Karl Denninger is an technology expert and businessman, finance blogger, political activist and is sometimes referred to as a founding member of the Tea Party movement. Denninger was also the founder and CEO of MCSNet in Chicago.
Denninger is a founding contributor to the libertarian-oriented finance blog The Market Ticker, found at http://market-ticker.org. He uses his blog to levy harsh criticism of the criminal element who are wrecking the global financial system. In the aftermath of the March 2008 collapse of Bear Stearns, he founded the website Fed Up USA. He came to national attention for the criticisms of the Emergency Economic Stabilization Act of 2008 which he posted on Fed Up USA in September that year. Of special concern to Denninger was the over-the-counter trading of credit default swaps, as well as the high leverage of financial institutions; his objections to the bailout plan stemmed from the fact that it did not address either of these issues. He has also spoken out against high-frequency trading, particularly in the aftermath of the 2010 Flash Crash.
As a publicly outspoken and early member of the Tea Party movement, Denninger is sometimes referred to as a founder. On January the day of President Obama’s first inauguration, he published a blog post calling on readers to mail tea bags to the White House and Congress on February 1st, echoing a suggestion by a commenter on one of his earlier blog posts. However, Denninger later expressed concern with the Tea Party movement, specifically that establishment Republicans had hijacked it and perverted its original goals.
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ANNOUNCER: Welcome to Creating Wealth with Jason Hartman! During this program Jason is going to tell you some really exciting things that you probably haven’t thought of before, and a new slant on investing: fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible. Jason is a genuine, self-made multi-millionaire who not only talks the talk, but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom. You really can do it! And now, here’s your host, Jason Hartman, with the complete solution for real estate investors.
JASON HARTMAN: Hey, welcome to the Creating Wealth Show. This is episode number three hundred and thirty-nine; this is your host Jason Hartman, and thank you for joining me today. I’ve got Michael here with me to help during the intro portion of the show, and then we have a repeat guest this time, and that is Karl Denninger, who’s the ticker guy, and he’s going to talk about some of his economic outlook in several ways, and I think you’ll find that interesting. But Michael and I are going to talk about equity in property, tax liens, possibly getting ripped off investing in tax liens, and I think that may have happened to me, actually. We’re going to talk about two different properties; we’re going to talk about my favorite city in America, Detroit [LAUGHTER]. I’m totally joking. And then we’ll get to our guest here. So Michael, welcome, how you doing?
MICHAEL: Good! It’s good to be back on the show.
JASON HARTMAN: Yeah, it’s been a long while for you. You’ve been surfing a lot lately, haven’t you?
MICHAEL: Yeah, just enjoyed summer maybe a little too much, and making the most out of my time in California. I may be headed to Texas in 60 days for a permanent move, so, I gotta enjoy the beach while I live a block away.
JASON HARTMAN: Good for you! Well so, so you’re on the verge of moving to Dallas! The Big D, it looks like! And I gotta tell you something. I don’t know if you actually saw this on Facebook this morning, but yesterday was the last day to file corporate taxes. And I just gotta mention something, by the way. Some listeners attribute things to me that just aren’t accurate. One of them [LAUGHTER] is this one: that I’m so organized. Folks, I am making a disclaimer—I am not so organized, okay? But thank you for giving me all this credit. I just don’t want to take credit where credit isn’t due. And that’s one of the places where it isn’t due. I’m moderately well organized. But sometimes I might sound better at teaching than actually practicing for myself. There’s that old parable of the shoemaker whose kids have no shoes, right? Sometimes I feel like that’s me. Listen, I’m only human. But I’m trying to do so many things that it really gets overwhelming. Anyway, so, yesterday was the last day to file corporate taxes, and I talked to my CPA, and wow. I don’t know if you saw this this morning when I—
MICHAEL: Yeah, I commented on it. The $11 billion in new taxes for California?
JASON HARTMAN: Yeah, that’s right, you did. But what was my personal part of that? My personal experience, well, it was this. Just by leaving the Socialist Republic of California and moving to Arizona two years ago, I saved enough on taxes, from what it looks like here, a rough estimate of course, to pay for six round-the-world trips. Now, if you move to Texas, I’m going to be really envious. Because you could probably pay for twelve around-the-world trips in this example! It is amazing. No state income tax at all—in Texas it’s zero. And in Arizona, it’s a lot lower than California. But wow! Just what an amazing difference! What an amazing difference it is. And that money—it’s like, you don’t really get anything for it! I don’t know. California’s overcrowded, overtaxed, overregulated, I kind of don’t get it. I really—I mean, all my life I’ve pretty much thought it was great. But now that I’ve moved, my eyes are open, and I see that there’s—there’s just better stuff out there, and certainly when you pay a lot less in taxes. What a relief. Boy, I think Texas is my next move. I don’t know. But—
MICHAEL: I’ll see you out there.
JASON HARTMAN: Yeah, I might see you there. So why did we bring that up, about the Dallas thing? Moving to Dallas? Oh, just because we were just making small talk there.
MICHAEL: Yep.
JASON HARTMAN: Well, good for you! Good for you. So, this first article that I shared, and you agreed we should talk about it on the show, what do you think?
MICHAEL: Well, it goes along with your philosophy that our investors should not keep equity in their homes. And this is the article from Newser, and it seems just baffling, but: a 76-year-old retired marine lost the $197,000 Washington, D.C. home he had paid in full 20 years ago, because he had a property tax bill of $134.
JASON HARTMAN: Unbelievable. So, look. Folks? Here’s what I always say to investors. Real estate is—not real estate necessarily, but, good income property in the right locations, structured properly, doing the deal right, okay, in the right place, is the best investment going, in my humble opinion. It’s like that thing on Saturday Night Live many years ago—the guy used to say, “baseball been very very good to me.” Well, real estate has been very very good to me. And it’s the best investment, I think. But it’s a mediocre bank. What do I mean by that? I mean, look. If you have to buy properties with cash—many people do—hey, that’s fine. It’s still a pretty darn good investment. But if you don’t have to buy them with cash, if you can leverage them highly, as long as you can get good long term investment-grade financing at historically low rates, that is a great deal! Because whenever you have equity in the property, equity is always in jeopardy, okay? And this is a great example of it.
And the same thing that’s happened here with this guy’s tax bill—that I guess he forgot to pay it—the same thing can happen with homeowners associations putting liens and then foreclosing on your property, I’ve read articles about that. And equity is always at risk. So, what I like to say is that one of the great forms of insurance that you can get on your properties is a high loan balance. Because that loan basically makes that lender a partner with you and an advocate for you. And it makes you much less likely to be foreclosed on. Because if someone is out there, you know, like a homeowners association, or a tax collector, and these tax liens are sold at auction, a lot of times they’re in different locations, but, they’re sold to investors, and investors buy these tax liens. And what do they think? They think well, if this property’s got a whole bunch of equity—if it’s owned free and clear, if there’s no loan against it—hey! If I can foreclose on that tax lien, I’m going to foreclose. Now, on the other hand, if it has a big loan balance against it, they’re going to be less likely to foreclose. They’re going to be more likely to either pass on it completely, or give you a call and try and work with you in some way, right? So, equity is always at risk. And that’s the moral of this story.
MICHAEL: But I don’t know if you realize, Jason, that you just made a little comment in there that is a complete paradigm shift for people. You’re saying a high mortgage balance potentially lessens your chance of foreclosure.
JASON HARTMAN: I am absolutely saying that.
MICHAEL: But I’m saying, to 99% of people, if you go and ask them, what’s the highest potential risk of foreclosure, the only thing they’re thinking about, I would say most of the time, is going to be a high loan balance.
JASON HARTMAN: They’re going to be running out to their friends and saying, you know, I listened to this podcast with this guy Jason Hartman, and he sounds like a quack. I am not a quack. I am experienced. I have experience: the school of hard knocks, and that’s just not good, okay? So, learning through these other people’s experience, and learning through my own experience. You just—having equity in properties is—it’s better than nothing, okay? It’s better than keeping your money in the stock market where you have equity, because when you buy stocks, you usually put 100% down. When you buy a mutual fund, you usually put 100% down. When you buy a bond, you usually put 100% down. When you have a savings account in a bank, you’re putting 100% down.
But god! If you could put 20% down on a property, or 25%, don’t put more down! You’re crazy! Put as little down as you possibly can. I know that this is counter-intuitive. I completely understand that. However, experience and all these unfortunate stories that you hear from other people like the one you’re talking about right now—this poor guy who bought a property and it was paid in full 20 years ago, and he lost it over a $134 tax bill. Not good. And it says, this tax bill—Bennie Coleman was the guy’s name—he said, let me see. What does it say here? Okay, instances of foreclosure, okay, the Post found 509 such instances of foreclosure. About 200 homes, the rest commercial real estate, parking lots, and vacant land, since 2005. In Bernie Coleman’s case, his $134 tax bill grew into a $4999 debt, okay? So, $5000 debt.
As many of the victims are vulnerable, Coleman is battling dementia. A 95-year-old woman in a nursing home with Alzheimer’s lost her home over a $44.79 debt. “This is destroying lives,” an urban real estate professor. Folks, tax liens, homeowners associations—these are your two biggest worries when you have a lot of equity in a property. So, don’t do it! Engage in the practice of equity stripping. Strip the equity out of the properties, if you can. You can’t always do it, I understand. But if it’s available, get the equity out of the property. Remember, the property will go up in price, or down in price, regardless of how much equity you have. It will produce whatever the market rent is regardless of whether you have a high or a low mortgage balance on the property. All of this happens regardless of the loan balance on the property, okay?
Now, Michael, I wanted to just—because I alluded to it—I want to just mention, and I’m going to have more to come on this in a future show. But, I did a show a long, long time ago on tax liens, and I’ve invested in tax liens over the years. And I am not positive, but I think I just got ripped off. And I’m pretty stressed about it, but I haven’t fully investigated. But I’m pretty sure I got ripped off by the people that I had on the show! Okay? So you know, you think it doesn’t happen to yours truly—it does, believe me. I have my hard knocks, okay? And I think this is one of them. Well, this company called PIP West—Empowered Investor Properties West—a rather similar name to one of my companies’ names. This is not Empowered Investor Network, which is the name of one of my companies. But this is Empowered Investor Properties West, or PIP West. And the guy I had on the show seems like a really nice guy. His name’s Don Fullman, and his partner Charles Sells—well, Charles sells lives back in like I think Hilton Head, South Carolina area, and Don Fullman lives, I believe, in Orange County, in like maybe Aliso Viejo, California.
Well, they told me a couple years ago that there were 10 tax liens that I owned, similar to the story we’re talking about, that I should consider foreclosing on. But they told me I had to send them $1750 per property to start the foreclosure. Well, they picked 10 of them, and I told them I was uncomfortable sending them all of the money. So they told me who the attorney was I needed to hire, and the attorney fee was a thousand dollars per property, but their fee to oversee the process was another $750 per property, which—I thought that was kind of high, but whatever, I paid it. So I believe the way it all worked out, and this is a couple years ago, was I paid them $7500. $750 times 10. And then I paid this attorney guy that they recommended. And forgive me, his name escapes me right now. But I paid him $10,000, or $1,000 per property.
Well, listen to this little mess. They said that they couldn’t reach me. Now, if there’s anyone who’s easy to find and reach, it would probably be yours truly. They’ve talked to me a zillion times. I answer my own phone—I don’t have a receptionist anymore. So the phone comes directly to me. My phone numbers, email addresses are listed all over the Internet. All you gotta do is search Jason Hartman. They know a lot of the people I work with, because Don Fullman was on the show. He spoke at one of our Masters weekend events a long time ago. I’m a pretty easy guy to find, okay? I check my own email, I check it multiple times a day. Well, they said they couldn’t find me, and that I lost the right to finish the foreclosures on these properties. So, I started asking a few questions, and just by asking a few questions, they said well, I think you should talk to our lawyer. So I got suspicious. So now I got my lawyer talking to their lawyer, and it’s a big convoluted mess. We’ll see how it all—
MICHAEL: That was great overseeing that they provided.
JASON HARTMAN: Yeah. Yeah, they really, you know, I just think these guys ripped me off. But the jury’s out. I don’t have conclusive evidence on this yet. But, I will tell the listeners as soon as I know. So, there’s my tale of woe for the day. Okay? And the interesting thing about that is that it’s not just $17,500 down the drain. It’s the missed opportunity, because the tax lien amounts were ostensibly, per their recommendation, much lower than the value of the properties that I would have taken back in foreclosure. You see? Just like this guy’s $134,000 deal.
MICHAEL: $134.
JASON HARTMAN: Oh, sorry. $134 deal to gain a $197,000 property. So far in these tax liens—and I did make some money on some others over the years, with the same people, by the way. So I want to give a balanced opinion here, as a respectable news reporter that I am. But I think I got ripped off. I’m pretty sure I did. And we’ll see. We’ll see. In fact, Don Fullman, Charles Sells, and PIP, Empowered Investor Properties West—if you’re out there listening and you want to come on the show and debate this with me, and have your equal time, and share it with the listeners—be my guest. You are welcome to come on the show and explain how I lost the opportunity here, and how you couldn’t reach me. Because I don’t know how they couldn’t reach me. They said they tried to reach me, but they could never really explain how they tried to reach me. So, whatever.
MICHAEL: Carrier pigeon.
JASON HARTMAN: Yeah. How about just going to www.jasonhartman.com and just sending me a note right through the website?
MICHAEL: Maybe Coco ate the pigeon.
JASON HARTMAN: Yeah. You could have fond my on Facebook, Twitter, my own website, I got like 16 different websites. I mean…that’s not a legitimate excuse, in my opinion. But let’s move on. Michael, a property—we got two properties we want to talk about, so, give us the first one.
MICHAEL: Little Rock, Arkansas, one of our newer markets we’ve been working in. And I drove through real briefly three weeks ago or so. I was driving—I drove a good portion of the country. Stopped through Memphis, and drove through Little Rock, and really liked what I saw. So this one is 1800 square feet—
JASON HARTMAN: Just out of curiosity, what were you doing on that trip when you drove through Little Rock and Memphis?
MICHAEL: I was going from Virginia to Dallas with my little brother so that he could take his car back to SMU where he’s going to school. So, just nice to hang out with my brother, and you know, it was 1300 miles, so it was good for him to have somebody to hang out with.
JASON HARTMAN: Yeah, that’s a long drive. But yeah, so you saw some of the places, and good stuff! So tell us about this property.
MICHAEL: So it’s 1808 square feet, Little Rock. Purchase price is $121,900. Puts the cost per square foot at $67, which is pretty darn cheap considering it’s got a lot of brick on it.
JASON HARTMAN: Yep, that’s pretty cheap. And now let’s look at some of the projections. It’s projected to rent for $1200 a month.
MICHAEL: Yep, so that’s right around a 1% RV ratio, and that’s cash flow 276 a month, which is—I like these numbers on this property—total return on investment is projected at 33%, which is fantastic.
JASON HARTMAN: Yeah, and that’s with very conservative assumptions there. 6% annual appreciation, linear market, that’s been depending on what time period you look, but the national average—that’s pretty much thought to be the national average, but there’s ups and downs in the market. This is not a very volatile market like California or any of the cyclical markets would be. These little linear markets that don’t make the headlines, those are the ones that we like. And you’ve got your vacancy rate in there computed at 1 month per year, or 8%. Management fee at 9%. Of course is you self manage, you could save that. Maintenance percentage projected at 5%. So yeah, great. That’s a nice little deal. Nice little deal. Nothing bad about that. 11% projected as the—well, it’s funny. It says 11% cash on cash projected, but then in the pro forma it says 9%. I think he put that as like a headline, and then probably tightened up the assumptions, knowing that we would have gotten on their case, because we’re—by the way, this is one of the epic battles that goes on inside our company, folks.
You should know this. And Michael—this is pretty much—I don’t want to say it’s an everyday occurrence, but it’s a few times a week occurrence, where the local market specialist will upload properties to the website, they’ll put in all the numbers they want, and then we’ll go and get back to them and say, no, no, no. We think—we don’t think this rent estimate of $1200 per month is reasonable. We think you should have lowered to $1150. Or whatever it is like that. And they’ll have to reduce the assumptions. So this is probably exactly what happened here. He typed the headline in at 11% cash on cash, but then when we changed the assumptions, probably at the request of one of our investment counselors, it got a little bit worse than that. Right?
MICHAEL: Yeah, it could be. This is a 75% loan to value ratio, so I bet if you bumped it to 80 it might get one more point.
JASON HARTMAN: On the cash on cash?
MICHAEL: On the cash on cash. And then there may be some other number in there changed.
JASON HARTMAN: Yeah, that’s a good point. Okay. Well hey, I think we still have time to talk about Detroit, my favorite city, right? Because we said we would. Well, I want to play a little video for the listeners, and this is one you found, Michael, and it’s a great video. It’s really good. And it’s 5 minutes long, and we’ll pause it at least one time to do some commentary on this, before we get to our guest. But, this is mind-blowing, isn’t it Michael? I mean—
MICHAEL: Well, really it’s been prompted by every month I still run into people that still think, oh, well, there’s houses for Detroit for $5,000. People still think there’s this great opportunity. I say, it’s $5,000—it’s probably worth $200. And if you pay $200 now, you’re gonna be sorry.
JASON HARTMAN: Yeah. And that’s $200! In places as embattled and as treacherously bad as Detroit, they’re giving houses away! Like, the city will just give them to you for virtually nothing, if you’ll just agree to pay the property taxes and maintain the property so they don’t have to bulldoze it! That’s all they want, in one of these areas. And it is—it’s just mind-boggling to me, how our “competitors” are promoting Detroit properties! I mean—it’s beyond me. And look, folks. I always reserve the right to change my mind. Okay? Like, if three years from now something changes with Detroit—I can’t imagine it will. But maybe, who the heck knows, right? Maybe I’ll change my mind. But for the foreseeable past, I don’t think Detroit has really been a good deal for a couple of decades.
MICHAEL: Well, it’s just gambling. If your whole investment argument in Detroit is, well, it can only go up—that’s not a sound decision. What about right now? I mean, and you should be basing your judgment based on, what’s the one year pro forma gonna look like?
JASON HARTMAN: You gotta have cash flow, folk. Look, this is the bargain hunter’s mentality. In the stock market it’s the mentality of people who hunt for penny stocks, who hunt for those super-cheap stocks thinking, well, they can only go up. And if you talk to people in that world, the fact is, penny stocks can go down. They can—the companies can go under completely bankrupt, and they don’t perform. But it’s like this mentality of the bargain hunter—the collector bargain hunter mentality. And it doesn’t work! I haven’t found it to work. You want to buy good quality stuff that has a market for that stuff. In this case, rental properties. And just sit tight, and be a good manager, or a manager of your managers, and buy for cash flow. That’s the key to having a long, sustainable career in investment. And I mean, I’d ask you this. If it was all about prices, what would the bigger company be? Would it be Big Lots, formerly called Pick N Save, or Apple Computer? I mean—
MICHAEL: Well, let’s look at Berkshire Hathaway.
JASON HARTMAN: Yeah.
MICHAEL: When it was, what. I don’t know what it is. $100,000 a share?
JASON HARTMAN: What is Berk nowadays?
MICHAEL: I don’t know, let me look it up.
JASON HARTMAN: Look it up while we’re doing the video. But yeah, Warren Buffet’s become a little bit strange in the past 5 years or so, in some ways. Most people think he’ become a sellout to the establishment, and that’s probably true. But yeah, I don’t know. It’s an interesting thing. So, let’s start playing this video. You look up share of Berk, and remember, there’s two classes of shares for Berk.
MICHAEL: $173,300 today.
JASON HARTMAN: Wow! That’s pretty—I’m kind of surprised it’s that high. Last time I checked it was like, I don’t know. In the 120s, I think.
MICHAEL: Yep, that was in December of last year, it was still—and then even midway through last year. So it’s up a lot in the last year.
JASON HARTMAN: But hey, if you buy one share—and now you could buy a house instead—but if you buy one share of Berk, you get to go to the meeting, right? Literally that’s the reason some people buy the share. Is so they can go to that stupid meeting in Omaha.
MICHAEL: 315 shares traded hands today. Wow.
JASON HARTMAN: There you go. Okay, so let’s go to this video about Detroit. It’s 5 minutes. We’ll pause it at least once for commentary. And this is about what they call Operation Compliance, and it shows how Detroit is attacking small businesses. As if they don’t have bigger problems! Here we go.
REPORTER: Operation Compliance has to be one of the most troubling things that I’ve ever heard of in the city.
BUSINESS OWNER 1: Police officers ain’t gotta ride with this compliance. They ain’t even be out stopping people, just knockin’ people in the head, you know? I’m running a legit business.
REPORTER 2: Entrepreneurs have said, well look. Let them catch me if they can. Right now the city has decided, we’re gonna try to catch you, and we’re gonna put together a special unit to do so.
REPORTER: We all know Detroit’s in trouble. A bankrupt city full of crumbling houses, abandoned factory buildings, and a fast-dwindling population. Yet in the midst of all of this collapse and decay, former Detroit mayor David Bing announced the new regulatory crackdown on code-violating businesses—a crackdown expected to shut down 20 new small businesses a week. It’s Operation Compliance.
BUSINESS OWNER 1: What I think about Operation Compliance is, I think that they could be doing something better.
BUSINESS OWNER 2: They could be clearing out some of these vacant lots out here, and cutting some of the grass throughout the city. And boarding up some of these houses, clean up the streets. Take our tax dollars, cleaning it up.
REPORTER: These two business owners have managed to keep their businesses open on Livernois Avenue. But many other businesses along the road have been targeted and shut down by Operation Compliance in the preceding months.
BUSINESS OWNER 1: You know, we called for their services, as far as, someone breaks in—they never show up. Yet still they wanna come and blackball you and close your business, because you might be a little late paying fees or something like that.
BUSINESS OWNER 2: And it’s the same harassment from the city, complaining about our signs out in front of the buildings, and all this and that. [Unintelligible] about the people downtown with the money, but [unintelligible] the black community and the poor people.
BUSINESS OWNER 1: It is hard to run a business in Detroit. It’s taken me three years to get approval for an outside patio.
REPORTER 1: Larry D’Mongo runs Café D’Mongo, a remarkably successful restaurant and bar in downtown Detroit.
BUSINESS OWNER 1: I’m truly trying to serve the public interest. [Unintelligible] simplify things. Simplifying things in Detroit means loss of jobs. So, politicians rather try to tax me to death, charge me to death, to keep their votes, they gonna keep their relatives, and I’m gonna say it like it is—keep certain friends all on the payroll.
REPORTER 1: Accidentally, the city has created sort of an anarchistic culture in the city, where many entrepreneurs—especially the smaller retailers and restaurant owners, simply forgo getting the required permits that the city is demanding of them, because it’s too expensive, and because it often takes too long, and sometimes the inspections that are done are of low quality. So entrepreneurs have said, look. Let them catch me if they can. Right now the city has decided, we’re going to try to catch you, and we’re going to put together a special unit to do so.
BUSINESS OWNER 1: For people who would want to start a business today in the city of Detroit, I really don’t know how they would go about even starting. Because the amount of hurdles the city has set up to prevent them from going into business is just overwhelming.
JASON HARTMAN: Sounds a lot like California [LAUGHTER]. Isn’t this unbelievable? I mean, these politicians are such idiots! They actually—I don’t know if they’re idiots. They’re greedy and power-hungry, because what’s always happening is, and one of the people interviewed in this little clip so far alluded to that. That all the friends downtown are making all the money, you know—who’s on the compliance team? Well, it’s probably people who are owed political favors, and it’s just—I mean, Detroit, from its Model Cities Program years ago, it’s just a disaster. One corrupt mayor after another. One corrupt city council after another. Inefficient, crime-ridden, the police don’t respond, I mean, weeds, abandoned buildings—and now, all they’re doing is attacking what is left of the productive class.
And you know, Michael, that’s what California’s been doing for years now. Of course California has a more diverse economy, it has nicer weather, it has a beautiful coastline, and it has a brand. It has some definite advantages over Detroit, no question about it. But Detroit used to be one of the premier cities of the world! Motown? That’s where all that music came from. It was like, I think the #6 city in the US? The population was more than double what it is today. This can happen to places like California! You see all of the middle—not all of it, but—you see so many in the middle class leaving California, and you see higher end people leaving California. There’s some that are just so rich, they kind of don’t care. They’re just willing to pay the premium to live in California. But the parallels are stunning. Between Michigan and California. And that has led me to coin that phrase, California’s the new Michigan. Of course it’s not the same. I may be overly dramatic. I’ll be the first to admit it. But it’s hard to deny that there’s some parallels, and there’s some real truth to that.
MICHAEL: Yeah, I think so. I guess, we’ve picked up some other industries in California, but I know that due to taxation, you know, that had a huge effect of the movie industry. That’s a lot of studios were built, stuff in Mexico, and they were going to Canada to shoot things—
JASON HARTMAN: Florida—
MICHAEL: Yeah, it was just so expensive to shoot in California—
JASON HARTMAN: Yeah, Dawson’s Creek, in North Carolina—
MICHAEL: Even LA. I mean, just the business taxes in LA prompted a lot of people to move just outside of the city tax, because there’s just too many taxes.
JASON HARTMAN: Hey, history has proven that wherever Democrats go, misery will soon follow. Sorry about that, Democrat friends. I apologize [LAUGHTER]. Anyway, let’s listen to the rest of this. It’s almost over, okay?
BUSINESS OWNER 2: I was telling my sons, Detroit Athletic Company has just been doing business in the city since age 11, when he started selling peanuts and hats outside of Tiger Stadium. Even then, dealing with the city government was not easy.
BUSINESS OWNER 1: They would look for violations. So it might be the fire department, and they would come and they would say hey, you’re set up too close to the fire hydrant. They would claim that there were some rule you’re in violation of. They would suggest to us that maybe we should give them a hat, or give them something in return, and then that was kind of how it would get glossed over.
JASON HARTMAN: Little crony capitalism there, huh? Give us a hat, and we’ll go on our way. What a bunch of idiot government workers—can you—this is just so distasteful. It’s like doing business in a third world country. It’s ridiculous.
MICHAEL: I don’t know, it’s pretty dangerous. That guy was trying to set up a patio outside his restaurant.
JASON HARTMAN: Hey, I’ll tell you, the same thing happened in Corona del Mar, when I lived in Newport Beach, okay, there was this little café in Corona del Mar—I’m sure you’ve been to it, Michael, because you live in Newport Beach, still, for 60 more days. And it’s called Rose’s Bakery. Or, Rose Donuts, I think. And it’s right there on Pacific Coast Highway. And there’s so few places to eat, because it’s so hard to open a restaurant! There’s so many regulations. And in Arizona, the restaurants open left and right. There’s lots of choices, there’s great places to go. But in California it’s really hard. Well, Rose’s, you go there on a Saturday and a Sunday—even on a weekday—you can’t get a chair! There’s so few places to eat, this is one of the few, right? So you go to this little place, and it’s packed. There’s no chairs, and Shawn, the owner, who I personally know—he’s been to some of our seminars, and you know, I don’t know if he ever got started in investing, or if he ever had the capital to.
But you know, he’s the owner; he’s a really nice, conscientious guy, and he would constantly talk about how he’s fighting with the city to let him expand his patio by literally one parking space. Because the patio is like, right in the parking lot. And, will you just let me go over one parking space? And they would come in and they would regulate the number of chairs, the number of tables that are kind of expanding into the parking lot, and finally, he got some latitude, I noticed the last couple times I was there in California and went to Rose’s. He was able to expand his patio a little bit. But it’s still too crowded! You still can’t get a chair!
MICHAEL: You know what though, I—on something like this in particular though, in areas like Corona del Mar, Manhattan Beach—I was just up in Manhattan Beach—there are citizens that are contributing to this, though. Because I know there’s citizens that complain about parking extensively in Corona del Mar, and when I was in Manhattan Beach—I mean, I live on the Balboa Peninsula, and parking in horrendous. When I go to Manhattan Beach, it’s a thousand times harder, and clearly wealthy residents have had a hand in removing as many parking spaces as possible to keep people out of there.
JASON HARTMAN: I don’t doubt it. Look, it’s like Laguna Beach, okay? It’s the NIMBY Syndrome—NIMBY, Not In My Back Yard. You know, everybody wants there to be enough prisons—which, that’s a whole nother discussion. The highest incarceration rate in the civilized world, the United States. The prison industry’s gotten out of hand. That’s a business too, unfortunately. But they all want all this stuff, right? They want landfill to throw their trash, but they don’t want it near them, right? So, Laguna Beach, they don’t want anybody coming in, yet they make a lot of money off that. And the same—you’re absolutely right. There’s no question, that’s true. But anyway.
MICHAEL: But we do know how it goes.
JASON HARTMAN: Yeah, we definitely know how it goes. NIMBY—Not In My Back Yard. Just remember that one. Okay, final part of the video here.
BUSINESS OWNER 1: You just learn to comply. I think it’s really a shameful thing that people who were entrusted with—would become that corrupt to where they would even shake down a little kid.
REPORTER 2: Representatives from the city of Detroit declined multiple requests to be interviewed for this video. But the government website says that “we are sending a message that if you’re doing business in the city, you need to follow the law.”
REPORTER 1: Imagine that. In light of bankruptcy where businesses and people have fled the city in droves, they’re shutting down businesses that have succeeded. They may not have the requisite permits the city wants, but that hasn’t stopped patrons from patronizing them, and sharing their resources in exchange for whatever service the business is providing. That cries out for a different model.
BUSINESS OWNER 1: Once I paid for the compliance certificate, then I have to go to all these different electrical, this, that, set up appointments, this person might say I’m okay; the next one said, well, he shouldn’t have okayed you. I look at the bill I have to pay, and sometimes I just—really, and I have said it to him: why don’t I just come to you, because it seem like what you want is money. And just give you one check. Luckily I could afford it, but what about the person who’s just starting out? The reputation that they give their cousins, or relatives, or friends, who might think about doing it, they say, hey. Don’t. They rob you.
JASON HARTMAN: And on the video in the end it says, “In less the 9 months, Operation Compliance has resulted in the closure of 383 ‘illegal businesses’ according to the city.” Well, didn’t those champions in government do their thing? They shut down almost 400 businesses. Gosh, I wonder if Karl Marx would be probably proud of that? Those evil businesses. Those evil capitalists.
MICHAEL: I don’t know, it still sounds like a good place to invest, Jason.
JASON HARTMAN: Yeah, let’s just run out and buy some more houses in Detroit, why don’t we?
MICHAEL: Yeah.
JASON HARTMAN: What a bunch of—what a crock. Unbelievable. So there’s our opinion on Detroit. Enough of that. Hey, let’s talk about a real market, a real place to invest. You’ve got one more property, Michael?
MICHAEL: Yep, since we have that Austin tour coming up, we picked a home outside of Austin. And it’s really a beautiful home.
JASON HARTMAN: That is—I’m looking at the picture now. That’s a good-looking house.
MICHAEL: It’s 2260 square feet. It’s a pretty big house, for $136,800. $61 per square foot. Seems like a great deal, it’s all brick—
JASON HARTMAN: What do the projections say?
MICHAEL: $1400 a month in rent, and that is cash flowing—
JASON HARTMAN: So slightly more than a 1% RV, rent-to-value ratio, good.
MICHAEL: Cash flowing about $2300 a year, at 75% financing. And total return on investment, 25%.
JASON HARTMAN: Wow. That’s fantastic. So, cash flowing, about $2400 a year on 48,000, 49,000 cash invested. And the reason you’ve got more cash invested here is because you’re paying for your fix-up cost, or rehab cost, outside of your loan. So, that reduces your cap rate, and reduces your cash on cash return, but still, your overall return on investment is very good. And that’s a beautiful property, and it rents for slightly over a 1% RV ratio. Less than the cost of construction for a home built in 2003 is pretty darn good. And only $61 per square foot. So, awesome deal. And be sure to join us for our Austin Property Tour! It’s really your last chance. The hotel just called me today—they called me this morning, first thing. I think it was McKenzie there at the Hyatt Regency in Austin who said, Jason, the room block—it ends today.
We agreed it would end on the 17th, and we extended it for you once. But, you’ve technically, if someone registers, we won’t deny them that room price, so long as we’re not sold out. And I gotta tell you folks, Austin, in the fall, is—it’s tough. I mean, the city is just—it books up. The hotel prices are somewhat high, so, I understand, and you need to understand that too. But last chance pretty much to book for the Austin Property Tour. So go to www.jasonhartman.com, click on events and do that, and reserve your room immediately. And they’re still going to let a couple people squeak by in that room block deal, which is a good deal. Saves you about $30 a night. So Michael—thank you for joining me today, and listening to these rants about getting ripped off investing in tax liens; Detroit is a disaster; gosh, I hope people found some good stuff in here. But we’re going to talk to Karl Denninger, the ticker guy, here in about 30 seconds. So thanks, Michael!
MICHAEL: Thank you.
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ANNOUNCER: Jason provides an extremely unique service. Deal evaluator: are you interested in a property outside of our network? Need a second opinion? No problem! Let our experts evaluate the deal. Find out more about it at www.jasonhartman.com!
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JASON HARTMAN: It’s my pleasure to welcome Karl Denninger back to the show! He is an American technology businessman, a finance blogger, and political activist who is sometimes referred to as the founding member of the Tea Party Movement. He also has a book out about leverage, how cheap money will destroy the world. And I think that’ll be very interesting to talk to him about. And he was actually on my show, on the Creating Wealth Show—he was guest #285, just several months ago. So let’s welcome him back! Karl, how are you?
KARL DENNINGER: Oh I’m doing fantastic, thank you.
JASON HARTMAN: Well, it’s good to have you. Tell us what concerns you most out there nowadays in the markets.
KARL DENNINGER: The most concerning element of today’s marketplace is what’s going on in the emerging markets, and this has turned into a huge issue that not very many people are talking about. We’ve seen generally rising asset prices in the United States now for the last three to four years. And over the last six months, rising rather steeply. But if you look at, for example, India: their market is utterly collapsing. Their interest rate environment is going haywire, the stock market is crashing, it’s down some 12% over the last couple of weeks. And the stability of their credit markets is in severe question. This is being replicated to a greater or lesser degree all throughout the emerging world at the present time. And then of course you have the situation with the peripheral countries in Europe—Greece, for example, which is not over, despite what people will tell you. And all of this is in an environment which, from a US market perspective, looks very benign.
Well, this is exactly the same sort of environment that we saw just before the Asian Debt Crisis broke out in the 1990s. It’s somewhat similar, also displaced geographically, from the environment we saw in 1987 before the market came apart in 1987 in fall. And it is—there are some echoes of what we saw in the 2007-2008 timeframe, in terms of credit overheat. But again, in the overseas environment as opposed to here. And so, what we are seeing is the rotational trade that showed up in our markets prior to each of those dislocations. At the same time, we’re seeing the same kind of warning signals, but because they’re not happening here in the US, people are ignoring them, and I think this is extremely dangerous.
JASON HARTMAN: So, why are people ignoring them? This isn’t getting a lot of attention, is it?
KARL DENNINGER: No, and a lot of the reason for it, I believe, is that you have a market that has become drunk on the Federal Reserve’s credit emissions. The quantitative easing games, and what is, what they call the POMO—the Permanent Open Market Operations—where they essentially flood the system with free cash on a daily basis, taking treasuries out of the marketplace. This is nothing other than playing Wimpy with a hamburger. But on a greater scale. And so, the liquidity goes to work somewhere, and it seeks a return, as anybody that has money always does, and lately, it has been flooding into the stock market. So any time that you’ve seen any sort of a selloff thing going, then in come the people to buy this, because [unintelligible] buying opportunity.
Well, this is the same thing that we saw in 2007. In 2007 you had Kramer on TV every night telling you about the four horseman of the—you know, the apocalypse that were going to save the world. Of course, that worked right up until it didn’t. And in 1999 we had the same thing, in late ’99 and early 2000, there were the ten stocks of the new millennium that everybody was touting, and of course, of those I think there are three that are still in business. So, this is the same kind of thing that we’ve seen time and time again. It is the usual suspension of disbelief, if you will. The idea that a company like Amazon can make a couple of cents a share and [unintelligible] for $290 a crack. And that, well, we don’t need to make a profit today—we’re investing for tomorrow. And someday we’ll get done doing this, and after we get done making these investments, and all of this money that we are spending here will end up being returned in some form or fashion to shareholders. The problem is that you’re making the assumption that that day ever comes.
JASON HARTMAN: Yeah. Well, with some Internet companies and big brands, they seem like they can keep kicking that can down the road for a long, long time. And the US keeps kicking the can down the road. We just print more fake money out of thin air, and—you don’t even have to print it anymore; it’s electronically created, which is even worse. And at some point, I mean, the chickens have to come home to roost, right?
KARL DENNINGER: Yes, they do. And the problem that most people have some trouble getting, although they see it in their daily lives, they just don’t connect the events together. And that is that the difficulty in making ends meet, and the pricing of things—the financialization of everything in our life—it gets to the point where you’re essentially charging your groceries. And at that point, the end is near. Because, of course, what do you [unintelligible] after your groceries [unintelligible], that’s the last thing that’s in your budget that you could actually afford with cash. We don’t shop for the price of cars anymore. We price, you know, 299 for the payment, right? That’s what it costs per month. Nobody talks about how much the car costs. We don’t talk about how much the house costs. It’s, how much is the payment. We don’t talk about how much our cell phone costs! A cell phone is now 50, 60, $70 a month? $100 a month?
Same thing with your cable television. How much is a month? What is the payment? It’s not how much is it, anymore. It’s how much is the payment. And what this reflects, is a 30-year long secular decline in the rate of interest. The cost of borrowing money. And so, at the personal level, this is bad. But at the corporate/government level, it is extremely destructive, because corporations and governments, as a general rule, never actually pay off their debts. They just roll them over. So from one day to the next, we just roll over—whatever comes due today, we just reissue tomorrow. And as long as the interest rate tomorrow, when we roll that debt over, is lower than it is today, the illusion continues that we are spending less as a percentage of revenue in order to service this debt. The problem is, the principal amount continues to increase. And so, as long as that trend is able to be maintained, everything’s fine! You seem to be solvent, you’re able to make your debt payments, and nobody seems to have any problems.
Then we get to the point where interest rates get to zero, and one of two things mathematically has to happen. Either rates have to have to [unintelligible] the line at a very low rate, at which point there is no more financialization. There’s no more turning of the crank that helps you. Or, the more likely scenario, is people perceive that credit risk now comes back into the game. Rates back up and go the other direction. The secular trend shifts from declining rates to rising rates, and now, all of a sudden, everybody that’s out there [unintelligible] goes under—if you look at a chart of long-term interest rates. Take a 10-year treasury, for example. Or you can take the 30-year mortgages if you want, it doesn’t matter. They look pretty much the same. And you graph them out, you will find that every major dislocation that we’ve had in the market over the last 30 years—1987, mid 90s, the Asian Debt Crisis, the 1999-2000 crash in the NASDAQ. The 2007-2008 blowup in our markets, in the housing market.
Every one of those was preceded by a shift—a cyclical shift—in interest rates from lower to higher. You look at the 10-year curve and you will see that the 10-year curve turned up in front of every one of those events. And the reason that that precipitated those crashes, is that those people that had too much leverage on when the cost of rolling that debt and refinancing went up, they couldn’t make the payments and they went out of business. Now what you have is a situation where the secular trend is going to be the opposite. It’s going to be rising rates with periodic times that you have cyclical downturns, alright? So the problem here is that the—in a secular, upward-moving environment, if you take on debt, you’re in trouble. The more debt you take on, the more trouble you’re in. Instead of the other way around. So we’re going from a market and an economy where financialization is profitable to one where it’s suicidal. And this is a shift that nobody is understanding, but it’s going to come and hit you square between the eyes if you’re not prepared for it.
JASON HARTMAN: Okay, so, let me ask you to just, in a nutshell, explain how—I mean, we’re talking about at a national level, about the country. About America. Or the US. And how this debt has to come home to roost, because for the consumer and the nation, when we roll that debt, as you talked about, it’s going to be more expensive the next time around. Am I summing that up correctly?
KARL DENNINGER: That’s exactly right. What happens is that—let’s say, for example, that today you can go out and float a one-year revenue bond for your schools at 2%. Okay? And that’s because today the short-term interest rates are very low. And the risk of your school system not being able to pay because it doesn’t collect its taxes from your house—you know, from your property taxes—is pretty low. And so the interest rate’s pretty reasonable. Well, next year when you go to do this, they will probably be 2½%. Then it’ll be 3. Then it’ll be 3½, then it’ll be 4, instead of going the other way. So, what this means is that if you don’t actually pay it off—if what you try to do is just pay the interest, the carrying cost goes up instead of down. And what we have lived on for the last 30 years is the opposite. We’ve always been able to roll the debt, and the carrying cost has always decreased. So you could take more debt on without actually increasing the number of dollars, numerically, that you had to lay out. That is no longer going to be the case.
JASON HARTMAN: Right. So here’s—and sensibly, economically, mathematically, I couldn’t agree with you more. However—and this is what I want to run by you—at the national level, Karl, does the US even have to play by those rules? I mean, it would seem that they do. But I have a bit of a theory as to why the US is almost immune to rationality as a country.
KARL DENNINGER: No, the US can’t get away from this mechanic. They certainly think they can, and for a period of time it appears that you can do so. But that’s the same sort of situation that Ally Financial, formerly called GMAC, thought that they could get away with for a period of time as well. That’s what Lehman Brothers thought that they could get away with for a period of time. That’s what everybody thinks they can get away with for a period of time. And it appears to work for a while. But remember what happened to Lehman Brothers. Lehman Brothers was running along just fine, until one fine day about a month before they went out of business, actually—and this was in the Valukas report. It was in the formal forensic write up of the bankruptcy. Very dry reading, but very well written, by the way. And the gentleman that did it is someone that I am somewhat acquainted with, and he’s extremely sharp. Lehman went to Citibank to do a tri-party repo transaction. An absolutely ordinary overnight financing transaction. It took them some collateral, said we want cash to—just, because banks have to settle their accounts every night with their customers, right? Somebody comes in and they want to cash this investment, they want to invest this—there’s always cash floating back and forth between these firms. And Citibank took a look at their collateral and said that’s trash, what else do you have? And Lehman’s answer was nothing.
JASON HARTMAN: Fair enough. So everything you said is about functioning in a normal—well, not normal. But a rational market where you have counterparties and regular motivations and so forth. So, what I was getting at—hang on for just a second, let me just run this by you, you might find this kind of interesting. So, what I’m getting at is, I completely agree. I mean, the US—maybe not on the balance sheet, but certainly on the PNL, is insolvent, okay? I mean, this is absurdity, what we’ve had going on for the last couple of decades. And especially the last five years. I mean, it’s beyond absurd, okay? We are spending ourselves into oblivion. However, when you go beyond the economics of it and you look at the military, the position of the US in the world, the reserve currency status—which, granted, there are many countries that don’t think we deserve that anymore, and they are right. But, the question is, will we ever give it up. I mean look, at the end of the day, when push comes to shove, the guy with the biggest military and the biggest economy, even if it’s built on a house of cards, is probably still going to get their way. And that’s why I’m saying that this isn’t a real game. It’s again, there’s more to it than just the numbers.
KARL DENNINGER: Well of course there is. But you need to—you know, at the end of the day, 2 + 2 still equals 4. And what we have in the [unintelligible] is essentially a confidence game, just like all economies and all currencies.
JASON HARTMAN: They’ve gotta be built on confidence.
KARL DENNINGER: The entire—the stock markets, all of this, is built on a confidence game. Why did not the market crash when the NASDAQ went dark for three hours? And the answer is, because confidence was not lost. There was a belief that the only—there was a technical glitch, and it was not the end of the world, and things would be fine. And it turned out that this time, things were. Okay. As long as confidence is maintained, everything is okay. But, we whittle around the edges of this every day that we continue this charade, because we continue to drive up the cost of living for ordinary people. The cost of going to college, the cost of going to see the doctor, the cost of buying a pound of steak.
And as we squeeze from the bottom, we eventually get to the point where the people at the top have higher and higher demands for tax rates, and the only alternative to jacking those taxes up, which eventually people will simply say, you know what? And this happened back in the 1970s, and in the 1960s and 50s. People got to the point where they got to the 90% cutoff and they just said, you know, I’m gonna go to the beach for the rest of the year. I’m not gonna work and keep 10 cents of every dollar that I make. I’ve had enough. I’m gonna go live the life of luxury, and you can go stick it, Uncle Sam. And that’s a perfectly logical thing to do. People started to ask the question, how much is enough? Well, what happens are you start to shove that up is that your only two options are, cut it out, stop that, or, you continue to debase, and as a result, the wedge keeps being pushed further up the scale towards the wealthy. Well, at some point—and this is what caused the revolt in Egypt. This is why there were essentially two revolutions in Egypt in the last three years. It was not, as is commonly perceived, because the people were upset with Hosni Mubarak. The reason people rioted is because they were hungry. You saw a doubling of the cost of living over there in the space of 18 months. Well, when you have nothing in your belly, it’s very easy to talk you into picking up a rifle.
JASON HARTMAN: No question about it. Yeah. I completely agree. Okay, so, to keep food in the belly of US citizens so they won’t rise up, and you know, look at our government’s very good at that. I mean, we’ve got Obama Phones, we’ve got—now we’re going to have theoretically free healthcare, which is going to be incredibly expensive. If you want to make healthcare really expensive, just make it free. That’s always been my opinion. And that’ll obviously be a disaster. But politicians here are very good at pandering. I mean, they’re very good at doling out the goodies to keep the peace and buy the votes. You gotta give them a lot of credit, unfortunately, for that, right?
KARL DENNINGER: Certainly. I mean, but this has been the game for the last several years. And one of the first things that was done when Obama took office was, he essentially eliminated all means testing for Food Stamps. Okay, so all you had to do was just not make enough money. All of the rest of the things that used to go into getting a Food Stamp application went out the window. So now you have people like this guy that was on television a couple weeks ago that is in perfectly good condition—he can work if he wants to, but he’s out in California and he collects Food Stamps.
JASON HARTMAN: Oh yeah, that guy, I remember him on Fox. They did a great story about this guy who is—feels completely entitled to just collecting Food Stamps, and sitting at the beach and picking up chicks all day, and partying, and—so just unbelievable. The abuses are just absurd. But that means that ultimately, when more and more people tip to that side of the scale, then the production goes down, the innovation declines. At some point everybody just says, hey! Well why knock myself out, right?
KARL DENNINGER: Well, what we have coming, and what people need to understand from a standpoint of how do they manage their own finances, if you run a business, how do you manage that? If you are in a management role in a larger company, what do you—how do you realign your thought processes. What people need to understand is that no one that is currently in the working population—if you’re younger than about 60, you have never known a time in your working life, as a professional, when you have not been in a declining rate environment, and where cranking up leverage has at least been non-destructive. In most cases it has been one of the ways that you’ve made money and have become wealthy. If you don’t stop doing that before the [unintelligible] turns on you, it’s going to destroy you. And it doesn’t matter whether you are an individual, whether you are a business, whether you are a government, or the United States! And people are sitting here looking at this saying, oh no, no, that can’t happen. Well I assure you it not only can, it will.
JASON HARTMAN: Well, that’s the only thing I was saying. I believe it happens on an individual, a municipal level, even a state level, but at the federal level, I think they can just defy gravity for a darn long time. They’ve been doing it, and I think they can just keep kicking that can down the road for a long, long time! You know? I don’t think it’s fair, I don’t think it’s right, but essentially, we’re outsourcing the problems to other countries. We get other countries to buy our debt, and we can keep kind of bullying them around the buy it! As long as we have that military, and as long as we have all that influence, what are they going to do?
KARL DENNINGER: We all had military in the 1970s, right?
JASON HARTMAN: Well, yeah, but—
KARL DENNINGER: We came off that—wait a minute. We came off Bretton Woods, right?
JASON HARTMAN: Sure, in ’71.
KARL DENNINGER: —no convertibility, right? And things seemed to be just fine for about 4 or 5 years.
JASON HARTMAN: Till ’75.
KARL DENNINGER: No big deal. And then all hell broke loose.
JASON HARTMAN: Well, look who we had captaining the ship, right?
KARL DENNINGER: Well, who’s captaining the ship now?
JASON HARTMAN: Actually, you got me on that one, Karl.
KARL DENNINGER: Well—and oh, by the way. How high did the 30-year treasury bond go?
JASON HARTMAN: I don’t remember, but it was bad.
KARL DENNINGER: Here’s the—there’s two sides to this. Whether or not that was good or bad depends on which side of that you were on. There were people predicting the end of the world, the United States. Hyperinflation, and the end of America. When Jimmy Carter was in office and all this was going on, right? If you had the stones to buy 30-year treasury bonds in size at that time, and simply sit on them, you would have lived the last 30 years in a very comfortable place.
JASON HARTMAN: Yeah. It’s hard to argue with that. It’s hard to argue with that. So, let me ask you. I mean, to sum this up, what is your prediction? I mean, what do you think will happen, sort of more specifically? I mean, what can individuals expect?
KARL DENNINGER: Well, what I expect individuals to find is that as the cost of borrowing goes up, and as the credit squeeze continues, you’re going to—the paradox is that you’re going to actually see the impact of what—if we were honest about it—we would call deflation. The reason we won’t call it that is because we didn’t call the inflation inflation. We didn’t call the S&P 500 going from 150 to 1600 inflation. We didn’t call the price of houses going from, you know, $30,000 to $300,000 for the same house inflation. And so, we won’t call the reverse—
JASON HARTMAN: We called it appreciation.
KARL DENNINGER: Yeah. We did, didn’t we? So, call it depreciation, if you prefer. Because that’s what’s coming. The price earnings multiple will compress. The ability to use financial [unintelligible] to expand earnings that aren’t really there will disappear. And the price of assets will come in line with the productive output of the economy. This will not happen overnight.
JASON HARTMAN: It will not happen overnight. So, the cycle, if one is looking at a, you know, say a graph with an x and y axis, right—time on one side, asset prices on another—at first, we’ll see more inflation of those assets to the ultimate time when you gotta pay the piper. And then we see deflation of those assets. Is that the correct way you’re looking at it?
KARL DENNINGER: No, I would say that what we have is a secular shift from increasing multiples against production in the price of all assets, to a decreasing multiple. That’s the secular trend. So, we’ve had a secular trend over the last 30 years has been the opposite. There’s been an increasing multiple and all those things. We are now entering a secular decrease; however, this does not mean that it will be a straight line. It will, first off, the exchange between those two states—and it’s going to be extremely volatile and dangerous for people in the capital markets for quite a period of time, I expect several years of that. Where you will still have people hanging on to the idea that the stock market is going—you know, the Dow is going to 36,000, or 40,000, okay? And they will die very hard. And they will be carried out on stretchers and shields, because they will not give this idea up until they buy the last dip that does not come back.
The same thing is going to happen to the price of other assets. But, it’s not going to be a straight line! The same thing is true, is going to be true, of bond yields and credit. But again, it’s not a straight line. So what you have to look at, as an individual, is—if you are over-levered now, you want to get out of that situation if you can. If you get trapped, you will probably get an opportunity, but the problem is that you don’t know how far the market’s going to move before that counter-cyclical—before that cyclical counter-trend in the secular change occurs. And whether you can stay solid long enough for that to happen, and take advantage of it and get out with your hide intact, is an unknown. It’s—what we have right now is a market that is extremely unstable in all respects. We just had a housing number, a new home sales number, that came out, that was absolutely terrible. Everybody who’s been running around for the last two months, telling us that the shift in interest rates—which has been small in percentage terms, okay? But in percent of change terms, has been very large. But in percentage terms has been very small. We’ve had everybody telling us that this is not a big deal, it’s not going to hurt the home cycle, it’s not going to hurt the housing market. It’s not a big deal. And then all of a sudden whammo, here comes a figure that is massively off-plan.
JASON HARTMAN: So, give us a timeframe on this, if you could. I totally understand it’s a prediction. Nobody really knows. I mean, my thesis is, they can just kick the can down the road for another decade or two, but you don’t seem as optimistic as I am. I mean, and I say optimistic with biting my tongue. I don’t think that’s optimism. I think it’s ridiculousness. I just think they can get away with it.
KARL DENNINGER: I don’t. I believe that we’re going to see a turn, and my thesis a year ago said that this year we would see something come out of either the emerging markets or Europe, and I thought it was coming from Europe. I may actually be wrong about that; it may come from India. But, it’s the same problem, okay? And, it’s a global liquidity squeeze. Because of the interconnectivity, we will not be able to escape the impact of it coming over here to the United States. And I expect that we’re going to see the start of it. The worst part of it, the part that really bites into people’s backsides, is not going to come for another year or two. Maybe even a little more. But I do believe that the eye of the storm, if you will—the center of the hurricane—is pretty much, we’re seeing that eye wall on the horizon coming from the other side.
JASON HARTMAN: This is a global issue, obviously. It’s not just the US. And believe it or not, I know we probably disagree on this a bit, from our conversation here, but I think the US is in a pretty damn enviable position, to tell you the truth. As—not by the numbers, not by the ridiculous spending and the debt levels, but by the brand name, the Brink’s truck mentality—you know, we’ve always—investors around the world has always looked at America as the Brink’s truck safe place to keep your money, safe place to keep your capital, your assets. Rule of law, which of course the Constitution’s getting trampled on left and right. I’ll agree with the Tea Party on that, for sure. Biggest military, etcetera, all the things I’ve pointed out. So the question is, the capital has inflows and outflows. If Europe continues its collapse, which it most surely will—I got back from Europe two weeks ago, and I gotta tell you—Spain is a disaster. Obviously Greece is—you’ve got Ireland and Portugal, and Italy, they’re all messed up too, and the more socialist, better-off seeming countries—they’re not so great either, okay?
But—and then obviously everything you said about India. But so, will capital flow out of those places because they are worse off than we are? And where will it go? I mean, I’ve got a friend who lives in China and who thinks China is the greatest thing—he’s American—and I keep sending him articles about all the Chinese millionaires that want to move to America, that want to move their money to America, that want to get their money out of China. It’s all—it still seems all about the US! That’s where the capital flows! I mean, foreign direct investment here is—it’s phenomenal! No? Am I crazy?
KARL DENNINGER: No, you’re not. For a period of time, you’re spot on, okay? We have benefited tremendously over the last 6 months from those capital flows. As the European situation and the Chinese situation—you look at their PMI, or their production numbers, and all of their economic indicators—they started to turn a little bit, but the last 6 months they’ve been absolutely awful. And yet our markets have gone up while theirs have softened, and in some cases, the [unintelligible] have just been bizarre. But the emerging markets have been terrible. And then you go, well, why does the Dow keep going up? Why does the S&P? Because the money comes over here, and it’s the rotational trade. It’s the belief that we will be fine even though they are hosed. The problem is that due to the interconnectivity of the banking system, especially in the derivatives trade—that is not going to work out. And for that matter, when you look at the multinationals, you take a look at what Caterpillar is saying about demand for their machinery outside the United States. I saw a report that I believe they said they were off 23%? That’s a huge number.
JASON HARTMAN: Yeah, I agree. So that’s a sign that there’s not that much building, in other words. And infrastructure. Right?
KARL DENNINGER: Yeah. The demand’s just not there. This is the problem, is that you have all of this financialization, and when you take on leverage, what you have to understand is, it’s like putting a multiplier. All our leverage is is a multiplier. It’s a lever. And so, it magnifies gains, but it also magnifies losses.
JASON HARTMAN: It magnifies losses if you exist in the real world. And I just—I just think America doesn’t exist in the real world. Listen, I think it’s ridiculous, it’s illogical. But I’ve mentioned all the reasons. So, we shall see, my friend. I mean, by all logical standards, you should be right and I should be wrong. I just think that there are these other factors that I mentioned about the brand name, the reserve currency, the theoretical rule of law. Still better than most places. Or a lot of places, at least. And the good ol’ military, and the fact that we can just throw our weight around. It’s not right—it’s kind of bully-ish. I mean, I disagree with it. I think it’s wrong on many levels. But it’s the way it is.
KARL DENNINGER: I think they’ll be—you know, there’ll be plenty of that that’ll go on for a while. But the end result doesn’t change.
JASON HARTMAN: Yeah. And the question is, how long can it go on? At some point, the charade has to end. You are 100% right about that. The only question is, who knows when? I mean, who the heck knows when? You know, we’ve been spending like drunken sailors since the 70s in this country, and it’s just—it’s absurd. You mentioned something before we actually started recording that I’d like to just bring up again about GDP numbers in the US, and how they’re not adjusted for inflation. And in reality, it’s much worse than it looks, isn’t it?
KARL DENNINGER: Absolutely. The reality, if you graph this—I put this chart up every quarter when the Fed Z.1 and the GDP numbers come out, because the Z.1 is the canonical listing of all of the flows of funds that the Federal Reserve monitors. They keep an enormous amount of data. Their data cycles all the way back to 1953, so it’s extremely complete, and allows you to look at the trend in things over very long periods of time, which is really nice, if you’re doing analysis. But when you look at that, you plug all this stuff in, drop it into Excel and start running some charts on it—what you find is that from 1980 until 2008, there was not one three-month period where our output—our GDP—increased faster than the debt in the system did. And in fact, at the height of the bubble, just before it blew up in 2007, we put $6 of credit into the system for every dollar of output that we added. Now when you think about that, that’s particularly insane. Because what that is is all rollover, and the reason it’s all rollover is because every dollar that you borrow, you spend on something immediately. So, it’s counted in GDP. Alright? So if I’m borrowing five more dollars than I am producing, then in fact, what I’m doing is just rolling over old debt furiously to try to keep somebody from calling the loan and me going out of business.
JASON HARTMAN: Oh, yeah. It’s kiting, basically.
KARL DENNINGER: Yeah. It’s essentially check kiting on a grand scale. And yet this is what we did for 30 years. And we never paid the bill. Then, in ’08 and ’09, we got the bill. And boy did it stink. And now we’re back to doing it again.
JASON HARTMAN: History repeats itself, my friend. It’s just mind-boggling. It’s just mind-boggling. Well hey, Karl, very interesting and lively discussion. Give out your websites, if you would. I mean, www.market-ticker.org, where you do a commentary on the capital markets, but tell people where they can get your book, or any other resources you’d like to give out.
KARL DENNINGER: Yeah, the book’s called Leverage: How Cheap Money Will Destroy The World. Amazon, and all the other usual suspects have it. There’s a link to it on my webpage, on www.market-ticker.org. if you click there it’ll take you over to the publisher’s page, and you can pick where you want to get it from. It goes to all the common online places. So, just not to be discriminatory for or against one particular company. And then there’s going to be a new offering coming in the next few months, so if you keep your eye on the ticker, you’ll see an announcement on it.
JASON HARTMAN: Okay. You want to give us any clue? You can’t just leave us with that. You gotta give us a clue!
KARL DENNINGER: I have something in the pipe, but unfortunately it’s not announced yet. It won’t be for another couple of months. There’s some software and systems work that has to be done before it’s ready. But it is related to analysis in the markets.
JASON HARTMAN: Good stuff. Well hey, Karl, thanks for joining us again today. We’d love to have you back on the show for a third time in the future, and call us any time something comes up. And maybe we ought to bet ten bucks and see which outcome—well, that ten bucks won’t be worth anything by then. But—
KARL DENNINGER: I think a steak dinner! I mean, a steak is always gonna be a steak, right?
JASON HARTMAN: That’s true! That’s why commodities, and things that have real value, other than currency—let’s bet the steak dinner. Absolutely.
KARL DENNINGER: I can always eat the steak, that’s right.
JASON HARTMAN: Fantastic, you’re absolutely right. Alright, well Karl, thanks so much for joining us today.
KARL DENNINGER: Thank you.
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ANNOUNCER: This show is produced by the Hartman Media Company. All rights reserved. For distribution or publication rights and media interviews, please visit www.HartmanMedia.com, or email [email protected]. Nothing on this show should be considered specific personal or professional advice. Please consult an appropriate tax, legal, real estate, or business professional for any individualized advice. Opinions of guests are their own, and the host is acting on behalf of Empowered Investor, LLC. exclusively.
Transcribed by David
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