Economy

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: Implications of a Collapsing Japan

Back in March of 2011, when the Fukushima situation was just unfolding, one scenario that had me concerned was this one:

For decades, the world has been running its own nuclear-style reaction, only in the currency and debt markets, where exponentially-accelerating piles of debt and money have spun about faster and faster in a gigantic, complex, coordinated reaction, the core of which is, and always has been, the United States.

At the very center of this ungainly money reactor is the main fuel pile itself, the US Treasury market. With any interruption to smooth flow of money through this pile, it will immediately become unstable.

The threat I see goes like this:

Stage 1:  The world watches, riveted, as Japan suffers a tragic and horrible earthquake and tsunami, but as horrifying as these are, they are localized phenomenon affecting a relatively small percentage of the country. The real trouble lurks within damaged nuclear plants, which are now ruined and will never again produce electricity for Japan, creating instant shortages that will take years to remedy. Worse, a dangerous plume of radioactivity is carried south by winds. Tokyo partially empties and shuts down for all practical purposes.

Stage 2:  The abrupt slowdown of the world’s third largest economy alters the smooth flow of cash around the globe, and even causes reversals of some other long-standing flows. Chaotic eddies emerge in a decades-old pattern of ever-increasing flows of money into and out of the money centers, and various carry-trade and other interest-rate-sensitive strategies blow up. Manufacturing in Japan screeches to a halt, disrupting just-in-time manufacturing strategies both internally and across the globe.

Stage 3:  In order to fund the rebuilding effort, Japan has to buy a lot of items from foreign suppliers at the same time that its exports plunge precipitously. At first Japan simply does not participate in US Treasury auctions, leading to a shortage of buyers. But eventually Japan has to sell some of its vast hoard of US bonds in order to pay for external items needed for its reconstruction. Further, insurance companies, huge holders of US bonds, face stiff liability claims in the wake of the worst natural disaster to hit a heavily industrialized center and are forced to redeem enormous amounts of Treasury paper. US Treasury yields begin to climb.

Stage 4:  Continuing unrest in the MENA region serves to keep oil elevated and local funding needs high, while Europe’s weaker players (the PIIGS) continue to slip under the waves. Money continues to ebb away from the US Treasury market. Forced by circumstance, the Federal Reserve reverses its linguistic course and opens the monetary floodgates once again. There’s nothing like a crisis to justify more money printing, especially to a one-trick pony (the Fed) that only knows how to stamp its hoof on the ‘print’ button.

Stage 5:  An increasingly chaotic monetary and fiscal situation spills over into the derivatives arena, creating a number of financial accidents. Stressed governments find themselves in more of an arguing mood than a pull-together-and-sing-Kumbaya mood, and agreements are hard to come by. Banks begin to fail again, global trade falls off, unrest continues to build, and then it happens – a currency crisis.

Stage 6:  Everything changes. Faster than you think.

Obviously, Tokyo did not get evacuated as the scenario postulated, but given that the piece was penned on March 15^th and posted on March 16^th, just four days after the devastating earthquake, it was a reasonable scenario to consider (especially considering the Japanese government was considering that exact possibility at the very same time). Looking back on that scenario now, it stands up pretty well in all other regards. 

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: Key Insights for Those Buying Real Estate as an Income-Generating Investment

In Part I, we looked at a variety of factors affecting the demand for housing, both resident-occupied homes and rental properties, because demand ultimately establishes valuation and price for both sales and rentals. In Part II, we address the many issues investors have to consider when they buy real estate for income generation (i.e., they become landlords or absentee owners).

As someone who has owned rental property for over 25 years, I have seen the pitfalls and the positives. As with all investments, it’s prudent to go in with eyes wide open and to ask, am I prepared if the future doesn’t unfold as anticipated?

One of our core operating principles around here is that when pressed by circumstances, the authorities will simply change the rules. And by “circumstances” we mean anything that could destroy the markets, or perhaps be just politically convenient, or anything in between.

Examples include the NYSE unilaterally and without precedent breaking trades following the flash crash of 2010, the mysterious inability to enforce the rules in the case of the “missing” MF Global client funds, and the avoidance of any and all criminal action against banks and mortgage companies caught red-handed in falsifying documents. 

To this list, we need to add the recent actions of the European Central Bank (ECB):