Asset Deflation Takes Hold

By: Steve Moyer | Mon, Jun 12, 2006
Print Email

"I believe in practicing prudence at least once every two or three years." ~ Molly Ivins

I forget where I was with my 18 year old son, Ramsey, but I casually pointed out what looked to be an attractive young woman standing some distance away and he responded by saying, "Nah, Dad, I know her and she's a 40 yard fake-out."

"She's a what?" I asked.

"You know, a 40 yard fake-out. That's a woman who appears to be attractive from a distance but the closer you get, the worse she looks," he explained.

Kids these days, I thought. They have a term for everything.

2005 was a 40 yard fake-out for investors. Whoever bought pretty much anything for investment in 2005 will get short-sheeted. Mind you, it's not easy for me to say that; I happen to be an investor, and an investment realtor. But the fact is, 2005/early 2006 was the worst time possibly ever to invest in pretty much everything, even though many asset classes looked like they were poised to do well.

We had offered analysis a year ago that deflation was inevitable and advised our readers to prepare themselves for the coming decline in many if not all asset classes. The good news is that everyone received an 11 month stay of execution, as most markets benefited from one final run-up. Investors often speak of "risk/reward;" that 11 month period was a classic example. Plenty of risk; limited reward. You may have been lucky to catch the end of the run and get out at the right time, but if not, those gains are being wiped out quickly and as we speak. The deflation train is coming into the station. It is all about asset preservation at this point.

2005 featured the last drunken push with respect to the Fed-induced, borrowing-infused, post-NASDAQ bubble money supply trade. Frankly, the 2003-2006 "recovery" was substantially a mirage -- built upon the ability of individuals to borrow money against their homes in order to stimulate the U.S. economy. U.S. central bankers did their best to give a Code Blue post-bubble patient handfuls of amphetamines to keep it on its feet until it had no choice but to collapse. But that predictable college try is over now; asset deflation has begun to take its inevitable post-bubble hold and the next several years will offer investors a sobering view of what really happens when investment manias end (in this case, I'm referring to the initial 80% crash of the NASDAQ, which took place from 2000 to 2002).

I truly hate being the guy who spoons our readers this castor oil. It may be good for what ails you but I'd rather be tap dancing down the runway with top hat and cane, telling you how great everything is going to be over the next ten years. Unfortunately, that is not how post-bubbles work. My solace will be to prepare Ponder This...readers for the coming investment era so you can work to protect your existing net worth. Asset preservation will be the buzzterm for the rest of this decade and, very possibly, beyond. Keep what you currently have and you'll not only survive financially, you'll be in position to flourish. Stand there holding stocks, investment real estate and precious metals (for now anyway) and it won't be long before you're joining in the national chorus of, "What the hell happened?"

Major investment manias take place every 70 years or so because everyone who thinks there is risk inherent in run-of-the-mill investments has pretty much passed away by then. Those generations which come up investing behind them ultimately feel assured that asset appreciation is a birthright; they make the ultimate assumption that asset values -- stocks, real estate, precious metals, commodities, you name it -- "always go up in the long run," and believe that policymakers have the power to insure it. This psychology eventually invites reckless lending practices, extremely speculative investment behavior and excessive leveraging. Individuals become so convinced that values will continue to appreciate no matter what -- perhaps with slight pauses along the way -- they borrow against other assets thinking that there is little or no risk to their investment behavior. This is how bubbles become bubbles.

Our Federal Reserve attempted to "fix" the 2000-2002 NASDAQ crash with a money supply pumping the world has simply never seen. This is a typical reaction by policymakers to any investment mania crash, but, unfortunately, it is one that has never been successful in any economy after any mania in recorded history. To pump the money well is just plain human nature. The Fed's misguided attempt to reflate the bubble ended up causing two more bubbles of major consequence: A real estate bubble and a borrowing/lending bubble. Historically-low interest rates, loose monetary policy and lax lending standards meant that virtually every homeowner in America was able to make use of the equity in their homes for everything from home improvements to college education expenses to SUV purchases to travel budgets to a source for what, by all appearances, was easy-money speculative investment. Many homeowning Americans lived beyond their income-generating means during these years via this extra borrowing.

The Fed's flow of money was so impressive, housing prices took off artificially in countless regions across America at a time when quality job growth was sluggish and national personal income figures were languishing at best. Inferring no risk at all to repeatedly borrowing against the equity in their homes and based on a sense that values are assured and will continue to rise or, at worst, plateau, Americans had no qualms about borrowing more and spending more. Refis, interest-only loans and 100%-of-value purchase money mortgages became the norm because "home values always go up, right?" Ready market acceptance of mortgage-backed securities allowed for increasingly massive amounts of mortgage money to flow through the pipeline. Almost everyone in America was betting on the same horse.

That source of money is what fueled the "rebound" of the American economy from 2003 to early 2006. Mortgage borrowing increased more than 82%. Impressive short-term home value increases and a sense that this manna would continue in perpetuity prompted many to leverage into 2nd and 3rd homes, as well, much the same way Americans bought NASDAQ stocks on margin in 1999 and into 2000.

If investors aren't able to learn the lessons of over-speculation from a few short years ago (that is, with respect to the NASDAQ collapse), is it in their make-up to ever learn at all? The answer is yes, but that process always requires hard lessons, usually in the form of unanticipated and falling asset values over a period of years. It has happened post-mania every time since the 14th century, and we have begun that normal and inevitable post-bubble (and now post-bubble-bubble-bubble) process once again. Please don't be caught with your pants down.

Those who felt there is no risk to investment will become the next generation to learn that not only can asset values decline post-bubble, those investments can actually fall completely out of favor. It is likely that our generation will be the next to warn our children and grandchildren that you really can lose your money in the markets and in real estate.

Languishing long-term interest rates relative to short-term rates are a persistent deflationary clue. Yield-curve inversion is another. Emerging market stock market crashes taking place one-by-one, worldwide, point to the same outcome. So does the sudden, precipitous 2006 drop in the Homebuilders Index ($RUF). One by one, commodities will be taking unanticipated hits. Rampant, style real estate speculation is already drying up nationwide as local markets soften one by one. Take it from this investment realtor: Real estate deflation has begun and will persist for a longer period than almost anyone can imagine.

The stock market is paying the price right now, as well. What you are seeing is the early stage of a precipitous and persistent third-wave decline in equities; one that will have investors baffled and wondering what happened. Precious metals, after a run that had most investors thinking the sky was the limit, have begun their initial splat (although "helicopter" Ben Bernanke could conceivably revive the precious metals trade if he pushes the liquidity button again when the real economy falters). The last leg of the recent metals run was built on the availability of liquidity, hedge fund trading and pure speculation, not fundamentals of the marketplace, and leveraged speculators will learn the hard way that even those markets can indeed fall and fall hard. (Note: After the long post-bubble shakeout is complete, we expect precious metals to be a particularly good investment).

Using history as our guide, our call is for a grinding asset deflation, a painful credit contraction, a potentially severe liquidity crisis (exacerbated by our country's currently negative savings rate) and an astonishing percentage decline in real estate values over the next ten years. The stock market is in the early throes of falling victim to the same fate.

If you currently hold investment real estate, it will likely serve you well to sell it immediately. Those who work to eliminate debt and maintain cash positions in the coming environment will see the buying power of that cash increase substantially relative to other asset classes, and those investors will eventually position themselves to buy assets at substantial discounts. For maximum protection, cash can be held in treasury money funds (T. Rowe Price offers one currently yielding 4.09%: Not an investment return to write home to mother about, true, but one that will look quite strong when contracting credit lays waste to overly extended investment vehicles.



Steve Moyer

Author: Steve Moyer

Steve Moyer,

Steve Moyer is a columnist and assistant editor of the monthly newsletter, Ponder This.... ( He has been an investment real estate broker since 1982. Contact Steve at

Copyright © 2005-2010 Steve Moyer

All Images, XHTML Renderings, and Source Code Copyright ©