Inflation Bubble

Richard Prager pointed out that gold’s rise (http://davedelany.com/inflation) from $34 to $1,200 represents 6.7% annual inflation averaged over 55 years.  In terms of currency, however, that rate has almost doubled since the crash of 2008, with no sign of slowing down.

The so-called “bail out” is our first example.  The money lost when the banks crashed over insane housing practices was not “lost” at all.  It exchanged hands, all right, so where did the money come from, and where did it go?  The answer is, it came from the economy, and it went back into the economy.  Because the banks lost so much, though, it was “replaced” with newly printed linen currency.  The “beneficiaries” of the printed currency are the printers — the Federal Reserve.  Here’s how, in a very real fairy tale:

Mr. Builder built 100 houses in Builderville, selling them for $10,000 each.  The bank financed 100 families to buy those houses, with 20% cash down payment and 10% interest on thirty year mortgages.  A happy little community was born. As the wealth of the nation increased (GDP) by 2% per year, the houses also increased by 2% per year.  In year 3, all 100 $10,000 homes were worth their original amount, plus GDP increase: $10,612.08.

Builderville becomes all the rage.  Nice town.  Nice people.  Two of the families have to sell their homes, though.  Mr. and Mrs. Smith are leaving the community for a better job, and Mr. and Mrs. Brown leave the earth, dead.  The Smiths sell their house to a family from the big city.  They did well and have too much money for their own good, and pay $20,000!  The Brown’s children sell their parents’ home for $15,000 to a buyer who found a loose, wonderful, nothing down, low interest mortgage.  They saw on Zillow that the same house down the street just sold for $20,000!  He and the lender were aware of the “bargain.”

As the Builderville market climbs to $25k and even $30k, people begin taking second mortgages on their now expensive homes.  The Johnsons use $10k in home equity to replace the kitchen, add a deck, and take a nice cruise.  The Jacksons use their equity to add a third bedroom and second bath.  They also buy a new car on credit and a small business of their own.  The banks are happy to do it.  New debt, but “completely covered” by the resale value of their homes!

When the next houses also come up for sale, the prices keep rising.  And then, one day, house 41 goes up for sale for just $22k, and nobody wants it.  It’s a bit more rundown than the average.  It stays on the market and two bids come in for $11k and $12k, but nothing close to the new standard.  The owners need to move, so they finally accept am offer of $12,500.  Though disappointed, that’s not too bad for them.  They were original owners, so they actually made $2,500 from the sale.

The neighbors experience the same thing, however.  When the Johnsons and Jacksons both need to move, they still have the original mortgage, paid down to $6k, and the home equity mortgage, barely paid down to $9,800, but nobody will buy their houses for more than $13,000.  They owe $15,800, and have no way to come up with the extra money.  They must turn the keys over to the bank and declare bankruptcy.

The bank finally sells the Jackson home for $11,000, but after nearly a year on the market, the Johnson home windows are broken, and storm and rain damage take a severe toll.  When a DIY guy offers $5,000, the bank jumps.   Overall, Builderville homes are worth about $12k.  The new buyers who paid $25k, and the original owners who took home equity loans, are in a world of hurt.  Many of them walk away, and Builderville begins to crumble.  Nice neighbors move away.  The homes deteriorate rapidly.

The houses, let’s say, continue to be worth $12k — 20% more than their original price — but a small fortune was lost by the many of the owners and the bank.  Some of the houses must be demolished.

Where did the money come from, and where did it go?  It came from foolish, gullible, and/or naive home buyers but mostly it came from bank customers.  Through outrageous practices, it went to tradesmen, home improvement, lawn maintenance, airlines, beach and mountain resorts, car dealers.  It also went to foolish bankers who literally bankrupted their customers.

So, what happened?  What happened to “save” us from our banks?  There is a very, very interesting answer that might just make you sick.

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