Photo: Associated Press
Billionaire hedge-fund manager John Paulson doesn’t talk in public much, but a recent speech at the University Club shed some light on his current thinking.Based on his comments, John Paulson is still (VERY) bullish about gold and real-estate.
Specifically, thanks to the Fed’s incessant money printing, he sees inflation leaping to double-digits by 2012. Because of this, he thinks that gold is headed to $2,400 and that we should each borrow as much money as possible and buy more houses.
On the latter, Forbes’ quotes him as follows:
“If you don’t own a home buy one.”
“If you own one home, buy another one, and if you own two homes buy a third and lend your relatives the money to buy a home.”
Now, we get the gold logic. Every government on earth is frantically printing as much money as possible to stimulate weak economies and drive inflation, which will ease the real burden of the world’s massive debts. If the central banks are successful, the value of paper currency relative to real assets like gold will continue to plummet. And, as with most manias, gold prices will eventually overshoot. So gold prices could double (or better) from here.
We don’t necessarily agree with that thesis, in part because everyone we know agrees that gold will at least double from here–and, in part, because when we turn on the radio we hear advertisements crowing about how gold will at least double from here. Whenever there’s a consensus so widespread that it seems like common sense, our alarm bells start ringing, and they’re clanging frantically right now.
But the house logic we don’t get.
Yes, houses are real assets. Yes, over the long haul, in the case of hyper-inflation, houses will act as a hedge against that hyper-inflation. Yes, over the long haul, houses will preserve some of the purchasing power that people might lose if they just stuffed cash under their mattresses.
But in the intermediate term, if we DO get hyper-inflation (which, right now, there’s no sign of), house prices will likely BADLY lag that rate of inflation.
In part for the same reason that house prices are in the tank now:
- Consumers are strapped
- Credit (mortgages) is harder to get than it used to be
And, in part, because, if inflation DOES accelerate, mortgages will become a LOT more expensive.
Right now, money is basically free. Long-term mortgage rates are in the ~5% range–unheard-of pricing relative to a few years ago. If inflation surges to double-digits, however, as Paulson thinks it will, bond prices will tank, because bond investors will fear losing their shirts. Interest rates, meanwhile, on the other end of the bond price see-saw, will go through the roof, to compensate bond investors for the value they’ll be losing to inflation.
If inflation surges to double-digits, mortgage rates will rise to at least 12%-15% a year, up from ~5% now. That surge will DRASTICALLY reduce the price per house that the average buyer can afford to pay, because it will jack up monthly mortgage payments. It is this effect, in fact, that the Fed is trying so hard to avoid, by buying up $1.5 trilling worth of mortgage bonds.
Now, EVENTUALLY, after inflation has run at double-digits for years, and house prices have adjusted to this new reality by dropping in real terms (after inflation), house prices will begin to pass through the inflation and serve as a hedge. But not until house buyers have gotten creamed by skyrocketing mortgage rates.
But houses will be a better hedge against inflation than cash stuffed under the mattress, right?
Yes–than cash stuffed under the mattress, which earns no interest whatsoever.
But not cash stuffed in a money-market account.
If inflation surges to double-digits, interest on money-market savings accounts will leap to double-digits, too (unless the Fed surrenders completely and stands by as the country’s savers get demolished by inflation). These accounts will therefore be earning a good nominal rate of return in the hyper-inflation years, one that might compare very favourably to that of real house prices.
So we wish John Paulson would explain his thinking on house prices. Because we don’t get it.
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