In this edition of Clues in the News™, we take on the biggest story most real estate investors are ignoring…and discuss why we think it matters to real estate investors…
In the studio to discuss China’s latest moves and the potential impact on U.S. real estate investors…
- Your clued in host, Robert Helms
- His clueless co-host, Russell Gray
The world is in constant flux. There are SO many variables moving around out there. It can make your head spin…even more than a thick, frosty imperial IPA. 😉
To make sense of it, we try to take all these events we read about in the news…and put them into major categories.
In this case, today’s episode is really about the future of the U.S. dollar…specifically as the world’s reserve currency…and how a change might affect every day real estate investors on Main Street.
So let’s start with the Big Picture…
Out with the Old and In with the New
Virtually all active real estate investors today only know one financial world. The U.S. is the dominant economy and the dollar is the world’s reserve currency.
This means that interest rates, job creation, access to capital have always stood on the foundation of U.S. financial dominance. And not just in the U.S., but around the world too.
BUT…this has been slowly changing…and the evidence is right in front of you IF you take the time to look at it.
There hasn’t been anyone for the U.S. to be accountable to for decades. Uncle Sam can just go into debt and wage war endlessly. No one can stop him.
Understanding Economic Cones
When it comes to your real estate investing, the LOCAL economy is what really matters.
Of course, your local economy may be VERY much connected to macro and even global factors. To figure all that out, you need to understand the concept of an economic “cone”.
A “cone” or Primary Driver in any geographic market is something that brings money into the region from the outside.
Think of Google or Apple. They’re based in Silicon Valley, but bring in revenue from all over the world, which creates jobs, incomes and spending in Silicon Valley. Google and Apple are “cones” that funnel outside money into the local region.
Now think about Walmart or Costco.
Sure, Walmart and Costco sell all over the world…but each location only sells to local customers. That means the income is generated in the local community. So when the people who work in the local store spend they wages in the local economy, it’s simply a recycling of local money.
The idea is that when a Walmart or Costco is located in a place like Silicon Valley, the OUTSIDE money is funneled into the local economy through the employees who work at Google or Apple is then spent at Walmart and Costco.
In other words, if Google or Apple went away, it’s likely that business at the local Walmart or Costco would decline. That is, the overall region would have LESS prosperity because they only would be trading among themselves…instead of pulling in money from around the world.
So think about how the U.S. government affects the flow of money into the local communities where YOU invest in real estate...and what would happen if the government was no longer able to go deeper and deeper into debt just to keep on spending.
What happens to YOU if Uncle Sam’s credit card is cut off?
If you own properties near military bases or defense contractors, you’ve been an indirect beneficiary of Uncle Sam’s blank checkbook.
Money flows through those operations into the local community…directly as wages which are spent on rent…and indirectly when the military, its contractors, their suppliers and employees all trade with each other locally.
Are YOU invested in an area where many of the employers are directly…or INDIRECTLY…nursing on Uncle Sam’s…checkbook?
If you own Section 8 housing, you’ve been a direct beneficiary of government subsidies. How often do you worry about your Section 8 check bouncing?
But if Uncle Sam is forced into “structural reform” and “austerity”….with is geo-political jargon for shutting down spending programs and cutting costs…what happens to YOU if the Section 8 program gets a big haircut…or completely shut down?
What about college towns and student housing? There’s been hundreds of billions of dollars of government subsidized student loans which feed the college towns.
Your student tenants might be using their loan proceeds to pay their rent. Or maybe Mom and Dad are using the tuition savings to pay the rent on behalf of the kids, while the student loan pays for the tuition.
And of course, if you’re renting to employees of the school and they depend on tuition paid by student loans and the student loans stop…then what?
How exposed are YOU to austerity in student loans?
What about senior housing? Do you have tenants who are collecting social security and using it to pay the rent?
Disability, Food Stamps
There are RECORD numbers of people on disability and food stamps in the U.S. right now. But Uncle Sam already admits that the disability fund will be insolvent in 2016.
How many of your tenants are depending on these subsidies to survive? What happens to their ability to pay you rent if their benefits are cut off?
Real Estate Loan Subsidies…Fannie, Freddie, Ginnie, VA, FHA; plus down payment assistance
For decades, homeowners and real estate investors have benefited from cheap mortgage money.
In fact, the risk premium (interest rate) on those funds wasn’t enough to compensate for the risks, and that’s why these programs always teeter on insolvency. Fannie, Freddie have both been bailed out by Uncle Sam…with BORROWED funds…because Uncle Sam doesn’t have any savings.
It’s Greek to Me…
So…what happens if the U.S. can no longer go into endless debt? What happens when the U.S. is accountable…say…like Greece?
Right now, Greece is broke. Their Prime Minister came right out and said, “We’re broke and we can’t pay the ECB (European Central Bank)”.
How many times has the U.S. said, “Hey, we’re broke. We can’t pay our debt?”
Okay, so they SAY it…but it’s never been an issue because they can always…
Raise the Roof!
Actually, the U.S. has threatened to “default” a few times…but then Congress simply raises the debt ceiling.
In other words, they just borrow more. It’s like applying for a new credit card every time you run out of money…rather than deal with the fact you have a spending problem.
How is it the U.S. can do that and Greece can’t?
It’s because the U.S. gets to print the world’s reserve currency, the U.S. dollar.
And when places like China produce more than they consume and produce excess, they keep their saving in U.S. Treasuries.
In other words, the world “saves” by loaning money to Uncle Sam. What a deal for the U.S!
How did the U.S. get this sweet deal?
Way back in 1944… in a place called Bretton Woods… the world “agreed” to allow the U.S. to be the world’s banker. And why not? Uncle Sam had the biggest army and biggest stash of gold.
Because…back then, gold was money. And U.S. dollars were redeemable for gold…
Well, not by citizens. Because in 1933, Franklin Roosevelt used an Executive Order and took away the right for citizens to own gold.
But other countries COULD turn in their dollars for shiny yellow metal.
So all international trade would be settled in dollars, and then the holder of those dollars could go the U.S. and redeem those dollars for physical gold.
The ability to redeem dollars for gold kept the United States accountable to not printing too many dollars…at least that’s the way it was supposed to work.
But it didn’t.
Handed a virtually unlimited credit line, the United States began spending like crazy…the same way we do today…on endless wars and social programs. In the 60’s it was the Vietnam War and Lyndon Johnson’s War on Poverty…also known as the Great Society.
So the U.S. printed billions of dollars (which was a lot back then) and as they made their way around the world, holders would come and redeem them for gold.
Before long it was apparent that the U.S. was running out of gold.
So on August 15, 1971 President Richard Nixon announced to the world that he was “temporarily” suspending the redemption of dollars for gold….and…we’re still waiting for the “temporary” ban to be lifted.
In the next few years after that, the dollar crashed (gold went from $35 per ounce to $850), interest rates soared (and creative real estate was born)…as the world figured out how to conduct business in this new financial environment.
But they did figure it out. People are amazingly resourceful.
Along the way some people got rich. Other people got wiped out. That’s what happens when financial systems re-set. People who are prepared and paying attention do well. Those who aren’t…don’t.
Right now, the wheels are in motion for a changing of the global financial guard. We’ve been monitoring this for the last couple of years and wrote about it in our Real Asset Investing report.
EVERY DAY IT GETS CLOSER.
You may have seen these headlines…
March 17, 2015 NPR – European Allies Defy U.S. in Joining China-Led Development Bank
FOUR key allies…Germany, France, Italy and the UK (“one of American’s staunchest allies”) all got on board the new Asia Infrastructure Investment Bank (AIIB), despite U.S. opposition…
“The Obama administration opposes the AIIB and has pressured allies such as South Korea, Japan and Australia not to join…says there’s no need for another international lending institution.”
“It’s believed China is prepared to put half of the initial $100 billion budget, probably giving it veto power, much the same as the U.S. has with the World Bank and International Monetary Fund.”
March 23, 2015 (Reuters) – China’s Premier asks IMF to include Yuan in SDR basket
SDR = Special Drawing Rights – it’s an international reserve currency made of dollars, yen, euros and pounds. Now China wants a seat at the SDR table…
“China hopes to, through the SDR, play an active role in the international cooperation to maintain financial stability and promote the further opening of China’s capital market and financial area.”
The IMF’s Managing Director is reported to have said, “China’s yuan at some point would be incorporated in the SDR currency basket”.
The Reuters article concludes with “The yuan’s inclusion could be seen as diminishing the dollar’s standing internationally.”
March 24, 2015 (Reuters) – UK Official says IMF inclusion of yuan a very live issue
“The yuan is the world’s fifth most-used currency in trade, and Beijing has made almost weekly strides this year in introducing the infrastructure needed to float it freely on global capital markets.”
“Almost weekly strides this year”! In other words, things are happening FAST.
March 28, 2015 (Reuters) – More countries join China backed investment bank.
“Russia, Australia and the Netherlands became the latest to…join the China-led Asian Infrastructure Investment Bank…adding clout to an institution seen as enhancing China’s regional and global influence.”
“Other countries such as Turkey and South Korea have also said they would join. Brazil, China’s top trading partner, said it would sign up.”
“China’s Finance Ministry said Britain and Switzerland had been formally accepted…Austria had also applied.”
“The AIIB has been seen as a significant setback to U.S. efforts to extend its influence to balance China’s growing clout and assertiveness.”
April 6, 2015 (Reuters) – Larry Summers has a major warning for the US economy and everyone should be paying attention.
In an op-ed piece published in The Washington Post, former Treasury Secretary Larry Summers wrote, “This past month may be remembered as the moment the United States lost its role as the underwriter of the global economic system.”
“So while the US has been the dominant global economic power of the last 50 years, the point is that now countries across the globe are seemingly falling over themselves to be more closely aligned with China.”
Summers said, “I can think of no event since Bretton Woods comparable to the combination of China’s effort to establish a major new institution and the failure of the United States to persuade dozens of its traditional allies, starting with Britain, to stay out.”
The article concludes, “The global economic tide has started receding from the US and moving toward China.”
And what happens if the US loses its role as the “underwriter of the global financial system”?
The U.S. loses the ability to go into endless debt and it becomes more like Greece, dependent on the largess of global central bankers.
Up to now, the U.S. has been the dominant force in global banking. The headlines say…along with Larry Summers…that that’s in the process of changing.
What will it mean for real estate investors?
We’re not completely sure…but you can bet we’ll be discussing it with the biggest brains we can find.
It seems like government spending will need to be reeled in, so if your real estate portfolio is heavily dependent on government subsidized tenants or industry, you may want to diversify.
Long term inflation is a very serious concern…even though it may not seem like it now. So long term debt (30 year fixed mortgages) seems smart, as does owning real assets…like cash flowing real estate.
The most important thing is to be aware things are changing…to watch carefully as events unfold… and constantly ask, how does this affect me? And where are the opportunities?
James Rickards said in his best-selling book, The Death of Money, that the SDR is the most logical choice for replacing the U.S. dollar as the world’s reserve currency.
Of course he said that years ago and now it’s making it’s way into the mainstream news.
We’re guessing more of this stuff will be popping up in the mainstream…which tells us that the changes are getting closer.
History tells us that most of the great opportunities are found in the midst of change. But the prizes go to those you are aware, prepared, nimble and fast to react.
So stay tuned for more insights as this important trend continues….
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