The recent price rises in gold, possibility of more quantitative easing by the Federal Reserve, collapsing home prices and uncertainty about the future of the US dollar have sparked much debate about what steps to take in order to achieve maximum preservation of wealth and ensure that you are holding on to the right assets if the SHTF.
Just today I was chatting with one of the other attorneys at my new firm.Â It came up because he was asking me for advice on whether or not he should walk away from his house.Â He is recently divorced…and he kept the house, which is way to big for him – though technically he can afford it (he makes good money now…and his family has some money).Â It’s an expensive house – c. $1M…BUT he really isn’t under water because he contracted out himself. So, at the time it was completed, it was really worth around $1.5M…now worth around $1M…which is about what it cost him to build.
I went through the math with him…and my conclusion was that it is a close call – basically because he really isn’t under water…BUT at the same time, he’s got one heck of a mortgage payment every month.Â My advice to him was to see how much it would cost him to rent a “suitable” place (for his rather expensive tastes)…and see how much he could save each month.Â It boiled down to him – i.e., how much he wanted to “hunker down”Â – if at all.Â If he would be happy in a place like mine ($1000/month), he should probably walk…
One of his concerns was that if we did experience some legit inflation over the next decade, he would regret walking on the house – because its value should go back up then…
One of the big issues in the discussion is how one defines inflation (or deflation) – as you and I have been over.Â Just sticking to the term “inflation” for now, there are two things that can happen.
1) The clowns at the Fed REALLY, REALLY crank up the “printing presses” in such a way that the end result is that “everyone” has more “money”…then everyone starts buying stuff – including houses…which SHOULD drive prices back up.
2)The other, possibly related, situation would be a “loss in faith of the dollar” sort of thing (perhaps called a “fear of hyper inflation” or something) in which people start buying “stuff” because they don’t want to hold on to money.
I THINK these two possibilities are distinct…though I guess they could be related…
MY POINT to him (and you) is this – IMO, neither situation is likely to cause prices on “stuff” to increase any time soon.Â Why?Â Because the first possibility (true, “money supply” inflation) does not appear to be happening AT ALL right now.Â That is, it’s not like Joe Schmoe living in Anytown, USA is sitting on a bunch of money right now and is just waiting to start buying stuff.Â It’s just the opposite – for now – because people simply don’t have money right now.Â Heck, they are digging into their 401Ks and such to get by.Â On top of that, credit is shrinking…and banks are acting more responsibly – not making dumb loans (well, at least not to the same extent they were during the boom).
Re the second possibility – even if we do see a “oh crap, dollars are worthless” kind of thing, IMHO, the usefulness of the dollar will vanish VERY quickly.Â That is, people will just start bartering and/or using gold, etc….and just skip the rising “prices” part.Â Besides, in that situation, people would still need more “dollars” in order for the nominal prices of “stuff” to go up.Â IMHO, it goes back to the first possibility – people need a lot of dollars to spend in order for prices to rise – when measured in dollars.Â Thus, IMHO, even if we did see a “loss of faith” situation, it would not really lead to “price inflation” – it would lead to “stop using the dollar inflation,” because people just don’t have the dollars to spend right now.
IMHO, the second possibility is more likely in the near future – and, IMHO, if that happens, things will get uglier a lot faster than in the true, money-supply inflation scenario.
My point to my friend was that I do not see prices on houses rebounding to their ’05 levels for a long time – because people do not have money and/or banks are not making the same ridiculous loans they were back then (which is a good thing for us…in the long run).
Rick brought up some excellent points, and my response follows:
In regards to the two distinct possibilities â€“ I am seeing similarities with them. In both cases it seems to me that we have a money supply increase, but more importantly, I am currently more focused on â€œvelocityâ€ as being the main factor in any sort of inflation.
With regards to your friend and his homeâ€¦ I agree about your assessment regarding prices not reaching 2005 levels anytime soon.. In fact, I would be very surprised if we had a return to the same prices (in REAL terms) anytime in the next 10 yearsâ€¦
I understand your friendâ€™s concern regarding the actual â€œpriceâ€ of the home.. But the question is really more about â€œvalueâ€ than price in my view. Say we hit a non-hyper inflation rate of 7%Â over the next 10 years.Â Starting with a current home value of $100,000, that price would be roughly $200,000 by 2020. So, sure, the â€œpriceâ€ in dollars is double, but what is the actual value of that dollar? In terms of purchasing power compared to food and gas, I suspect it will be the same, all things being equal.
Now, letâ€™s throw in a horrible decades-long real estate marketâ€¦Â In this case, maybe we have an inflation rate of 7% over 10 years, but his house price may only go to $150,000 over that period. While the price of other goods like food and gas may be rising at the 7% rate, essentially doubling in that same time frame. In this respect, he actually loses 25% value in real terms, though he still â€œmadeâ€ $50,000 in that time frame.
This is the tricky part for most, I think.
So, the way I am approaching this problem right now is kind of from that standpoint. What can I buy right now that will â€œpreserveâ€ valueâ€¦ I am thinking food is one of those â€œassetsâ€ and precious metals are another. I also have a little place in my heart for real estate, actually. However, I currently live in suburbia, where I just donâ€™t see any value in owning the home I currently rent. A rural house, however, to me has some additional value in terms of productive capacity. Though rural/farming/ranching homes and properties may gain price and lose value at the same time in terms of dollar amount, the fact that I can utilize the extra acreage on a rural farm for production of food, livestock and perhaps a small business around these particular â€œassetsâ€ gives me the perception that there is more value there than one would originally spot if they were looking at just â€œdollarâ€ pricing models.
Just some thoughts on the matter and something I am struggling with hereâ€¦ I am definitely moving out of the city soon, but I still donâ€™t know if I want to plop down a bunch of cash for a down payment on a farmâ€¦ Still, renting a farm style home/property for the same amount I pay for my suburban home now seems to have much more for potential value for me in terms of the things I mentioned above.
Rick responded with some additional points:
I don’t see anything happening NOW that is going to cause the price on his house to go up significantly in the NEAR future…mainly because I THINK the only way that could really happen is with some serious inflation (i.e., prices going up because people have more money in hand to buy stuff).Â It is my understanding that all the BS the Fed is doing right now is NOT resulting in people having more money…yet.
On top of that, something I didn’t mention before, I think consumer’s attitudes have changed in such a way, particularly with respect to housing, they aren’t going to be lining up to buy houses – even if they could afford it right now.Â I THINK that will also keep housing prices down for quite a while…
My point was simply this – because I THINK that his house is not going to significantly go up in value in the near future, if he was willing to “hunker down” as to rent something more reasonable, the money he would save by having a low rent payment would probably “out run” any increase in the value of his house.Â Thus, if he hunkered down, it might make sense to walk…but if he was going to rent something for like $4K/month…not so much.
Your comments get a little more into “SHTF value” I think – with respect to the rural home having more value in a sense than a suburban one…
As Rick mentioned to his friend, the perception of “value” is an important factor to consider and is different for every individual. In Rick’s case, value is a $1000 per month rental property, as opposed to paying a $1 million mortgage on a home like his friend with expensive tastes. In my case, a $1500 rental property in the suburbs has value, but definitely not more than a $1500 rental property in a rural area where the land can be used to generate overall productivity in terms of food, energy, etc.
Thus, if you are making decisions on whether to walk away from a home, stay in a home, stay in the suburbs, move to the country, buy gold, or purchase hard asset commodities like rice, corn, and wheat, it will all come down to what you feel is valuable to your specific situation and what your expectations are going forward. If this is a run of the mill recession, then making SHTF considerations when deciding on what assets to acquire (or sell) may not be appropriate. On the other hand, if you are expecting a severe economic calamity on the level of the Great Depression or worse, then you will have a completely different perception about what “value” actually is.
Political columnist James Glaser (http://james-glaser.com/) posed a related question in a recent email. It is likely a question on the mind of many Americans who understand the looming threat of inflation and are taking steps to protect themselves.
James asks, “If inflation goes way up, will I be able to sell silver and gold at a high price, and pay off my mortgage with inflated dollars at the amount I owe today?”
My response, which incorporated a portion of my response in the discussion with Rick, is as follows:
This is a great question, and as a renter myself, it is one that I have been contemplating for several months.
One of my web site contributors and I are actually having an email discussion on this very topic and I sent a response over to him which I pasted below. The initial discussion started when he mentioned that a coworker of his was trying to decide between walking out on his mortgage on a roughly $1.5 million (original valuation at the height of the bubble) home, because it is worth in the range of $1 million today. He built the home at around the onset of the real estate bubble. His coworkerâ€™s concern is that he would essentially be walking away and ruining his credit for the next 7 years, but he would be able to move into a much cheaper, scaled-down home and save a ton of money as a result. The question that came up was, if we are to expect inflation, wouldnâ€™t the price of a home actually go up, and even though it is $1 million today, if inflation hits, wouldnâ€™t the value of his home in 10 years be worth much more than it is today? And wouldnâ€™t he then be able to pay for that home in inflated dollars?
This was an interesting topic to explore. First, I must note I am not an economist in any sense of the word, but have found these topics to be interesting from a personal perspective, so I have spent much time researching, reading and commenting on them.
Here is a portion of the response I sent over to my web site contributor (Rick Blaine):
[I pasted the majority of my comments to Rick from above in which I discussed the rate of inflation, and asset values based on personal perspective. To prevent redundancy, reread my response to Rick]
With that in mind, Iâ€™ll turn to silver and gold. While we may very well have inflation in coming years, that does not necessarily mean that the price of silver and gold will rise at the same rate. Now, obviously, precious metals are through the roof right now, breaking records regularly for the last several months, but I must point out, for the sake of accuracy, that during the 80â€™s and 90â€™s we experienced inflation at roughly 6% or so (I donâ€™t have the exact figures in front of me, but letâ€™s just assume for the sake of argument), but during this period precious metals didnâ€™t go up â€“ they actually went DOWN. My point is that inflation will not necessarily be the driving force behind precious metals. Someone who would have bought gold in 1983, fully expecting to keep up with inflation and exchange that gold into dollars and pay off their home in inflated dollars would have been a net-loser on the deal because 1) gold didnâ€™t keep up with inflation 2) house prices kept up with inflation 3) house prices actually went up as a result of not just inflation but easy lending and government policies that promoted home ownership.. So during that time frame into 2006 or so, the price of a home sky rocketed in terms of value and price compared to gold and real estate was a much better investment.
From what I am able to gather, PMâ€™s respond not to inflation (or deflation as they did in the Great Depression in terms of gold stocks), but rather, to instability in the government sector â€“ or a loss of confidence in the public sectorâ€™s ability to mitigate economic and social problems.
So, to answer your question, (Sorry I took so long to get here) I would say we need to look at what the collective perception of the worldâ€™s population is on global government policies related to the economy. If the people perceive that the world is about to go into a depression and all asset classes are considered risky, many will look to precious metals as a way to â€œstore valueâ€ or â€œpreserve wealth.â€ If this is the case, then letâ€™s assume the price of a home keeps up with inflation, again taking the example of the $100,000 over ten years at 7% inflation, and the home will be valued at $200,000. Then, letâ€™s assume the price of an ounce of gold today is $1200, and it appreciates at least at the rate of 7% inflation, doubling to $2400. This means the â€œvalueâ€ of these assets in relation to each other remains the same, even though the â€œpriceâ€ has changed. Now, letâ€™s consider further global turmoil for whatever reason â€“ economy, war, significant increases in essential commodities â€“ and we can see how precious metals could potentially increase at much higher than the rate of inflation, simply because people donâ€™t know where else to put their money and store their value. Essentially, we would be creating a â€˜Gold bubbleâ€™, the one that George Soros spoke of earlier this year.
So, as an example, rather than gold doubling at 7% over ten years, letâ€™s assume it triples from $1200 to $3600 because itâ€™s not only keeping up with inflation (which is not necessarily a foregone conclusion, but weâ€™ll use it for demonstration purposes), but demand is increasing because of the aforementioned global turmoil. Over ten years your house only kept up with 7% inflation in terms of price, but the value either remained the same, or perhaps, because real estate is a debt based asset, the VALUE actually goes down in terms of other assets and products, while the PRICE is rising. Here you can see that, in fact, you actually create value by holding some of your assets in PMâ€™s and actually end up paying LESS for your home in terms of gold if you then exchange the gold for dollars and quickly pay off your note.
James, I hope that wasnâ€™t too long of an explanation, but it is a topic that, like I mentioned, is one I have been contemplating for quite some time. I may be totally wrong here, but for the time being, this is how I am looking at the â€œproblem.â€
The end result of contemplating these scenarios yields no guarantees. If there is inflation, we have to ask whether or not that inflation is during “boom times” like the late mid-1980’s to the mid-2000’s, or whether it will be more like the inflation of the 1970’s through the early 1980’s. The value of gold will depend on what type of crisis, if any, we are in.
At the risk of sounding like I am making a prediction, the movement of gold over the last eight years suggests that we are not in a typical inflationary time period – in fact, we are likely struggling with deflationary pressures at this time. Yet, gold is still rising, which indicates that we are dealing with a different kind of animal – one of economic, political and social uncertainty. If this trend continues, then the price of gold will likely continue to move in the upward direction.
At the same time, real estate prices, as well as the values of other assets that were primarily driven by debt, may collapse in “real” terms, so their value may either stagnate or drop, even though their “price” increases.
The bottom line is, when investing into real estate, precious metals, commodities or other assets, it is important to consider not just “price,” but “value.”
We’ll contemplate the topic of value in a future article. Incidentally, it includes yet another discussion with SHTF contributor Rick Blaine.
A few minutes prior to running this article, Tom of the North, author of the Outside the Cardboard Box web site, sent over a chart worth viewing. It depicts the price of gold vs. the price of real estate from 1970 through 2010. You’ll notice that since 2001, the price of real estate in terms of gold has collapsed over 75% percent!