7/15/12: Banking, Monetary Policy and Real Estate

Whatever you may think about the Federal Reserve or its motives and contributions, one thing is certain:  The Federal Reserve has a profound impact on the supply and cost of capital.  This alone makes paying attention to the Fed an important part of any investor’s routine market vigilance – and real estate investors are no exception.

While attending Freedom Fest in Las Vegas, we caught up with a 2012 Summit at Sea™ faculty member who was one of several keynote speakers – along with Steve Forbes, Peter Schiff , Robert Kiyosaki, Andrew “Judge” Napolitano and Mark Victor Hansen.

Coming to you from Las Vegas, Nevada:

  • Your straight dealing host, Robert Helms
  • Your royally flushed co-host, Russell Gray
  • Special guest and best selling author of The Creature from Jekyll Island, G. Edward Griffin

This is G. Edward Griffin’s second appearance on The Real Estate Guys™ radio show.  Last October, as part of our Halloween theme, we traveled to Southern California to interview Mr. Griffin – and didn’t quite know what to expect.  After all, his signature book, The Creature from Jekyll Island – A Second Look at the Federal Reserve, is somewhat controversial to say the least.

But after spending a week on our 2012 Summit at Sea™ with both G. Edward Griffin and Robert Kiyosaki discussing the Fed, banking, investing and real estate, we were excited to reunite with both of them at Freedom Fest.

We took advantage of the opportunity to sit down with Mr. Griffin one more time, in the wake of several Freedom Fest speakers (including Robert Kiyosaki, Peter Schiff and yours truly) talking about the Fed and its impact on real estate.

Whether or not you subscribe to the notion that the Fed is a nefarious cartel of international banks bent on world domination, or a misguided but very powerful 4th branch of the U.S. government; or a necessary, effective and benevolent steward of the U.S. dollar – no one seems to disagree that when then Fed expands the money supply (quantitative easing), that new currency flows through the economy and ultimately has an affect on all types of asset classes, including real estate.

Therefore, we ask Mr. Griffin to give us a short review of the history and mechanics of the Fed.  Since he literally wrote the book on the subject, he’s one of the best qualified people we’ve met to help us with this essential understanding.

While Ed’s position is that the Fed is a problem (hard for us to disagree), we also know that for every yin (negative) there’s a yang (positive), so (parents, cover your children’s eyes) we enjoy pulling out our yang (the force is strong with us) and discussing the opportunities that the Fed’s shenanigans create for real estate investors.

It’s a topic we’ve covered before, but as we listen to Peter Schiff and other financial pundits turn up the warnings of a falling dollar, we can’t help but smile.  After all, there is no better financial vehicle with which to short the dollar than a low interest 30 year fixed rate mortgage on an income producing property in the right market.  In fact, that was the topic of our presentation at Freedom Fest.

It’s one thing to walk around talking about market cycles and how what goes up must come down and vice-versa.  It’s another thing to understand the mechanics of money from the Fed to Wall Street to Main Street so you can see the wave coming and ride it.  And it starts with understanding the Federal Reserve Banking System.

So listen and learn as we discuss banking, monetary policy and real estate with G. Edward Griffin.

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The Great Debt Ceiling Debate – Part 4

This is part 4 of a multi-part series on the “great debt ceiling debate” written as an accompaniment to our radio show broadcast and podcast, “Raising the Roof – How the Great Debt Ceiling Debate Impacts You”.  You can download the episode on iTunes or find it on our Listen page.

We’re excited you’re here.  In case you missed the header, this is Part 4, so if you just got on the bus, be sure to go back and read parts 1-3 before jumping into this one.  For those who’ve been on board since the beginning, welcome back!  Now go grab an espresso and let’s get into it!

How the Fed’s Purchase of Treasuries Affects the Money Supply

Most people who pay attention to the economy have heard of “quantitative easing”.  But in talking to lots of people and teaching this topic in seminars, we’ve found most people don’t really understand how it works.  Since there’s been a lot of QE’ing going on, and potentially more to come, it’s important for all investors, real estate and otherwise, to really understand how it works.  And the topic is especially relevant in light of the current debt ceiling debate.

As you should recall from previous installments in this series, the Fed has a Magic Checkbook.  We explored how and why Big Ben is inclined to use it.  Now we’re going to discuss what happens when he does.

The Sound Money Concept

Big picture economics can be intimidating and confusing.  But a global economy is simply a collection of national economies.  And a national economy is simply a collection of many citizens’ economies.  So if you understand basic economic principles on a small scale, when everything blows up (figuratively speaking, at least so far), the numbers get bigger, but the principles still apply.

So, let’s imagine that you show up at a Treasury auction and you decide to buy Treasury bonds.

When your write your check and hand it over to the Treasury, they deposit it into their bank account (with the Fed) and the Treasury’s bank balance is increased by the amount of check.  When your check clears, your bank balance is reduced by the same amount.  What you have done is exchanged the cash in your bank for Uncle Sam’s bond.  This is your basic everyday transaction.  Just like buying furniture.

Now imagine that you and Uncle Sam are the only two people in the economy.  If, between both of you, there were $100,000 divided evenly, then you would each have $50,000.  When you buy $10,000 worth of bonds from Uncle Sam, you write a check and Uncle Sam’s now has $60,000 cash, while your balance is now $40,000.  You have a $10,000 asset (Uncle Sam’s bond) and Uncle Sam has a $10,000 liability (the debt to you).  But when you add it all up, it balances.  This is a “sound money” system because after the transaction is closed, everything balances.  That is, the same amount of money ($100,000) is in the economy is before, it is just allocated differently between the parties as a result of the transaction.

The Funny Money Concept

Now let’s look at what happens when Big Ben Bernanke buys a U.S. Treasury bond using his Magic Checkbook.  Remember, Ben doesn’t have any money in his checkbook.  He doesn’t need any because his checks never bounce. They’re magic.

Big Ben buys $10,000 worth of bonds from Uncle Sam.  Uncle Sam’s bank account goes up by $10,000 and Big Ben gets the bond.  Seems normal right?

Well, let’s take a closer look.

In our two person economy (you and Uncle Sam), you each had $50,000 for a total money supply of $100,000.  But when Big Ben buys the bond, Uncle Sam gets $10,000 for a total of $60,000 and you still have your $50,000 for a total money supply of $110,000.  The money supply just grew!  The technical term for expanding the money supply in this fashion is “Quantitative Easing”.  You may have heard of it.  There’s a lot of it going on lately.

Take It Queasy

What is the effect of this “quantitative easing” on an economy?

Remember, you can’t use money itself for anything, so it’s only valuable when you can use it to purchase products.  Money (for the purists: technically, “currency”, since real money is a product, which is what make it real)  isn’t a product.  Money is simply a means of storing value until you can convert it to something useful (i.e., buy something).

Let’s say that in our little economy, we have 1000 bottles of water, 1000 sandwiches, 1000 magazines, and 1000 more of 7 other things so there’s a total of 10,000 products.  In the real world, the price of each product would reflect the effort to locate and convert the raw materials into finished goods, and then prices would fluctuate based on supply and demand.  But to keep it super simple, imagine that all the products are priced equally, so the $100,000 in our economy is divided equally among the 10,000 products.  Now each product is worth $10.  $100,000 / 10,000 = $10

But if our money supply expanded to $110,000 courtesy of Big Ben’s Magic Checkbook (when he bought the $10,000 of Treasury bonds), then each product is worth $11.00 because $110,000 /  10,000 = $11.00.  That’s inflation.  More dollars divided over the same productivity.

So simply stated, inflation occurs when the amount of purchasing power (money, credit) goes up faster than the supply of goods (production).  In a stagnant economy (one that isn’t producing more stuff), when you add new money, prices go up.

The important thing to know is that when people with regular checkbooks (like you) buy Treasuries, the transaction balances out because the buyer’s checkbook balance decreases while Uncle Sam’s increases.  But when Big Ben uses his Magic Checkbook, NEW money enters the system because Uncle Sam’s balance goes up, while all the regular checkbooks stay the same.  Again, this is Quantitative Easing and it’s inflationary.

In the real world there are lots of moving parts, but if you just stick to the basic principles, you can clearly see what’s happening.  Because it all gets blended in with real world supply and demand dynamics (and confusing econo-speak), a lot of inflation can be hidden for awhile.  But not forever.  After a while it all “trickles down” to the man on the street and first prices rise (you know, like food, gas, clothing, etc.), and then eventually in wages (that one hasn’t hit yet).

Got it?

If you want to understand this “trickle down inflation” better, listen to our 2/20/11 radio episode The Coming Wave of Inflation – Profiting When the Levee Breaks, available on iTunes.

So now that you have all of this under your belt (just think how much fun you’re going to have at your next cocktail party!), in our fifth and final installment, we will finally look at how all this affects the Great Debt Ceiling debate.  And, we’ll unveil our bold prediction of what we think Congress will actually do about the debt ceiling.