Monday, March 31, 2008


The good folk at Strafor appreciate that the latest fight and cessation of fighting in Iraq were two steps forward in the Iraq-Iran situation. The attitudes and actions of Iran are no longer the key factor in stabilizing Iraq. The American people do not understand the nuances of progress. It is easy to read that 4,000 American soldiers have died and to conclude that the war is a mistake. Over the weekend, a couple of republican anti-war politicos from Pennsylvania threw there support to Obama. No one knows if the improving situation in Iraq will determine the outcome of the US elections because more and more folk have developed a tin ear. Still, family safety and security is the deep seated desire of all Americans.


A couple of thousand years ago, the population of the city of Rome was roughly equal to the current population of Dallas Texas. The people of Rome lived on only 2% as much land (per cafe hayek web site). The two main reasons for the difference are security and transportation costs. The cities of old were densely populated because the people generally congregated behind walls or in close proximity to one another because they wanted to be safe. Many a city was populated by farmers who slept in the city at night but went out to the fields and vineyards by day. Before 911, the threat of attack from "outside the walls" had seemingly disappeared. The threat Americans have felt is the threat of harm from thugs and criminals. Moving to the suburbs has been the way to provide safety for ones family. Until congestion problems arose, the automobile provided the inexpensive means for the migration to the suburbs.

Julius Caesar was the first to tackle the problem of traffic congestion. Because Rome was so densely populated, Caesar passed laws similar to today's big city traffic laws. Carts were not permitted on the streets during certain hours of the day. Those who live 20 miles out of Dallas today can get to the Mavericks game in about the same amount of time that it took the citizen of Rome to get to the "games" at the Colosseum.

The government of Iraq, has started to demonstrate that it can and will provide security for its people. The government's actions of the past week demonstrated that the government is "in charge". The Iraqi elections scheduled in October are now all the more important. Iraqi militia groups need to work the ballot box to influence the direction the country will take. A successful election in October will be another step forward for the people of Iraq and it should take some of the steam out of the anti-war movement in America. The important question will be, "Is the world a safer place because a democracy has taken hold in the Middle East?". The most radical people of the Islam faith despise the concept of democracy and one of the aims of their "holy war" is to prevent democracy from taking place. People have been killed for voting! When the people of northern Iraq got a taste of the extremes imposed by the radicals, the people switched sides. In the past week, the people of southern Iraq have been faced with a similar problem. They have had to decide if they want to continue the insurgency and face bullets being fired at them from their fellow countrymen or do they want to "fight at the ballot box". It appears that the ballot box is winning!


A key reason Americans moved to the suburbs was lower transportation costs. The total transportation costs were lowered again when many businesses moved from center cities to the suburbs. Total transportation costs have soared in recent years but much of this increase has been the "congestion costs". The total cost of the commuting time wasted is in many cases higher than the cost of the actual transportation. Here again, attitudes are changing and the results are starting to show up in the marketplace. When one person decides to "catch the bus", the next person is behind one less vehicle on his way to work. The cost of transportation goes down for the bus rider and for the car driver who makes it to work in less time.

Total US oil product demand in the last 4 weeks was at the lowest level seen in 4 years. Some of this is a result of the economic slow down and some is the result of changes that will not be undone when the economy rebounds. The fellow who buys a high mileage vehicle will not trade it in as soon as the price of fuel declines a little. The person who moves to be close to schools and offices has made a commitment to lower his use of fuel.


The people at GaveKal research are among the smartest people around. Here are the words of Anatole Kaletsky written three weeks ago: "It feels to me that we are very near the point of total capitulation. ...friends and clients...seem to think the depression thesis is an established fact.... Meanwhile, the US figures still indicate nothing worse than a normal mid-cycle slowdown."

Anatole went on to discuss real estate prices: "It seems to me that US real estate prices are at most 5 to 10% away from a long-term bottom. In fact, a strong argument can be made that ... house prices in many parts of America have already hit unsustainable lows. seems to me that the risks are mostly on the upside."


Many a city, including ancient Rome and modern day San Francisco practiced policies that irrationally drove up real estate prices for the benefit of the "establishment". In America, it has become quite common for cities to manipulate real estate price through zoning restrictions. Forcing large tracks to become green space, pushes the value of existing properties up. The big drop in real estate prices, as reported by the Case-Schiller Index, is partly a function of including cities in the index where zoning games have been played. When politicians artificially drive markets, markets ultimately find the way around the politicians. The unwinding of silly games is often painful.

The story in the "heartland" is different than the story of coastal, resort and "protected" cities. In the past year, Zillow reports that the average home in America fell by 3%, but, again, the average was hit hard by the steep drops in the aforementioned markets. In North Carolina, a state that saw significant declines in home values at beach and mountain resorts, home prices rose 4.5% during the past year. Over five years, the average home in America appreciated 40%; 110% over 10 years. In North Carolina, the five year appreciation was 31% and the 10 year was 68%. The bottom line is that high beta real estate plays perform like high beta stocks and the "news focus" is on the most volatile of markets. The result is a misleading story by the media and the opportunity for politicians to make speeches and to enact laws to "fix the big problems". The opportunity for investors is to make money off the false information.

Price maps of the whole country show that much of America saw increases in home values last year. Now, with mortgage rates at the levels seen during the boom days of 2004 and 2005, homes are more affordable than they have been in a long time. The affordability index has risen from 100 to 135 in just a couple of years. Yes, there are a lot of homes on the market, but, building has slowed and the months supply on the market will drop rapidly as the sales rate picks up.


The timing of the helicopter money drop has been coordinated with the timing of the interest rate push. In the weeks ahead, families will find themselves with a few extra dollars from rebates, on top of a few extra dollars from mortgage resets and on top of a few extra dollars from wage hikes. The spending of the first few will stimulate the spending of the next few and it will not take long for service workers, such as real estate agents, to "catch the wave". Two steps forward in Iraq-Iran, accompanied by two steps forward in the economy will give Americans and incumbent politicians hope. Investors should keep in mind the example of the last real estate down turn. The yield curve inverted in 1989, the recession hit by late 1990 -- just at the start of the next big move in the stock market.