Wash, rinse, repeat…

Traders who play in the futures markets are familiar with the phrase, “Wash, rinse, repeat”. It describes how pros routinely relieve amateurs of their wealth in the Wall Street casinos.

But the same thing happens on Main Street … it’s just MUCH slower … and it’s easier for newbies to win because the action is too boring for real sharks.

Of course, as we discovered in 2008 and are constantly mindful of … the games the Wall Street sharks play often have Main Street ramifications.

We’re not too far removed from our most recent Investor Summit … this one on the sand. So our heads are still very much into how macro factors affect Main Street micro-investing.

One of our Summit themes, since we were in an area once frequented by pirates, is that sometimes it’s easy to miss the pirates for the seas.

It’s the idea that investors tend to focus on the waves of capital and people moving around, the rising and falling tide of interest rates, and the sunshine and storms of expansion, recession, or even depression.

Of course, it’s important to pay attention to all those things. They’re the stormy seas we all must navigate.

But there are also the powerful and perhaps even nefarious people behind many of these financial and economic events. The wizards who pull the levers.

But we do think it’s important to understand the way they think and what they might be up to … so we can better understand how they might use their substantial influence to either float or rock our boat.

Of course, it’s too much for this humble muse to delve into the eight amazing days of intense presentations, information and conversations on the Summit.

But we think there are some things savvy Main Street investors may want to be aware of as storm clouds loom on the horizon.

You’ve probably been hearing a lot of talk (denial) of inflation. And maybe some discussion about why inflation is not only good but necessary.

We think inflation is a MUCH bigger deal than as presented by TV talking heads and officials from the government and Federal Reserve (NOT the same thing).

This doesn’t mean you should be scared.

But it’s EXTREMELY important to be prepared. This means you need to understand what’s happening, why, and how things are likely to play out.

Of course, we don’t have a crystal ball.

But we have the next best thing … several decades of experience and a big network of really smart friends who pay close attention to all of this.

So let’s dig in …

On our 2012 Investor Summit (our 10th anniversary), it was our first time with Robert Kiyosaki and G. Edward Griffin.

The world was still emerging from the 2008 financial crisis … and the Fed was more active in markets than ever before. At the time, we thought the Fed would be a big story going forward. Little did we know!

Remember, the Fed entered the 2008 crisis with an $800 billion balance sheet. It exploded to $4.5 trillion. They literally printed enough money to pay off every mortgage in America.

Of course … and we know this may surprise you … those trillions of dollars didn’t end up on Main Street. They went to Wall Street.

That’s shocking … said no one.

But the part few people understand is that all that currency creation, which the Fed cleverly rebranded into “quantitative easing”, kicked off a powerful chain of events.

We’re living with and through those ramifications today … and there’s a lot more coming. It’s the real reason behind absurd deficits and spending.

We little people can’t do much to stop the Wizards. Wizards are gonna whiz. or something like that.

But we can consider the consequences as these enormous sums of currency are released into the economy.

Back in 2012, we called it “The Dam Eb and Flo”. It’s our way of understanding how freshly printed dollars work through the economy … and who it helps and hurts.

As they say, hindsight is 20/20, so now that we’re 9 years in, it seems like a quick trip down Memory Lane might be an instructive exercise.

The premise of “The Dam Eb and Flo” is a play on words characterized by the two characters featured in Grant Wood’s iconic painting American Gothic.

It’s a picture of a hardworking Main Street couple in some flyover state. Think Dorothy and Kansas from the Wizard of Oz.

The Dam Eb and Flo goes like this …

When a currency (which is not “money”, but that’s an important concept for another day) is conjured out of thin air … now digitally … by the Fed (whether they admit it or not … and they’ve done both) …

… the new currency rolls through the economy like a wave … damming up at each level before breaking through and moving to the next level.

Here’s the typical sequence (and yes, it matters, because it eventually ends up in real estate, which is starting to happen) …

When the currency is printed, astute observers fear inflation and move into stocks and commodities. To do so, they sell bonds, which puts upward pressure on rates.

Of course, for reasons we’ve expounded on many times, rising rates are a HUGE problem for the Fed.

(It’s long story, but the short of it is the entire financial system implodes if rates are allowed to rise)

So to keep the wheels on the financial system, the Fed prints MORE currency to buy bonds and suppress rates.

Of course, this requires there be enough bonds in the market for the Fed to buy.

That’s why Uncle Sam spends so much … so they can borrow by issuing bonds the Fed or their proxies can buy.

Right now, the Fed is buying over $1 trillion per year. And it’s been going on for a LONG time. They buy Treasuries and mortgages.

In other words, the Fed’s bond-buying is a direct pipeline of fresh currency into real estate. They supply the air to blow up the bubbles.

Remember, pre-2008 the Fed’s ENTIRE balance sheet was $800 billion. Now it’s growing by more than that each year. That’s a LOT of currency creation.

Like cancer cells, this extra cash ends up in the system and starts to develop into tumors (bubbles). There’s a lot we could say there …

For now, let’s focus on the chain of events that ultimately results in rising prices and wages, but less prosperity.

One place excess cash ends up is in commodities. When big money thinks currency is going bad, it looks for shelter in things that are real and essential.

Commodities are things like oil, lumber, food, metals (including precious metals). Even casual observers know these have been inflating for a while.

Of course, manufacturers of products use commodities, so rising commodity costs eat into margins. That is, manufacturers absorb or “dam up” the inflation as long as they can.

It’s important to note that there’s a new school of thought entering the minds of the Wizards. Just as John Maynard Keynes’ ideas have impacted generations of economists, so now is Modern Monetary Theory making inroads into policy.

The core idea of MMT is that an issuer of a currency who borrows in that same currency will never default. Makes sense as long as the currency is valuable.

MMT contemplates this suggesting that inflation (rising prices) is the signal you’ve printed too much.

We think we’re about to find out if the Wizards really believe this … because rising prices are here, but the printing and spending continues unabated.

But as we discussed on the Summit, the bigger issue is how much inflation has been absorbed (dammed up) at the business level.

Business operators get up every day trying to drive costs DOWN. They invest in people, processes, technology; they negotiate for better deals; they innovate.

Their goal is to increase profits to reinvest into more and better products, increased production capacity; and to reward their best people for doing a great job and attract more top talent.

When currency creation (inflation) drives UP the very costs businesses are trying to drive down, ALL those productivity gains are STOLEN. It’s the “inflation tax” you hear about.

Profits don’t increase. Reinvestment doesn’t happen. Production (supply abundance) doesn’t grow. The numbers are up, but real growth is not.

Sadly, one of the first areas a struggling business operator seeks to cut is labor. So inflation not only steals purchasing power, it kills jobs.

Worse, the negative impact is hidden in phony numbers.

We’ve shared this before, but it bears repeating because it explains SO much of what is ailing the economy.

Think about this …

If a company produces 1 million widgets at $100 each, it’s a $100 million business. And let’s say this company needs 1,000 employees to operate and generates a 10% or $10 million operating profit.

Now inflation comes along and drives up costs to where the company MUST raise its price to $120 per widget.

Not all customers can afford or will accept the higher prices, so sales fall 10 percent to where the company is only shipping 900,000 widgets.

With production down 10 percent, the company needs less people, so they reduce staff 10 percent to just 900 employees.

And because the company waited to raise prices (damming up the inflation), its profit margin dropped from 10 percent to 9 percent.

Let’s do the math …

The business started out selling 1 million widgets for $100 million and employed 1,000 people. The owners earned a $10 million profit.

Due to inflation, the business now sells 900,000 widgets for $108 million in sales, but only employs 900 people. The operating profit at 9 percent falls from $10 million to $9.72 million.

The business “grew” its top-line sales by 8 percent (from $100 to $108 million), but produces LESS in every way that matters in the real world …

LESS widgets for the world, LESS jobs for the people, LESS profit for the owners.

Worse, the owners are now labeled greedy because their business grew 8% yet they laid off 100 people … and they’re accused of not paying their fair share of tax on the “gain” even though their profit FELL.

This is called “nominal confusion” and it’s ALL caused by the indiscriminate printing of currency.

Of course, when the economy is producing less jobs, it has a DIRECT impact on real estate investors.

So if you’re out there underwriting the local economy based on financials, but aren’t looking deeper, you could be faked out too.

Now, back to the Dam Eb and Flo …

So far, currency has inflated commodities, pushing up manufacturing costs, and eventually consumer prices.

Along the way, inflation distorts financial results and creates nominal confusion. It makes recession look like expansion. Stagflation.

Meanwhile, people are laid off. There are less jobs than job seekers. So the bid on labor goes DOWN …

UNLESS policymakers step in to create a fake labor market, which is exactly what’s happened. People are quitting jobs or not seeking them because they get paid not to work.

Government and Federal Reserve policy is distorting the jobs market badly, so it’s important you know what’s happening, so you don’t get faked out.

But let’s set that aside for now and focus on the worker.

When consumer prices go up faster than wages, your tenants lose purchasing power. Gas, food, healthcare, rent … almost everything costs more.

And like our widget manufacturer, a consumer’s paycheck can go UP in nominal terms … people are making more money than ever … but DOWN in real terms.

Paychecks don’t go as far and the month starts lasting even longer than the money. Retailers feel it because they’re on the front line selling to consumers.

So retailers and manufacturers absorb a lot of inflation … lower margins, investments in technology, and productivity … trying to keep prices down.

They even resort to something called “shrinkflation” which hides the loss of purchasing power by changing packaging to sell less for the same price.

But they’re fighting a losing battle. The system and the people who pull the levers are absolutely obsessively devoted to creating inflation.

Worse, they’re going to have some real trouble putting the inflation genie back in the bottle. Jacking up interest rates a la Paul Volker is not an option.

So real estate investors … and everyone else … should probably brace for a world where currency expansion is the one-size-fits-all solution for all the problems currency expansion creates.

And if you’re dreaming of pushing rental increases, you better make sure you pick markets where populations and paychecks are growing in real terms.

The beautiful thing about real estate is you can find those markets. In fact, we’re doing a field trip to one in a few weeks.

But there will be markets where consumers are oppressed by inflation and a weak jobs market. When this happens, these voters get MAD.

Most don’t understand what’s happening.

In fact, we’re convinced most policymakers don’t either. Or if they do, they must have a different agenda than “price stability” and “full employment” as they purport.

In any case, the next stop in the Dam Eb and Flo is wages.

The government creates policies and pressure to force wages up, further eroding profits and the capacity for businesses to grow, innovate, and increase the supply of anything.

Of course, this ultimately means probable job shortages and product scarcity, though in the short-term pent-up demand from the pandemic and an abundance of stimulus will create faux economic growth.

When the stimulus wears off, like any stimulant, there’ll likely be a crash.

And the addict will either need more stimulus (kicking the can down the road) … or will suffer a NASTY withdrawal.

Our bet is on more stimulus. Printing obscene amounts of currency out of thin air is far too easy.

So we think all the pressure is on the dollar and any investment strategy in this environment needs to contemplate this.

Our views were reinforced by the things we learned on the Summit from Fannie Mae’s Chief Economist Doug Duncan, and our new best pal, the brilliant George Gammon.

We can’t wait for the 2022 Investor Summit to continue the analysis of this slow-motion shipwreck … and discussing ideas to thrive through it.

Until then, our next best chance (and yours) to rub brains with brilliant people will be at the upcoming New Orleans Investment Conference.
But whether you join us or go elsewhere, this is not the time to fall asleep at the wheel. There’s WAY too much going on.
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