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469: Property and Gold - Short Deflation Then Severe Inflation

04-27-2013 team

Rose Tinted Glasses: If you believe the economy is on the mend, things will improve, the economy will get back to how it used to be in the "good old days" and inflation will stay under control – then you might be inclined to invest in paper assets such as:

·         Paper financial assets, ETFs

·         Bonds

·         Stocks

·         Currencies – paper money

Turbulence, Bubbles and Crashes:  If you believe everything is not on the mend, a post baby-boomer depression is lurking,  things will deteriorate further sometime soon, the economy will not get back to how it used to be any time soon and inflation will eventually rear its ugly head  – then you might be inclined to invest in hard physical assets like

·         Gold, silver bullion

·         Property

·         Farmland, agriculture, commodities, forestry

·         Artwork

We are firmly in the second camp. Western governments have grown huge, they intervene, interfere and even manipulate markets, and in doing so distort capitalism. In fact, we no longer have capitalism. We have a weird morphing of state and business enterprise – with failed banks and business being propped up by central banks with low interest rates and waves of printed money – so called stimulus or quantitative easing. Markets are becoming very volatile in part because markets cannot work out the direction things are heading - there is so much hidden and so much propped up.

Inflation Illusion: Just to give one example, as we have described in depth before, inflation numbers are manipulated downwards by a combination of substitution, accounting for technology benefits, ignoring smaller quantities in packages and changing the inflation basket.  We all know inflation is running at more like 5-8% rather than the official 2.5% per annum in both the UK and the USA. When one looks at essentials like rent, fuel, transport, education, food and tax – most think its a joke to claim these are increasing at anything like 2.5%. Most are running at 6-12% a year. Living standards for the poor working class and lower middle classes are declining sharply.

GDP Illusion: Of course, in the UK the current GDP growth is claimed to be about 0.5% on an annualized basis – broadly flat. But this assumes inflation is 2.5%. If inflation is actually 5%, then the GDP growth is minus -2% or a pretty severe recession. The UK has been in recession for years now. It’s only London and the SE that have shown any real growth – and even then – it’s been marginal off the back of the super-rich foreigners moving in - in part from collapsing economies (Egypt, Spain, Tunisia, Libya, France, Syria) and super rich developed nations (Russia, China, Middle East oil exporter) viewing London property as a bargain after Sterling has declined.  When you look at the GDP numbers, it’s a realistic assumption just to subtract at least 2% from this because government inflation numbers are not accurate. Most new jobs are part time low paid service related jobs - and many of these in London are being filled by motivated migrants. 

Add R&D and Poetry for another 1%: The latest game in town is manipulating the GDP numbers. Firstly the USA has announced it will add into the GDP pot the following components:

·         Artwork, poetry, greetings cards, writing

·         Film making, TV productions, TV serials, video, photography 

·         Research and development, laboratory experiments

Depression – It’s Just An Illusion:  GDP already includes of course the spending of these employees or self-employed people – but the USA government will now add all these activities into the GDP pot even though they are expensed and written off in the same year – films, poetry, books and R&D. This should boost US GDP by about 1% per annum moving forwards. That should help the government convince foreign investors to keep buying bonds of course – probably the purpose. It will create an apples and pears type of playing field – since they will be the only ones in the world accounting like this for a while. This will distort things to the US advantage on the face of it. It will really confuse the numbers – for example – when economists print global GDP numbers, how will they reconcile these?  But not to be outdone, it looks like the UK will join in and do exactly the same as the USA in the next 12 months. This should also boost the UK GDP by 1% - and help create an impression or illusion of growth. So when the UK gets 0.8% GDP growth, it will actually be in a recession. So even if the UK gets a GDP growth of 3.5% - because inflation is 2.5% understated and the new GDP will be 1% too high – it will actually be 0% or pretty much a recession as well.  Added to this the fact that at least 1% of GDP is debt (or deficit) based spending, and you really are in a steep recession if people were not allowed to borrow or “deficit spend”.

Debt Mountain: The point of explaining all of this is to just highlight how distorted things have become. Let’s look at some of the debt numbers now.

Print to Oblivion: The US claims it has $16 Trillion of debt, but this is only the direct debt. It has unfunded liabilities totalling about $65 Trillion when Medicaid, Medicare, Pensions, Education, social projects and promises made to citizen are accounted for. That's $200,000 per person, or $800,000 for a family of four.  There is absolutely no way a family can ever pay back this debt or liability. Even at $16 Trillion direct debt, its $53,000 per person or $212,000 for a family of four.  Then there is the private debt. The average US home owning household owes about $150,000 to add to that amount. Then there are the new student loans and university costs to add. In our opinion the country is to all intense and purposes bankrupt. But how come bonds are so low? Because the US government buys most of them – and they use printed money to do so. They drive down the interest rates on their bonds by creating demand by printing money and buying them – that’s what we call gross manipulation or distortion. The bond debt market is a huge bubble that will eventually go pop – but no-one really knows when. Until then, the show continues on the road. The US oil and gas shale boom has given a bit of confidence to markets – at least the USA has these assets to fall back on and it looks like oil and gas production will continue to climb – all thanks to fraccing. Texas is booming - Texas looks set to get onto the high road after the bad years of 1986 to 2003.  But the discipline in Washington is so lacking, these future funds will no doubt be spent today and the whole thing looks like a huge bubble waiting to pop. When the bond market bubble pops or before that, the only way the Fed will be able to pay back its debts will be in printed or inflated dollars. The dollar will surely decline or even crash, once international investors finally lose confidence in the US dollar as the global reserve currency. The US will probably not default though, they will just print more money to pay creditors back in reduced value dollars. The inflation and GDP manipulation is all part of this game to create an impression the US economy is heading in the right direction to appease concerned bond holders around the world.

Asset Rich: To balance things a bit – the US is rich in oil, gas, human capital, buildings, technology, infrastructure and agriculture – plus it has a strong military machine. But so much of the growth is debt based spending – 70% is consumer activity – we doubt the economy is sustainable in its present guise. Furthermore the USA has far too many military bases and excursions around the world – they just cannot afford this and it’s also wrong. Crime is a concern – 300,000,000 guns. Erosion of freedom is a concern. Inflation is a concern. Unemployment is claimed to be coming down, but really – many people have given up trying to get jobs, are living on food stamps, and many people have 2-3 part time jobs to make ends meet – because inflation has eaten away their spending power. The number of people on food stamps has doubled in five years.

UK Mini-Me USA: The UK seems to have a very similar monetary strategy to the USA – it’s just the economy is about 8 times smaller. Print money. Deficit spend. Inflation numbers are far higher than claimed. GDP if deficit spending is subtracted is a lot lower. It’s like a Mini-Me of the USA, but with declining oil and gas production and a proportionally bigger banking sector and weaker manufacturing. The UK is really in a depression. Interest rates are manipulated as are the UK bond markets – because the Bank of England buys its own debt – forcing down interest rates. Eventually the inflation gene will come out of the bottle. You can see this already in West London where all prices are sky-rocketing.  A standard 3 bedroomed terraced house in Fulham costs £1 million ($1.5 million) – the same house cost £200,000 in 1995. But frankly, its difficult to see what else the UK can do except continue on their perilous course - because the problems and debt are already too big after 13 years of Labour spending, and declining North Sea oil revenues - partly caused by North Sea tax hikes. If Labour returned today, it would be a disaster, they would just tax and spend more. The Coalition are at least trying - albeit not very successfully - to reduce spending. If anyone has any doubts about what would happen if a socialist government was in power, just look at the depression France is heading for as the rich move out in droves - many to London - to escape 75% taxes.

A Short Deflation Then Inflation All The Way: So get ready for firstly a deflationary shock – some sort of crash – could be the stock market, oil prices and/or commodities – in the UK/USA (the trigger could also be more Euro problems). Then the Fed and Bank of England working in concert will make sure they print even more money to prop the stock markets up – keep creating an illusion of growth – then inflation will really take off, may be by end 2014.

Everyone Printing – How Can There Be Deflation:  We just don’t buy the deflationary premise – the western central banks will simply not allow deflation because the debts are too high. They can add zeros to their books at any time on the computer. The only way to pay back the gigantic debts is with inflated currency – printed “money” or paper. Now the Japanese have joined in – yes, the Nikkei is skyrocketing – why? Because of the cheap printed money goes into speculation in Japan as the prospect of a higher stock market and company profits is realised – just like it did in New York when QE1, QE2 and QE3 started. But this is not real growth – it’s just printed money. In inflation adjusted terms the FTSE100 and Dow Jones are 50% of their value of March 2000 – they are in a bear market when inflation is accounted for. The Europeans will start printing more currency soon, the US will accelerate and so will the UK to keep up – as currency wars intensify.

Tidal Wave of Money:  Also consider that this printed money is being hoarded. On companies balance sheets. Its hidden. It’s not being spent. One day, when the bond market pops and inflation takes off, everyone will start spending this money as panic starts – off-loading the currency - and inflation will skyrocket out of control – caused by a tidal wave of money. The US increased its balance sheet five fold since 2008 – but nothing happened. One day the flood gates will open and all this money will appear when inflation starts. Everyone will bid up physical assets. That’s gold, silver, artwork and properties – plus M&A activity and farmland.

Currency Crashing in Concert:  Eventually, currencies in the USA, UK, Japan and mainland Europe will drop sharply in value. The safe currency havens will be Canada, Sweden, Australia and Norway – the real winners. Small populations, disciplined finances, conservative finance ministers, commodities and land rich, they don’t print money, are well-educated and governments have high integrity with honest citizens.

Hard Assets: The reason for mentioning all of this background is – investors need to hold their nerve and expect inflation – and shift as much as reasonably possible into hard assets. That’s:

·         Physical gold, silver, oil

·         Property  (using cheap debt that will be inflated away)

Property – a store of wealth:  Only buy good quality properties close to where the richest 10% of people live in cities – with good rental demand, in areas of property shortage. With high inflation, the poor will get poorer unfortunately. The rich will definitely get richer. Art prices will rise. Wine prices. Jewellery. West London and central London property prices will continue to rise as other countries struggle and the richest foreigners seek safe haven in the UK. The trend of the French, Spanish, Greek, Syrian, Egyptian, Cypriotes, Chinese, Russian and other super-rich buying London property as a hedge against implosion will continue. If a country collapses, the rich shift their money out quickly – and this ends up in West London property it seems. The recent UK law that makes it illegal to squat has also helped ease the risk for rich foreigners – since empty properties in London have solid legal title and now intruders who break in can be and have been put in prison.

Spanish Housing Crisis:  Compare this with Spain – where even missing one month’s rental payment can lead to rapid forced repossession. Furthermore, if a squatter gets into a property – is not spotted - within 3 days, they can stay at the property – and it takes about 3 years and massive legal bills to try and get them out. No wander the Spanish property market has crashed – developers have left their properties behind and the banks don’t have the organisation to deal with waves of unemployed squatters that are taking over empty developments. It sounds like it’s not even illegal to squat in Spain – there are no consequences for squatters – if anything, they are encouraged. Compare this with London in 2013 and you can see why so many rich Spanish people are selling up and moving their portfolios to London.

French Tax Crisis: Then take the French. 75% tax on the rich – that’s gigantic. They are flooding into London – and Belgium. The French like quality property only – their favourite area is South Kensington – its most like Paris and has a French School (though it’s full, they are building another one out at Wembley). Take a look at South Kensington property prices in the last year – they have sky-rocketed ever since the socialist (anti-business and anti-rich) Hollande got into power. As anticipated, France has slipped into recession and foreign investment has dropped dramatically – after new regulations and higher taxes were introduced. Their socialist Budget Minister being caught and then denying they had a tax free Swiss Bank account has not helped.   

Don’t Sell Your Gold: In the next 5-10 years, we expect London prices to continue to rise as inflation rages, and with it gold and silver prices should rise sharply.

Gold and Property Hedge: Just one final thought. If gold prices drop, it’s likely property prices will rise. If gold prices sky-rocket, expect property prices to drop in inflation adjusted terms. So gold is a hedge against property and vice versa. But it’s quite possible both will rise sharply as currencies decline and inflation takes off, then any debt you have on property will be inflated away -  example, someone borrowing £150,000 on a £200,000 Fulham property in 1995 – now has 15% debt to asset value – since the property is worth £1000,000. In 2030, don’t be surprized if a Fulham house costs £3,000,000 – but these will be far less valuable pounds.  With all the waves of printed money – it’s difficult to see how property and gold could both go down against currencies, so if you have significant wealth and want to come out with something after a collapse, then gold and property seem about the best thing. We’ve probably got another 3-4 years to go before the gold bull market ends. If you look at Weimer Germany in the 1930s, it was people that owned gold, property and stocks that survived the hyper-inflation. If we get a mild bout - say 25% inflation - then gold and property should be winners.

Prudent Portfolio:  So as the government continues to print money, keep interest rates low, rents are high, savings rates are negative and inflation looks highly likely – to borrow this cheap money and buy property in quality London areas seems prudent at this time. But best hedge with gold, just in case the final financial collapse kicks in any time soon.

We hope this special report has been insightful and make sense – for your investment and portfolio decisions. If you have any comments or queries, please contact us on

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