Tuesday, July 27, 2010

Skew-flation: What it is and why you should know about it


While this is not a typical post for a Real Estate blog, I thought I would introduce a concept that I believe will get a lot more attention in the coming months/years.

With all the talk of inflation vs. deflation, I would like to make the argument that both groups of pundits are right.

Skewflation (defined): falling asset prices and higher taxes, accompanied by a rising cost of core goods and services.

As to growing consensus the global economy is on the mend, I believe both government "macro" data and corporate "micro" data are painting a much rosier picture vs. actual reality. The real macro story is there's too much productive capacity around the world and not enough demand. Thus, private sector incomes are down while debt levels are up.

We are still in the middle of a massive debt crisis and emergency government programs (ie. mortgage purchases, tax credits, TARP, etc) have temporarily kept the global economy on "life support". Simply put, governments have little room left to continue to postpone the restructuring that's necessary around the world as deficits can only go run so high.

Other major issues:

1) A pending commercial real estate collapse / extreme softening will subject the banking system to another round of big losses.

2) On-going banking fraud of accounting as the banks are not being forced to 'mark to market' (ie. they can claim that a loan that hasn't been paid in 12 months should be valued at 100% of the loan value to maturity. Thus, banks are reluctant to lend for 2 reasons: 1) they don't have the money since they realize they have huges losses coming; 2) they can invest risk free in US Treasuries at approximately 4% - why would they invest in your risky business, auto loan, or morgtgage to perhaps make an additional 1%?

3) Governmental debt problems, coupled with falling revenue. Simply put, government at the local, state, and federal levels are all in over their heads.

So where is the inflation?

I believe as the US government continues to print money, the dollar will naturally fall against other currencies (EURO excluded) leading to higher prices for global commodities. Further, if countries like Brazil, Russia, India, and China (collectively 'BRIC' for market followers)continue to grow as they have been, the demand for global commodities will continue to rise which will push prices for goods like steel, food, iron ore, etc. to new highs.

How do you invest?

Stay away from 'catching a falling knife' in Real Estate. I believe Real Estate is still on a general downward trend. However, due to the inflation issues above, companies that have STRONG international exposure will fair 'better' over the next 5 years. If you can, consider buying ETFs that focus on places like Brail, Russia, India or other countries with good governmental balance sheets as pull backs take place.

That said, I believe you have to be nimble. Long term buy and hold will be a difficult way to make money in the next 5 years.

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