it’s great to be an investor and not a W-2 wage slave!), and my opportunity cost of capital is roughly around 12% over past 6 years.
    Now John. I am NOT a perma bear on housing. I really don’t care. For me, it’s just another asset class. Something to have fun with. Just four walls and a roof. My real wealth lies elsewhere! When it makes sense for me to buy from an expected real return position, I will. OK?
    Sorry if the post sounds defensive. I’m just pressed for time. (Lots of stuff going on in the markets right now.) If there’s interest, maybe I will write up a “Satchel’s Guide to Being a Bitter Renter” in St. Francis Wood/Monterey Heights. The hysterical stories I can tell about the silliness I’ve seen over these 5 (now almost 6) years!!

  24. Posted by John

    Satchel,
    You obviously got a good deal on the rent. However, $3100 for 3000sqft is hard to come by. What’s the more “normal” rent in that area is?

  25. Posted by Satchel

    John,
    I know a number of renters here. Everyone seems to be paying between $2500 and $3500, except for a recent transplant from NYC who is paying $5K. One flipper gone flopped has rented his house out to a bunch of people – don’t know what they’re paying, but I guess that owner is doing ok because it’s multiple families. the owner is waiting for th “market to come back”. LOL! It’s gone over here. The money’s gone, friend.
    There was a much larger house than mine on top of a hill that was for rent at $4K per month. I bike rode by it every day, vacant of course, for about 18 months or so. Finally, they paid a corp relocation firm (who knows how much) and they got a transplant renter couple in. Don’t know how much they pay, but I’m sure they’ll vacate as soon as they buy.
    My friend, I think you can tell I’ve been around for a while, and I’ve traded a lot of markets. SF housing is not an equilibrium condition. Don’t tie too much equity up in your home. Take it out, invest it wisely in a range of diversified assets that are expected to provide positive real returns. You’ll thank me some day for this advice, but it may take a while!
    BTW, these rents are not that out of line. I have an angel investor friend in Marin, renting a $1.8MM house for $2600, and another friend in Ross renting a beautiful 5 bed/4 bath with pool for $3600! They’re there so their kids can go to the public schools! LOL! The dummies buying rightnext to them are paying between $25K and $50K PER YEAR in taxes so my friend’s kids can go to school for free! Hmmm, my little boy is getting ready, maybe I should start fishing in Marin.
    And it’s all over Cali. Guy I know is renting a house in Huntington Beach (at least $2MM) for $3K.
    See, as far as I can tell, there are NO credit-worthy renters left, who have substantial assets! LOL! They all bought houses. In fact, they bought two or three….

  26. Posted by Gavin

    Satchel: The rents you quoted $3000 for a home worth $1.45m is a very good deal. And as the home prices get higher the values get even better.
    However at the low end on the peninsula the deals are not so good. For $2,000 a month you can rent a home worth $600,000. If you are willing to pay $2,500 you can rent a home worth $900,000 in San Mateo.
    By the way in Stockton, CA the price to rent ratio is much more reasonable. If you are willing to spend $600,000 you can buy three single family homes that will each rent for about $1,100 each.

  27. Posted by james

    someone tell satchel’ landlord that he doesn’t appreciate the deal he’s getting on that house in st francis woods. double his rent, asap!
    gavin, get yee to stockton. enjoy the commute.

  28. Posted by james

    here are the rents everyone else is paying. don’t let satchel get you down. he’s like one of those doofus’s that populates the yahoo message boards to talk down a stock that he’s short until he’s blue in the face. total waste of time.
    http://www.sanfranciscosentinel.com/?page_id=680

  29. Posted by anon

    James – Try this link instead. I believe this pulls all the data from Craigslist and summarizes it by neighborhood
    http://mullinslab2.ucsf.edu/SFrentstats/

  30. Posted by anon

    forgot to mention. click on the tabs to the left for neighborhood data.

  31. Posted by MedusaSF

    How many of you are actively searching for rentals? When I sold my house a few months ago, I went looking for an apartment in a prime neighborhood (Pac Heights, Russian Hill, etc) that was semi-comparable to the house I just sold. I sold my home off-market so I had about 30 days to find a place. I was only looking at 2+ bedrooms at $5000+ per month. I looked at 20 apartments and about 18 of them were absolutely terrible. At that price point, I expected something fairly decent. I ended up having to spend quite a bit more for an apartment about 1/4 the size of my previous home. It’s not that easy to find a great property at $3000k per month in a desirable neighborhood that’s still in decent shape. The quality of rentals here varies wildly.

  32. Posted by anon2

    MedusaSF – $5k/mo will get you a very nice 1,200-1,400 square foot 2+br in the Marina/Cow Hollow. Was your old home 5000+ square feet (4x that size)? If so, did you really think you were going to find something comparable to that for anywhere near $5K a month?

  33. Posted by Jimmy (Bitter Renter)

    My brother’s moving in (today) to a nice 3/1 SFR in Palo Alto for $2450/mo. It’s a nicely kept house with new carpets and paint on a quiet side street.
    I have no idea what a 3/1 SFR on a decent-sized lot is worth in Palo Alto but I’d have to guess its more than $1M.
    Just one more data point…

  34. Posted by Satchel

    MedusaSF,
    You sound like a solvent renter, and congratulations n selling at an excellent time! If you would consider family neighborhoods like Forest Hill, St. Francis and Monterey Heights, there are a number of rentals that have come on craigslist from time to time. None of these have rented lately (the ones I could identify either through picture or address). It seems they have dropped off the craigslist for Christmas. Look right after the Holidays if you are interested in the area.
    Right now, there is one advertising every day at $4600, that looks nice from the pic. Drive around the neighborhoods and look for some signs too. There is a house on Darien with a for rent sign for at least 6 months that is 4/4/2 car garage. If you have any interest in the neighborhood, I could post the address and telephone number. I know for fact that they will take MUCH less than $5K.
    If you are only interested in the **prime** Nob Hill Pac Heights area, I can’t help you. The Bubble is still strong there, and denial is extreme, as you can see from james, who is of course a realtwhore. The bubble is collapsing inwards, and those are the last holdouts. Keep your powder dry, and – at least if you are interested in renting around those neighborhoods i mentioned – don’t even THINK about paying list. You are in the driver’s seat.
    BTW, at least 40-50% of the houses for sale around here in the last year have been pulled after failing to sell. Here are a few that maybe james can dig up some mls data:
    39 West Gate (and now two renovations rising literally to the right and left of it, and across the street too, all empty)
    135 Fernwood (featured on Socket Site, failed flip – check the tax record online, it is TAX DEFAULTED); appeared on craigslist one day as a rental, then pulled. Empty since 2005 renovation.
    1495 Monterey – failed to sell
    1470 Monterey – flip that flopped, about 3 families moved in
    1460 Monterey – flip that flopped in a HUGE way
    1260 Monterey (this guy is bleeding HUGE money, failed flip)
    110 San Aleso – pulled, failed to sell after reno
    15 Santa Clara – pulled, failed to sell after reno
    215 west Gate (still listed, and dropping fast)
    201 West Gate (still listed, and already 23.5% off original ask, and no interest)
    My wife is keeping a folder – there are many others (that is just from memory)
    Also look at 135 San Benito. That sold. Total appreciation since last sale 2004 = +2.86%. that’s TOTAL, not annualized. You read that right.
    75 Miraloma. That’s a total wipeout for the fools who developed it. Never sold, after years of trying. Intermittently rented.
    THere’s another one, empty, right down the hill from it,I believe 15 Miraloma. Owner left for southern suburb. House listed for a while, but failed to sell, so pulled off. Empty now for 6+ months.
    35 Santa Clara (nice big house, prime location). Sold $2.25MM Check the zillow estimate (a joke, I know).
    Prices here are back down to about late 2003 prices I would estimate for nice properties.
    Denial is still high in the glamour areas. Bubbles die hard, but don’t worry. the inventory that is building is stunning, at least from where I sit.
    The money’s gone, my friend, it’s gone…..

  35. Posted by joe shmoe

    But how much money is gone? If there have been $350B in writedowns, then $1000/per person is gone. A huge figure, but hardly a year’s income and much of the debt was held by foreigners. The houses and condos are still here.

  36. Posted by Dan

    “201 West Gate (still listed, and already 23.5% off original ask, and no interest)”
    There must be *some* interest– it’s under contract.

  37. Posted by Satchel

    Dan,
    Do you have the price? The sign is still up. Thanks for the info!

  38. Posted by Dan

    It’s under contract as of 12/12/07. Don’t know the price. I would guess the for sale sign will stay up at least until it clears contingencies.

  39. Posted by Satchel

    Thanks!

  40. Posted by Escape from SF

    This is what drives me CRAZY. Increasing productivity is the main way to increase living standards. In the policy arena however, this hasn’t been given much attention since Reagan and Carter. We need more, better-educated engineers and a more efficient government and regulation. Instead, our education system is slipping in competitiveness and our government is getting bigger in many non-key areas and performing worse. If we want to get the housing market going again we had better get the real economy going again (versus the roulette economy).

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