Gold News

The PhDeral Reserve's Unintended Consequences

The Fed has thrown money at the economic crisis – leading to some unusual results...

HERE'S WHAT a real news story would look like, writes Eric Fry for the Daily Reckoning.

The Federal Reserve issues a press release that goes like this: 

"Hey, we thought we could spark an economic recovery by printing a bunch of money and buying Treasury debt. But the tactic failed. Now we have no idea what to do."

But until that day arrives, the Fed will continue to epitomize Einstein's definition of insanity: Doing the same thing over and over hoping for a different result.

For nearly 100 years, the Fed has presided over the debasement of the US Dollar. Despite all the meetings, pronouncements, Congressional testimonies and Ivy League theories, the Fed has achieved only one verifiable result: It has converted a 5-cent Coca-cola into a $1 Coca-cola. In other words, the Dollar has forfeited about 95% of its value since the Fed came into existence in 1913.

"The Federal Reserve has exchanged the gold standard for the PhD standard," James Grant, editor of Grant's Interest Rate Observer, quipped on Bloomberg TV this week.

Absent the constraints of gold-based money, Grant explains, the Fed has increasingly played games with the paper-based kind…and this game-playing corrupts the free market. 

"The Fed is in the business of imposing false values," says Grant. "It is imposing false values across a range of markets. It has given us a zero percent funds rate…levitated the stock market…[and] depressed the value of the Dollar…

"My suggestion," Grant continues, "is that we learn to live in a world of transparent and objective values. And for that, the Fed might just take a little risk… We ought to get rid of the PhDs [at the Fed] and install someone who majored in a nice solid bachelor's degree, with a concentration in unintended consequences."

Grant may one day get his wish. But so far, the PhDs are still running the show…and are doing so in increasingly bizarre ways. They are printing money to generate economic growth, and then seem genuinely shocked when this moronic tactic fails.

Ben Bernanke is taking Dollar debasement to a whole new level. What used to be a subtle art has now become an overt manufacturing process. Bernanke has informed the world that he is printing Dollar bills to buy Treasury securities. 

He calls it "quantitative easing." The rest of the world calls it larceny. But this larceny is creating a wide range of unintended consequences – bad for some, good for others.

"By creating so many Dollar bills," Grant explains, "it's like a break ball in a pool game. You don't know exactly into which pocket the balls are going. But you know things are changing… The Fed has instituted this vast enterprise call 'quantitative easing.' And the consequences of this are still playing out."

The real estate market in Miami Beach makes Grant's point.

The Fed's monetary manipulations – which are both weakening the Dollar and suppressing short-term interest rates – are drawing growing numbers of all-cash buyers into the housing market. Foreign all-cash buyers, in particular, are becoming a conspicuously large presence in several regional markets like South Florida.

For many foreigner buyers, the depressed US housing market, combined with the falling value of the US Dollar, has moved American homes and condominiums to the discount shelf. In Dollar terms, for example, the US median single-family home price has dropped nearly 30% since mid-2005. But in terms of the Brazilian Real, the median in US single-family home price has tumbled more than 50%.

That's a big reason why Brazilians are combing the streets of South Beach looking for properties to buy. Almost no locale in America suffered as severe a housing bust as Miami. Prices fell more than 50% from peak to trough – and more than 65% in terms of the Brazilian real.

"In Rio [de Janeiro's] exclusive Leblon enclave," Bloomberg News reports, "apartments sell for an average $1058 a square foot… In Miami's South Beach, the average condominium price was $354 a square foot during this year's first quarter. 

"'Five years ago, it was the other way around,' explains Craig Studnickly, president of a Miami real estate firm that caters to Brazilian buyers. 'Miami was trading for $500-$1,000 a foot. Rio was trading for $300 or $500. It has absolutely switched.'"

Not surprisingly, therefore, Brazilians and many other foreigners with strong currencies are snapping up select portions of America's deeply discounted real estate. To take maximum advantage of the simultaneous declines in US real estate and the US Dollar, most foreign buyers purchase their properties with all-cash transactions.

"Brazilians today have the tide and the winds in their favor," Jose Nunes, owner of a Miami-based realty explains to Bloomberg News. "The exchange rate being the tide and prices here being the winds. If one of these falters, demand will also falter."

All-cash buyers are becoming an increasingly visible presence, especially in second-home markets like Miami and Phoenix. Nationwide, all-cash buyers now represent more than 30% of all homebuyers – up from about 15% two years ago and around 7% throughout the housing boom.

But in Phoenix, all-cash buyers have become more than half the market. Most of them are retiring baby boomers, many of whom would rather pay cash for a home than leave that cash in a bank earning nothing. (Thank you, Ben Bernanke). 

In Miami, many of the cash buyers are nouveau riche Brazilians, along with a large number of snowbirds from Canada, looking to take advantage of the weak Dollar. (A second thanks to Ben).

"In the Miami area," Bloomberg News reports, "Brazilians bought 9% of homes and apartments sold to international buyers in the 12 months through March 2010, behind only Canadians and Venezuelans.

There are probably not enough nouveau riche Brazilians or vacationing Canadians to rescue the entire US housing market. But there may be enough of them to spark a recovery in selected locations like Miami Beach.

One key point of this story, at least for us, is that not all hard asset investments are created equal. The forward-looking investor must not only consider what has worked in the past, but also try to imagine what might work in the future. This investor must also attempt to understand the nuances within a specific asset class – to understand what might cause Miami real estate to appreciate, even if Milwaukee real estate does not.

Hard asset investments are not homogenous. Natural gas is not nickel. Cocoa is not cotton. And when it comes to real estate, Milwaukee is not Miami…for better or worse.

Buy physical, Allocated Gold – stored in a secure vault in your choice of London, New York or Zurich – at BullionVault...

Eric J.Fry has been a specialist in international equities since the early 1980s. A professional portfolio manager for more than 10 years, he wrote the first comprehensive guide to American Depositary Receipts, International Investing with ADRs. Today he reports on Wall Street from California for the renowned Daily Reckoning email service.

See full archive of Eric Fry articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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