Monetary mess to officially continue on Sept 12 and 13…

On September 1, 2012 by Phil Champagne
Ben Bernanke (lower-right), Chairman of the Fe...

Bernanke speaking in Washington DC. How sad that the market is deciding which direction to take based on what a single man will say.

By Phil Champagne, Managing Partner at Wren Investment Group

I’m a fervent believer of the free market. Every time the government manipulated the price discovery mechanism brought up by the free market, a mess comes up. Just an example is rent control for apartment that occurs in some cities and countries across the world. In all those cases, it actually affects the availability of housing as few investors are willing to invest in such places where they cannot get a proper return on their money. The same occurs with commodities such as food. In the USSR or other countries where the government prevented the price of certain food to rise, it only made things worst by generating a lack of those specific commodities. As they say: the only solution to high prices of commodities is higher price of commodities. It drives producers to jump into it to sell more of it so they can make more of a profit until the offer and demand stabilize to a normal level.

Now, I’d really like to understand why would that be any different with the price of money: interest rate. Central banks such as the Federal Reserve are meant for essentially one thing only: to artificially alter the interest rate – the price of money – by printing new money and buying bonds, hence creating an artificial demand.

On September 12, the German Supreme court will decide if the ECB should be allowed to directly purchase PIIGS debt (PIIGS= Portugal Italy Ireland Greece Spain). This is highly inflationary. Equivalently, on September 13th, B. S. Bernanke, the chairman of the Federal Reserve, is expected to announce open-ended QE (although they are doing stealth QE right now). The article below reports on these events and what to expect:

So expect low interest rate environment to continue, hence pension funds and investment funds to struggle finding decent returns, driving any yields even lower. At the same time, expect inflationary pressure which will lead to more unemployment and then more justification for more printing…  Isn’t that the definition of insanity: doing the same thing over and over again and expecting different result? Welcome to the silly world of Keynesian economics. This is precisely what lead us to the stock market booms and bust in 2000 and the housing booms and bust in 2007/2008. The only different is they get to be worst and worst and the next one will be extreme.  In essence, they push for more debt in other to fix the problem caused by too much debt. The analogy to an alcoholic drinking more to avoid the hang over is very appropriate.

So your question might be: what does it mean for Commercial Real Estate? I expect multifamily to keep doing well as people will need to downsize in this inflationary environment. Multifamily are recession proof and the coming economic condition will heavily test this statement. However, a big catch will be on the property location being very key, but  also watching and managing those rising expenses that will make it very challenging to maintain properties properly with much higher inflation.  This also means gold and silver will resume their rising trend they have started 10 years ago but more aggressively as more people realize the dire situation this market manipulation is having on the economic foundation.

Eventually, the bond market will break on this 30 year bubble, the mother of all bubble as it is the core market being manipulated by central banks. When the institutional money start to lose faith on the bond market, we will see rising rates that the central banks will have to fight with even more aggressive printing, leading to even higher inflation. Prices of real estate in nominal term (in $) may stay the same while at the same time the yields will be rising up to follow the bond market. In other words, only the constant devaluation of the dollar will prevent a complete crash of the real estate market, but at a great pain to the economy and the general population.

What’s the alternative you ask? If they let interest rate go back up to whatever the market would chose, the Federal government would have to cut its spending level drastically while at the same time we would see a severe deflationary pressure on stocks and real estate with widespread bankruptcy across the board, including major banks. That’s why it is about certain they will not allow the patient to go through a detoxification but rather keep the printing going. This also means gold and silver can only go up while the stock market and real estate market will level off at worst (in $ that is).

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