What is inflation?

Inflation means the increase in the supply of fiat currency caused by the central bank printing (counterfeiting) currency to buy bonds, thus reducing the yield (effective interest rate) and increasing the bond price. Reducing interest rates reduces the Capitalization Rates for assets that are financed by debt, mainly commercial income property. Reducing the CAP rate increases the Capitalized Property Value (CPV), thus hiding the insolvency of the central banking system. If CAP rates were to increase, then the CPV would decrease, thus triggering a technical default on the commercial mortgage loans that exceed their Loan to Value ratio limits. Lenders would be forced to “extend and pretend” that the mortgage was not in default, causing a chain reaction throughout the financial system. Lenders positioned themselves somewhere within the tranche chain through debt re-hypothecation and cannot meet their redemption obligations, causing a domino collapse. This is what happened in the 2008 crisis. The US Dodd/Frank legislation focused on the symptoms (increasing risk by reducing qualification for the borrower and the property), instead of the underlying cause (the inherent flaw in central banking with fiat currency).

Inflating the currency supply dilutes the purchasing power of the currency, thus increasing the prices. The real concern is the insolvency of the central banking system caused by the same mechanisms that caused the 2008 crisis. Central banks cannot afford to allow interest rates to float according to the free market demand, or else the system will collapse again due to deflation of asset values caused by rising interest rates.

When real money (backed by gold and silver) was replaced with fiat currency (backed by nothing), the “store of value” was lost. Currency is now merely “distilled work”. Printing fiat currency without the investment of productive work in the general economy is counterfeiting, which is theft. That’s why governments outlaw counterfeiting, except for themselves. Gods and governments hate competition.

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Fractional Reserve System versus Central Banking System

There is a world of difference between the “fractional reserve system” (FRS) and the “central banking system” (CBS).

FRS merely spreads out the money deposits in the form of loans, and the total sum of deposits plus debt never changes. FRS is a kind of “leverage” on the deposit of money that strongly depends on the debt not defaulting. A default causes a cascade effect, like breaking a link in a chain.

For example, depositing 100kg of gold coins into FRS will spread out those coins (assuming unlimited divisibility) across derivative debt instruments, but the total money in the system remains at 100kg. Only the “name tags” of who currently controls that real money will change.

Prices will change according to the supply and demand of products and services according to the real money supply. The real money supply grows slowly due to the intrinsic nature of real money. Gold and silver must be mined from the earth or salvaged from waste products, and then introduced into the economy by purchasing products or services. The real money supply gradually increases, which may increase pricing pressure, but can be offset by growing the economy with more competition.

More products and services offered in the economy will put downward pressure on prices, because there is a fixed amount of money to distribute across an increasing supply of product and services. Price reduction is *not* a recession; it is a response to an increase in supply and not necessarily a decrease in demand.

CBS, on the other hand, prints currency out of thin air to match new debt (bonds, mortgages, credit cards, signature lines of credit, etc.). Currency is not money. Currency is “distilled work”, which is why printing currency is the same as counterfeiting.

Printing currency (without a commensurate amount of “work” added to the economy) causes inflation of the currency supply relative to the wealth of society, which devalues the existing currency and causes price inflation. Redeeming debt will erase that currency from the supply, which revalues the surviving currency, causing price deflation. Price reduction in a CBS economy *is* indicative of a recession, and is a serious threat to the stability of the CBS, because CBS relies on the price inflation of collateral.

When FRS is corrupted with counterfeiting fiat currency from CBS, the perfect storm is ready for a cascading domino effect when large defaults happen. Defaults in CBS are inevitable, because of the need to print more currency to lend out to cover the interest on the prior round of printing. The interest compounds exponentially until default. Then the collateral is confiscated, which is the whole point of implementing CBS. It is an insidious form of wealth confiscation.

An interesting video about the NYSE halt and the related effect on the silver market:

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My thoughts on Bitcoin and cryptocurrencies

Bitcoin (BTC) has been hacked several times, mostly for “proof of concept” and not for nefarious intent. The algorithms for creating new BTC are now so difficult to compute that most BTC farmers are out of that business. The processing power to break the global BTC ciphering ledger is well within the reach of organized groups of hackers.

All currencies are representations of “distilled work”. Counterfeiting (e.g., Quantitative Easing) produces currency with no beneficial distilled work product, which is why it’s illegal. BTC is currency produced by computer algorithms, which has no beneficial distilled work product. BTC has zero intrinsic value, only what a greater fool will pay for it in goods, services, or cash (i.e., government backed currency).

Exchanges, like BTC and Nasdaq and NYSE, set prices not by the intrinsic value of the cryptocurrency or the shares of stock, but rather by setting the “bid” and “ask” prices to produce a net profit for the exchange while balancing the demand versus supply. It is just like setting the odds line for sports betting. High demand increases the bid price to attract more supply. High supply decreases the ask price to attract more demand. The spread between bid and ask is the profit for the exchange, which earns profit regardless of which way the price moves.

When you buy stock, it’s because you think it will increase. However, you are buying it from someone selling that stock, because he thinks it will decrease. Very rarely will you have an opportunity to buy from or sell to the company that issued the stock. Your purchase of stock will not directly benefit that company.

This is why a “penny stock” company called CYNK Technology stock price skyrocketed to a market valuation over $1.5B for a company with zero revenues, zero capital, zero assets and a business model that cannot produce revenues due to existing more cost effective competition. It was all about computer algorithmic balancing of the demand versus the supply, and had nothing to do with the intrinsic value of the stock. The SEC had to step in and halt the stock. A free market would not allow a government entity to halt or manipulate trading in anything, but “exchanges” are designed to control the markets for the benefit of the government.

BTC and other crypto currency exchanges suffer from the same inherent design flaw. It’s all about creating a profit spread between the “bid” and “ask” prices while balancing the demand versus the supply. It has nothing to do with intrinsic value of the crypto currency, which is always zero.

This is why I recommend investing in real assets like, gold, silver, and income producing real estate. These are called “hard assets” precisely because of their identifiable, well recognized intrinsic values.

Income property produces sustainable cash flow, with proper management. That cash flow can be assigned a yield relative to the cost of investment, called the “Capitalization Rate” or the “Return on Equity” (also called the “Cash on Cash Return”) for leveraged investments. Income property is responsive to inflationary pressure on expenses, and a conservative debt coverage ratio can respond to deflationary pressure on rents without defaulting on debt. Income property can be leveraged through multiple financing tranches, which distributes risk versus reward relative to the tranche yields on investment.

If you are interested in learning more about the benefits of investing in income producing real estate without the management headaches, contact me on my support page.

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Discounted Present Value of Social Security Benefits

I just heard yet another “personal finance expert” offering some stupid advice on Social Security benefits. Social Security benefits generally become entitled at age 62. If the beneficiary defers receiving benefits for a few years, then higher monthly benefits are entitled. The so-called expert recommended NOT to elect to receive benefits at age 62, and to wait until age 67 or 70 in order to receive a higher monthly benefit.

That advice is stupid, because it ignores the Time Value of Money, as well as requiring the person to continue working up to age 70 at a job that may not be there.

Here is how to calculate the value of those varying benefit schedules. Suppose the monthly benefit at (1) age 62 is $1200, at (2) age 67 is $1700, and at (3) age 70 is $2260. Also, suppose that regardless of when benefits begin, the recipient will die at age 80 and the cash flow stops.

(1) The total payment stream at age 62 to age 80 is $259,200=216×$1200.

(2) The total payment stream at age 67 to age 80 is $265,200=156×$1700.

(3) The total payment stream at age 70 to age 80 is $271,200=120×$2260.

This is where most “financial experts” stop and point to option (3) as the “most money”. That’s where they are wrong.

A cash flow stream has a discounted present value relative to a discount rate. Also, each cash flow stream starts at a different time. Therefore, to calculate the correct choice, a discount rate must be applied to calculate the discounted present value at the point when the stream starts and then applied again to calculate the discounted present value at age 62. This is how to compare apples to apples.

Choose a discount rate of, say, 6% to represent the average inflation rate over the entire time period from age 62 to age 80. Then discount each of the cash flow streams to present value at age 62:

(1) The age 62 to age 80 stream discounts at 6% to a present value of $158,277.

(2a) The age 67 to age 80 stream discounts at 6% to a present value of $183,839.

(2b) Now discount the $183,839 at 6% from age 67 back to age 62 at $0 per month to $136,293. The present value $183,839 won’t exist until 60 months in the future relative to age 62, so it must be discounted twice.

(3a) The age 70 to age 80 stream discounts at 6% to a present value of $203,566.

(3b) Now discount the $203,566 at 6% from age 70 back to age 62 at $0 per month to $126,114. The present value $203,566 won’t exist until 96 months in the future relative to age 62, so it must be discounted twice.

Therefore, the true discounted present value at age 62 of the 3 choices are:

(1) $158,277 for 216 monthly payments of $1200 starting at age 62.

(2) $136,293 for 156 monthly payments of $1700 deferred 60 months after age 62.

(3) $126,114 for 120 monthly payments of $2260 deferred 96 months after age 62.

Clearly, choice (1) offers the largest discounted present value of the 3 cash flow streams. You can write a simple spreadsheet to perform the double discount calculation to experiment with different discount rates and timeframes. You will find the cash received sooner is more valuable than cash received later. That is a fundamental principle of the Time Value of Money (TVM).

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Only Cash Flow Matters

2014 Q1 is almost over. The lamestream media says everything is rosy (yeah, right). The problem with a cliff, even a demographic cliff, is that it is such a sharp drop-off that most folks can’t see the cliff until they are teetering the brink, especially when they are moving fast and thinking about something else.

Two realty brokerage firms in Las Vegas NV (ground zero of 2008 crash) are contradicting each other. One says there is a major downturn coming this year (wait a few months to buy when prices are lower), and the other says buy now before prices skyrocket. Who shall we believe?

The triggers for crashing real estate are: (1) Lack of debt financing and (2) lack of cash flow to service debt. The 2008 crash was caused by #1 when Wall St ran out of Other People’s Money (OPM), and then it was “solved” by the FED buying toxic mortgages with money printed out of thin air. #2 will happen when a sudden shift in demographics causes job losses and a sharp reduction in spendable income. The FED cannot “solve” that problem.

How much debt the FED buys won’t matter when there is insufficient spendable income to service that debt. Any financial calculator will show how Present Value (PV) and periodic payment (PMT) vary proportionately for a certain periodic interest (RATE). The PV and RATE vary inversely for a certain PMT (when RATE goes up the PV goes down). The FED can set rates to zero to try to prop up PV (to hide bank insolvency), but when PMT goes down, the PV must also go down.

Everything else in the economy depends on real estate. Real estate depends on debt financing. Debt financing depends on cash flow. Without cash flow (PMT) to service debt, the PV of real estate crashes.

Look for a sharp decline in private sector employment income due to job losses and wage reductions. Strangely, increasing the minimum wage will hasten the collapse due to losing jobs when the government mandates higher wages (and ACA taxes on health insurance). Fewer people in the private sector who are earning less money and paying higher taxes will have much less spendable income to service debt. Less debt service (PMT) means lower PV, which means real estate prices collapse. Whether the real estate is owner occupied or renter occupied, residential or commercial, it doesn’t matter. Only cash flow matters.

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Crisis Investing in Real Estate

Booms and busts always happen. You can’t defy the Law of Gravity. What goes up must come down. Today, the real estate market is a Sellers’ Market in most areas. Most average folks view real estate investing as speculating in price appreciation. The real objective of real estate investing is passive positive cash flow.

The next crash will have awesome opportunities to pick up foreclosed properties at “bargain basement” prices, even lower than the 2008 crash. However, your strategy must have a tight focus:

  1. Buy distressed income properties, fix it up, then rent out for long term positive cash flow with at least a Debt Coverage Ratio of 1.50, and refinance when possible to fixed rate, fully amortizing, long term debt.
  2. Flip the property “as is” to another investor for a cash assignment fee. This is “deedless transacting” and it provides the least risk and the highest yield on your invested cash.

Anything else will leave you without a chair when the music stops. Don’t get caught holding title to a property that won’t pay for itself with a positive cash flow or that you cannot sell for a conservative profit.

When is the next crash coming? My “Crystal Ball” is in the shop for repairs, so I cannot predict with certainty 🙂 . However, my “informed guess” is between 2014 to 2019, and probably much sooner rather than later. The crash will be unexpected and the Federal Reserve won’t have a clue (again) that it’s happening until the extreme damage is done. The rapid price inflation that led up to the 2008 crash won’t be as obvious the next time.

When the crash happens, serious deflation will drive down commodity prices, real estate prices, bond prices, and stock prices. You can hedge by buying investment grade gold and silver, using “dollar cost averaging” as the price declines. Remember, you’re not investing for price appreciation at this time. It’s all about storing “purchasing power” for when the real inflation strikes hard. Take physical delivery of your gold and silver bullion (American Eagle coins are my favorite) to provide a cushion, but don’t sell until very strong price inflation can offset your capital gains tax and the net profit will substantially pay down your debt. Avoid Exchange Traded Funds (ETF) for gold and silver. Paper gold and silver doesn’t exist. You must have physical possession of it, or the counterparty risk will destroy your investment.

The Federal Reserve only has a “hammer” in its toolbox, so every problem looks like a “nail”. Frantic monetary stimulus (printing digital counterfeit currency) to avoid deflation will eventually force strong inflation and probably hyperinflation. Time the inflation by watching the price of your gold and silver. When you have enough locked-in profit to cover your capital gains tax and to pay off your debt on your income property, that’s when you can sell. Your passive income and net worth will dramatically rise with “free and clear” real estate.

When the market price of your income real estate crashes, you’ll be very glad that you had the foresight to ensure a strong debt coverage ratio to tolerate recessionary pressure on income and expense. You’ll be in a strong financial position with positive cash flow to pick up awesome deals on good real estate, because everyone else will be in “panic mode” trying to raise cash by selling.

Learn more with my real estate investment courses.

Introduction to Income Valuation and Syndication

Property Analysis Worksheet

How to Pyramid Your Equity to Create Wealth and Financial Freedom

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Preparing for another economic crisis

Housing prices will collapse with a nominal increase in interest rates. Get your financial calculator: N=360 (30 years), Rate=4% per year, PV=100,000, PMT=477.52, FV=0. Those are the numbers for a $100,000 mortgage debt at 4% per year, fully amortizing over 30 years. Change the interest to Rate=6% and recalculate PV=79,628.87. That’s 20.4% decline for the amount of debt that the monthly payment can support. That translates directly to a loss of 20% in the property value, which *just happens* to equal the down payment required by the Banksters. When folks lose all of their equity, they will walk away from their devalued houses, the government will step in and take ownership through the Federal Reserve printing counterfeit currency to buy the bad mortgage notes.

Just a few years ago, a 6% interest rate was considered a very good rate. Artificially driving down rates below 4% caused prices to inflate. When the rates reset to “market rates”, the real estate market, especially commercial, will collapse and banks will fail and merge with larger banks.

You can prepare for this by calculating what the rental property can afford to pay when servicing debt at 8% with a debt coverage ratio of at least 1.5 to tolerate recessionary pressure on income and expenses. Don’t pay more than what the property can afford with those numbers.

With a portfolio of positive cash flow income properties, you’ll have some protection from the next great depression. Acquire rental income properties in “rental communities” with long-term fixed rate financing with the lowest possible down payment and the highest possible debt coverage ratio. You will repay the debt with debased dollars from your tenants (stay away from rent control areas, low income housing, and socialist governments).

See my YouTube channel for more information about real estate finance.

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Buy or Refinance Now

The valuation of income properties is directly tied to the cost and structure of financing. Real estate is a “borrowed money” business. As interest rates rise, the capitalization rate required to service the debt for a purchase or refinance also rises, and thus the valuation falls. As the valuation falls, existing debt Loan to Value (LTV) ratio exceeds the agreed maximum for commercial lenders, thus forcing a “margin call” on commercial debt that borrowers cannot pay, causing a technical default. Then the tide flows out and everyone sees who has been swimming naked. Commercial banks will crater and the FED will desperately try to print more counterfeit money at the expense of the tax payer to buy the bad debt.

Class C “Bread and Butter” apartments with high debt coverage ratio (DCR>1.5) can tolerate recessionary pressure on income and expense, but avoid Section 8 and Low Income Housing Tax Credit (LIHTC). Also try to refinance or buy now with FHA fixed rate with no balloon, amortized 25 years or longer and no prepayment penalty. You will be able to pay off the debt with debased “Bernanke Bucks”.

Learn how to buy apartments with Other People’s Money (OPM) with my course “Introduction to Income Valuation and Syndication” (click here).

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The Equity Waterfall for a Syndicator

I just wrote an article about my preferred structure for structuring the equity financing with senior equity, preferred equity, and common equity.

A syndicator that raises private equity may consider an equity waterfall that is similar to a combination of debt and equity. Treat the senior equity like a 1st lien and the preferred equity like a 2nd lien, with a debt-like structure with a fixed annual rate, amortization term, and rolled-in points. An amortization schedule shows…

You can read the article by clicking here.

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Guru Interest Rates

I am often astonished at the real estate “Guru” who charge outrageous (unpublished) interest rates for their products. As if their astronomical pricing isn’t bad enough, they offer time payment plans that are nothing short of usurious, making high credit card interest rates seem reasonable in comparison.

I recently sat through a yet another long-winded video pitch for an over priced product. At the end of the pitch (interspersed with assertions of the “good life” with easy riches), the price tag came in at $497 for a single payment, or three monthly payments of $175. You can choose to pay on your credit card $497 now, or three payments of $175 totaling $525. That seems reasonable, right? A $28 finance charge for the convenience of spreading out your payments doesn’t seem so bad, when you consider it’s a $497 product. Yeah, right!

First, why would you need to spread out the payments when buying on a credit card? Most credit cards allow paying off a purchase over time. Is your credit card maxed out? Then why are you buying yet another guru product when you can’t even manage your own personal finances?

Next, what is the effective annual interest rate on that time payment purchase? Three payments of $175 with the first payment now, leaves $322=$497-$175 to pay over the next 2 months. Get out your financial calculator, plug in 2 payments, Present Value $322, periodic payment -$175, Future Value zero, and solve for the interest rate. That comes to 68.92% annual interest rate! You would be better off just paying the full price and paying off your credit card at a 20% annual interest rate (less than one-third of the guru interest rate).

The guru is preying on financially illiterate folks who are desperate for a solution to their money problems. (Hint: They have money problems precisely because they are financially illiterate!) This is one of the ways that I filter out the greedy online marketers. Is their price reasonable considering the amount of real content versus puffery? Are they truly committed to their customer’s success? Or are they just trying to squeeze out every last penny from anyone desperate, foolish or naïve enough to fall for their latest pitch of easy riches?

If you are truly focused on getting out of personal debt, then take a look at my Excel 2007 spreadsheet Power Debt Plan by clicking here.

What if you are so broke that you can’t afford Microsoft Excel 2007? Just buy a $7 thumb drive (also called a “Flash Drive”) at Best Buy or Staples to hold your computer files, go to a public library and plug into one of their computers that already has Microsoft Office 2007 or later. Buy my product, download it and save it on your thumb drive. Then run the numbers on the public computer. I show you how to do it with several mp4 video tutorials. You can download a free mp4 video player for your Windows or MAC computer from QuickTime.com.

Financial literacy is the key to financial freedom. Take the first step by understanding what your personal debt is really costing you, then make a plan to get out of your personal debt by clicking here.

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