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Devaluation – The Other Alternative
Monday, July 06, 2009
There was an interesting article that was published in the Wall Street Journal a while back. In summary, the article argued that the reason why homes go into foreclosure is because of either a lack of initial equity upon purchase or existing equity that has been wiped out as a result of home price reductions. This was an interesting article in that it raised one of the core reasons for the current economy recession and situation. As houses continue to lose value the equity that is locked up within that property slowly dissolves. This has two effects on the economy. The first effect is the foreclosure effect. When homeowners achieve negative equity, they lose a key motivator and reason for continuing to make mortgage payments. Correspondingly, banks end up receiving more and more “jingle mail” (Keys the property surrendered by mail) arriving at their offices.
The second impact to this situation is one that is more insidious. This is the dramatic consumer pullback in spending, otherwise known as de-leveraging. They do this out of fear and in the attempt to pay off any debt before it can consume them.
How could the country quickly pick itself up against such a backdrop of continuously eroding home prices? There are many ways that have been attempted today to mitigate the situation. The government has tried to guarantee loan losses. They have forced the banks to modify loans. They have tried to keep homeowners that are in default on their loans in their homes. They have provided money for first-time home buyers and much more. And yet, all these activities have produced nothing more than a more gradual price decline in property values.
Currently, there is some optimism that the home market has begun to level off, in terms of price decline. It is this author's opinion that that these numbers are negatively skewed and that this optimism is not warranted. When comparing home price declines, these declines are compared against the previous month as well as the previous year. It is true that the rate of decline for homes has decreased over the last 30 to 60 days. However when put in the greater context of absolute home price declines, there still is continued erosion.
As jobs continue to be lost, consumers will continue to retrench. The more consumers that lose their jobs, the more foreclosures that will inevitably come. This will continue the vicious cycle of price decline, consumer pullback in spending, more job losses and more foreclosures. What if there was an alternative?
What if, in one fell stroke, the government was able to quickly reverse the situation? One possible scenario is currency devaluation. If the US government devalued their currency at the same percentage they did during the Great Depression (roughly 30 to 35%), that would immediately put a floor under prices of most hard assets, homes included.
No longer would people be willing to sell their home at the low rates that they currently are at now. Immediately everyone would get 30 to 35% more equity in their homes. The government would benefit by being able to devalue their debt. Those people that would lose would be the creditors, people who save money in dollar denominated accounts, as well as the banks and other sovereign entities. Politically, it is probably not possible to perform devaluation, as other countries would end up doing the devaluations as well.
However the government has also been unwilling to reduce deficit spending. As a result, they may be forced to go into default at some point in the future or devalue the currency; just as other third world countries have done the past century. Either way, the situation, as it stands, is not sustainable.
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