We dedicate this page to Peter Schiff, one of the rare individuals who speak the truth and does not loose the grip of reality. Please support Peter Schiff for Senate . Peter has been mocked, laughed at, ridiculed in mainstream media. He never gave up, consistently preached the truth about the markets to the best of his knowledge. And now, look who was right.
Irrational Exuberance Ends - for now
Housing prices are coming down. We need to recognize that there was a bubble. Everybody wanted to buy a home. If you did not buy, you would be left of the market for good. Your friends would get rich and prosper and you would be left out with an inferior life style. It was greed and fear of being left behind that moved them. Nobody asked why the hell on earth an investment that does not pay enough rent to pay the expenses would go up. All they wanted was to flip and get rich.
This boom was a result of credit inflation engineered by the FED which we will discuss on another page. If you research you will learn that house prices on the long run do not appreciate more than the CPI, so the bubble reached extraordinary levels by all measure.
As of now (September 2009), we still have a way to fall to reach normal levels according to Case-Shiller Home Price index. If the FED prints money, we all go to poor house and our 100 million dollar homes may be worth the same as a car in the near future, or if the FED does not print money, then the home values will continue to fall as the subprime mess is followed by resetting ARMs for other prime borrowers. After that we will be facing the commercial real estate bust since the consumers will be spending less and vicious cycle of job losses, bank failures, mortgage crisis will continue for a few years more.
Many experts such as Gary Shiller, Nouriel Roubini, Peter Schiff, Robert Prechter has warned us about the bubble. Unfortunately main stream media only cares about the profits and is not interested in giving equal air time to contrarian bears when it matters the most: During the time the bubble develops. Bears become popular after the bust which is too late for most investors and home owners.
Affordable Housing? Or a Ponzi Scheme?
In the past economy seemed to be doing OK solely due to credit inflation that FED has fostered. FED made it easy to borrow. America borrowed and spent. When we borrow money, banks create new money and give it to us. They do not lend existing money. Here is how banks create money.
Why does it matter? Well, all of our money supply is bank credit. It is borrowed money. It needs to be paid back as principal + interest. The interest portion is not even created yet. Borrowing MUST increase exponentially so that principal+interest amount exists in the economy so that people can earn it and pay back what they owe. What happens when borrowing stops? Deflationary crash occurs. Read about the debt problem here.
FED and the US government are running a ponzi scheme that is about to stop now. There is a limit to how much people can borrow. To make it last what did they do? They allowed people to deduct mortgage interest from income tax. That made mortgage more attractive. So people borrowed more and injected new money into the economy. This new money makes the current administration look good. In fact, they guarantee a future bankruptcy but who cares. As long as they get re-elected. The solution to the problem was delayed and left for future administrations to deal with.
Government talked about the American Dream and Affordable Housing. Now home prices are becoming affordable, but instead of celebrating, they are scared to death, they are trying to inflate prices again. But it won't work. Home prices are down, sales volume is down. After prime borrowers were exhausted, they changed the rules to allow sub-prime borrowers get big mortgages. Now sub-prime is exhausted and the crash has started. 8K tax credit won't work. Home prices must increase exponentially to sustain a recovery. People must borrow HUGE amounts to provide new money to the economy. Who is going do that? Here is why FED's easy money policy does not work beyond some point.
Where does that leave us? It leaves us at the top of the greatest bubble ever! What ever you do, make sure you do not take on more debt! Pay off existing debt! If you have existing savings in cash or cash equivalents such as short term US treasuries you should be fine for a few years. At the bottom of depression you may have to jump out of US dollars if FED freaks out and really prints money!
Deflation Hits Housing, Stocks, Commodities
All of the prices, and salaries you see around you were based on inflated credit that happened over 50 years. It is based on a money supply that is almost entirely bank credit. People borrowed and borrowed and spent. The amount of money borrowed reached sky high. You earned in good times! Now, it is reversing course!
Deflation is here!
There is nothing FED can do about it. Credit inflation happened for last 50 years. The bubble is inflated. The cause is in place, the effect will follow. It will deflate. For inflation to happen, all of the following must happen:
1. FED makes credit available. [Yes they do]
2. Banks must lend. [No they don't, because they don't think they will get their money back]
3. Borrowers must borrow. [No they don't, because they don't think they can pay it back]
4. Consumers must spend extravagantly and chase too few products with too much money. [Consumer is a saver now]
The best thing you can do now is to pay off debt and become debt free, because it will get harder and harder to make money in an economy where the total money supply is shrinking at record speed. M1, M2 does not matter. The bulk of the money supply is bank credit! 99% of our money is borrowed money. It has principle + interest to pay back. So, we have the principle since we borrowed it. Where will the interest portion come from so that we can earn it and pay it back??? It does not exist! It is a ponzi scheme. The music has stopped! In a credit based monetary system, we must keep borrowing or the economy will stop. That is what is happening. It is called deflation. The money supply is deflating. When there is 10 times less money in the system, it will be impossible to keep the current prices and salaries at the current levels. Pay off debt now and be debt free. Get ready for days where there is no money to be earned!
Stocks are over valued by wide margin. Prices are based on credit inflation of 50 years. It is like South Sea bubble! Stocks can crash and not come back for 100 years! We have not seen the stock market bottom yet!
But you got to listen to Peter Schiff, in his speech to Mortgage Bankers back in 2006:
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Let’s revisit the old debates on TV and reflect on how things turned out to be:
Peter Schiff argues that hyper inflation will be the result of FED and government efforts that result in excessive debt. He thinks the US dollar will loose it’s value and investors should invest outside the US. So far, he has been wrong about the inflation and the US dollars value.
On the other hand, Robert Prechter argues first deflation will take place (already happening) as de-leveraging runs it’s course and devastates the economy. After that hyper-inflation may happen if FED uses excessive effort to re-inflate the money supply. According to Prechter, the fate of US dollar depends on the health of other currencies since a world wide economic collapse may effect every major currency. But he argues that since most of the debt in the world is nominated in US dollars, when deleveraging occurs, that would create demand for US dollars and increase it’s value relative to other currencies. We have seen this happen end of 2008 also.
Even though Peter Schiff was correct about the housing bubble, it is too soon to call for inflation. Deflation will have to show it’s ugly head first. Before you jump onto inflation band wagon, please read our inflation / deflation - credit bubble page first.
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