Monopoly Money

Hey! Don’t worry! It’s all a game!

Now that the Fed has instituted QE2 (Quantitative Easing 2, for those of you not playing along at home) and is printing more greenbacks to the tune of $600,000,000,000.00 or so, what do we have to look forward to? 

No one really knows, but there are some guesses being made.  Our government has pretty much always had trouble balancing it’s budget, and this past year just pretty much said “why bother, no one’s going to like it anyway”, so they pretty much dispensed with a budget altogether.

They pretty much admitted that the intention was to cause devaluation of the dollar which pretty much guarantees inflation. The devaluation of the dollar is projected at 20%.  Assuming this is accurate, (which is probably not a good idea, but what the heck…) the question becomes 20% over what period of time, and will they repeat the process?  Interest rates for long-term debt must necessarily exceed inflation to be profitable for the investor. So if we have 20% devaluation in a year we can expect inflation to be around 20%, at least for that year.  It may or may not show up in that particular year.  If we have 20% inflation for multiple years or on a continuing basis I’m pretty sure that will be a bad thing.   Anyone remember the early 80s?  That was nowhere near what we are talking about here, but interest rates for mortgages were in the teens and in some cases in the 20s. We were praying for rates for 1st mortgages to drop to 12% so we could sell homes.

Which brings me to property appreciation.  We have come to expect that our homes and other real estate will go up in value.  Usually they do not.  What happens most often is that the money used to buy them is worth less, so they cost more in terms of dollars, and they appear to be increasing in value.  In the mean time everything in the home is older, and this usually means worth less.  Ever tried to sell a ten-year old water heater?  Carpet? Roof? Guess what, they are actually worth less than what you paid for them. With the exception of the land. The value of the land increases with increased demand and the overall value increases when the inflated value of the components exceeds the depreciation of the deteriorating components. Got that?

Now if you bought in an area that has increasing demand and decreasing supply you may see some appreciation. This is because the land is worth more, not the house.  The location is the important thing.  Land is worth differing amounts in different areas. Residential property is worth more in the areas where people most want to live, and raw land is more valuable if say it has gold, silver, or oil in or under it.

In some parts of California and other high cost areas the land value is really the bulk of the value.  That’s why a 50-year-old house in Malibu is still worth a ton of money. The house itself is only  a fraction of the value. Put the same house in another area and you’ll have trouble giving it away.  In areas where land is plentiful, and you’ll find that the value is much more dependent on the improvements.  New houses are almost always more desirable than old ones, and you will se a more profound disparity in areas in which the land is a smaller component of value.

So…back to the effects of QE2.  Basically, everything will cost more. Cars, gas, toys, food, and hopefully houses.  If the corresponding increase in interest rates absorbs all of the inflation in the housing sector people will continue to be underwater, at least for a while. If rates remain reasonable this will help bring home prices up again and we will see an increase in the liquidity of homes at higher prices if the overall economy improves.  The differential between the higher rates available and the low rates most of us now enjoy could also keep people from moving around much. It will still happen, of course.  People get transferred and need to move up or down in the housing market, but even this will certainly be diminished by the higher interest rates that are coming.

This brings us back to the 20% devaluation.  20% a year will be extremely painful and change the way we do business fundamentally.  20% over 5 years, or around 4% a year might still keep rates in single digits, and be considerably less painful.  If the federal budget is NOT brought under control and quanitative easing becomes a habit the long term effects may be devastating.

In any case this practice cannot continue without dire consequences.  We can handle a little inflation.  If we don’t find another way to deal with the federal budget and slow the printing of additional money 20% will become 50% could become 100%, otherwise known as hyperinflation.  This could wipe out the savings of the nation and leaving the Baby boomers to retire in poverty, including those who have done the right thing and saved millions for their retirement. A million dollars might someday be required to buy a nice suit.  Or maybe not so nice.  We need to tear up the credit card and start dealing with reality, and get rid of about two-thirds of the federal government.  We need to start asking them to do less, not more, and cut entire departments which are not needed anymore. There are dozens of them, and a lot of duplication, both at the state and federal level.  There is a lot we can do, if Congress can find the guts.  Write your representatives.  

Hey! Don’t worry! It’s all a game!

Now that the Fed has instituted QE2 (Quantitative Easing 2, for those of you not playing along at home) and is printing more greenbacks to the tune of $600,000,000,000.00 or so, what do we have to look forward to? 

No one really knows, but there are some guesses being made.  Our government has pretty much always had trouble balancing it’s budget, and this past year just pretty much said “why bother, no one’s going to like it anyway”, so they pretty much dispensed with a budget altogether.

They pretty much admitted that the intention was to stimulate inflation and devaluation of the dollar, which pretty much guarantees inflation. The devaluation of the dollar is projected at 20%.  Assuming this is accurate, (which is probably not a good idea, but what the heck…) the question becomes 20% over what period of time, and will they repeat the process?  Interest rates for long-term debt must necessarily exceed inflation, otherwise what’s the point? So if we have 20% devaluation in a year we can expect inflation to exceed 20%.  If we have 20% inflation in a year I’d guess that is a bad thing.   Anyone remember the early 80s?  That was nowhere near what we are talking about here, but interest rates for mortgages were in the teens and in some cases in the 20s. We were praying for mortgage rates for 1st mortgages to drop to 12% so we could sell homes.

Which brings me to property appreciation.  We have come to expect that our homes and other real estate will go up in value.  Usually they do not.  What happens most often is that the money used to buy them is worth less, so they cost more in terms of dollars, and they appear to be increasing in value.  In the mean time everything in the home is older, and this usually means worth less.  Ever tried to sell a ten-year old water heater?  Carpet? Roof? Guess what, they are actually worth less than what you paid for them. With the exception of the land. The value of the land increases with increased demand and the overall value increases when the inflated value of the components exceeds the depreciation of the deteriorating components. Got that?

Now if you bought in an area that has increasing demand and decreasing supply you may see some appreciation. This is because the land is worth more, not the house.  The location is the important thing.  Land is worth differing amounts in different areas. Residential property is worth more in the areas where people most want to live, and raw land is more valuable if say it has gold, silver, or oil in or under it.

In some parts of California and other high cost areas the land value is really the bulk of the value.  That’s why a 50-year-old house in Malibu is still worth a ton of money. The house itself is only  a fraction of the value. Put the same house in another area and you’ll have trouble giving it away.  In areas where land is plentiful, and you’ll find that the value is much more dependent on the improvements.  New houses are almost always more desirable than old ones, and you will se a more profound disparity in areas in which the land is a smaller component of value.

So…back to the effects of QE2.  Basically, everything will cost more. Cars, gas, toys, food, and hopefully houses.  If the corresponding increase in interest rates absorbs all of the inflation in the housing sector people will continue to be underwater. Homes will remain difficult to sell because of the high interest rates. If rates lag behind then we will see an increase in the liquidity of homes at higher prices if the overall economy improves.  Rates would eventually slow or stop housing inflation. The differential between the higher rates available and the low rates most of us now enjoy will also keep people from moving around much. It will still happen, of course.  People get transferred and need to move up or down in the housing market, but even this will certainly be diminished by the higher interest rates that are coming.

This brings us back to the 20% devaluation.  20% a year will be extremely painful and change the way we do business fundamentally.  20% over 5 years, or around 4% a year might still keep rates in single digits, and be considerably less painful.

In either case, this practice cannot continue without dire consequences.  We can handle a little inflation.  If we don’t find another way to deal with the federal budget and slow the printing of additional money 20% will become 50% will become 100%, otherwise known as hyperinflation.  This could wipe out the savings of the nation and leaving the Baby boomers to retire in poverty, including those who have done the right thing and saved millions for their retirement. A million dollars might someday be required to buy a nice suit.  Or maybe not so nice.  We need to tear up the credit card and start dealing with reality, and get rid of about two-thirds of the federal government.  We need to start asking them to do less, not more, and cut entire departments which are not needed anymore. There are dozens of them, and a lot of duplication, both at the state and federal level.  There is a lot we can do, if Congress can find the guts.  Write your representatives. 

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