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Asset Matrix Inflation versus Deflation

Jason Hartman



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Jason Hartman takes us to a recent investment seminar that discusses the topic of investing in income property during an inflationary period. Housing inventory continues to be an issue as more people are buying as the January sales point out. Looking at the Trump administration, Jason reflects on inflation as it relates to the general population and the type of inflation that the IRS doesn’t take into account. 

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Welcome to the Solomon success show, where we explore the timeless wisdom of King Solomon and the Bible, as it relates to business and investing false prophets and get rich quick schemes are everywhere. Let’s not be distracted by these. Instead, let’s go to the source, the eternal principles that create a life of peace, power and prosperity. Here’s our host, Jason Hartman.

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One of the things I talked about at a meet the Masters event several years ago is I talked about the asset matrix strength of various investments in different economic scenarios. And so here we’re just covering inflation, deflation and taxes, not stagnation, but as you can imagine, of course, staggering is somewhere in the middle, right? So this is an interesting matrix because when you talk to the inflation people, and we know that income property as the most historically proven asset class in the world is fantastic in a deflation in an inflationary scenario, it’s a home run, right? But you’ll talk to other people who are, you know, big Federal Reserve conspiracy type people and so forth. And they’ll say, Well, you’ve got to own gold. The gold bugs will definitely say own gold, own precious metals. But I say gold because it’s a one dimensional asset class is very, very inefficient. And it has no tax benefits. Of course, it has no cash flow, and so on and so forth. All the stuff you hear me talk about on the podcast, but your mortgage is an asset. Most people consider it just a liability, right but your mortgage is a fantastic asset, because you can take advantage of what we all talk about inflation induced debt destruction, you Inflation induced at destruction. And that means that the mortgage will vastly outperform gold, okay, in the inflationary scenario, but really what you want in any inflationary scenario, of course, is commodities in general, commodities are fantastic. So when you look at an income property, our properties are, of course made of all those ingredients. They’re made of concrete. They’re made of lumber, they’re made of glass, steel, copper wire, petroleum products, all of these great commodities that are traded around the world, and they’re not attached to any one currency. They have universal need. Everybody on earth needs these commodities, because they are in the ingredients of any structure, any house or any any kind of building. So when you look at gold, it’s helpful to just tell a little story that happened to me many years ago. This was back when the gold price was just over $400 and I got a call from this company, a gold dealer in new Port beach who advertises on the radio extensively, and this is when I lived in Orange County, California. And the guy calls me up and he says, Mr. Hartman, you know, you’ve got to invest in gold because the Federal Reserve and Iraq and Iran and all this uncertainty in the world, you know, the gold bugs love gold, because of the doomsday scenario or the inflation scenario, either one, they love it for that reason. So he goes on to say, all of these reasons, you’ve got to have gold in your portfolio. And I said, Okay, okay, stop, stop, stop. you’ve sold me. I will buy a dozen coins from you. A dozen one ounce you know, American Eagle gold coins, and I will send you the money. I’ll just send you a cashier’s check on Monday. You send me the gold. Great. So you’ve sold me Stop pitching me. Now. I go on to explain to him and this is admittedly just to do the Jerry Seinfeld thing and kind of rasm a little bit, you know what he does to telemarketers, right? And I said, so I’m an income property. investor. I love investing in income property. And one of the reasons I love income property is because I can acquire that asset and I can rent it to somebody else. And that produces income for me. Do you know anyone who will rent my gold coins? And of course, he says, No, people don’t do that with gold coins. I said, Okay, fine, fine. I’ll give up the income. But the other thing I love about income property, and the reason I think it’s the most historically proven asset class in the world, is that income property can be financed for three decades with incredibly low, historically low fixed rate mortgages. And it’s debatable, like we were talking about at dinner last night, that that fixed rate mortgage is actually a negative interest rate. In other words, I’m literally borrowing money below the rate of real inflation, not official inflation. Because we know the government manipulates those numbers and understates them, how do they understate them? Well, they understate them with three major techniques weighting substitution, and what hedonic acts the hedonic index, which means the amount of pleasure you get from an item versus what you paid for the item, right? So the way weighting works is they just give more weight to one thing and less weight to another thing, right? And that will change the inflation index. And the way substitution works is they say, Well, if the price of beef goes up, they just think, Well, everybody will just switch to chicken, but maybe you don’t like chicken, you think chickens a dirty bird, right? Which I, by the way, think. So that’s the reason that it’s manipulated just in those two ways. But with hedonic, it even gets more complicated and conceptually, the idea of hedonic adjustments. Remember the root word here is hedonism. Pleasure seeking, right? Is that they, they they have a logical basis but In practice, what it means is that we as people, you, all of us are not entitled to progress. We’re not entitled to progress. So here’s an example, this computer when I bought it, it’s about two years old now cost about 20 $800. And now, I can get a brand new computer that is dramatically better than that one from almost two years ago. And the interesting thing is, if you, you know, buy Apple products, you know that they’re pretty much always the same price. You know, every new iPhone is pretty much the same price as the old one. It’s just better, right? And that’s the same thing that happens. So I’ll pay when I buy a new one, I’ll still pay about 20 $800. I always seem to pay about 20 $800 for a new Mac, right? But they keep getting better and better. So what the hedonic index will do is it will adjust the price and say If the new computer is twice as good as the old one, because what that’s Moore’s Law, right? The speed of the processor every 18 months, doubles. And that’s why we get this massive obsolescence. And that’s why if you follow it all my show the longevity and biohacking show. And you might also follow if you follow that show Ray Kurzweil right. He talks about singularity, this whole idea that humans will basically merge with computers by 2030. And one of his metrics for that is that a, the processing power of a computer would be equivalent to the human brain for $1,000. In today’s dollars, for $1,000, you could buy another human brain, pretty awesome deal, right? We’re not there yet, or they’re not there yet. But imagine what the hedonic adjustments will be then because literally our brains are the most incredible miracle in the universe so far that we know of, right? So in the hedonic adjustment Not to get off on another tangent in the hedonic adjustment. If this, if the new computer is twice as good as the old one, and I still pay 20 $800, the index will assume I only paid 1400 dollars. That’s the hedonic adjustment. But I really didn’t pay 1400 I really did pay 2800. But what I got was twice as good. So you see how that works, the hedonic adjustments. So the mortgage because of inflation induced debt destruction, is the most powerful tool by which to take advantage of the home run of inflation. And I totally get that inflation is relatively low now. And it has been for a couple of years unless you talk about the cost of health care, college tuition and real estate. What’s interesting is that nobody considers inflation to be the they consider to be the what’s called the rental equivalent in the price of a home. But you’d have to live in, right? Because we all need to live somewhere. But they don’t consider the price of becoming an investor. Interestingly, so and I don’t know of anyone that talks about this, but I think it’s legitimately part of the concept of inflation. Because if the s&p and the Dow Jones and the price of investment property is higher than it costs more money to enter the investor class, and we all know that the only way you really get ahead is being part of the investor class, right? Otherwise, you get creamed. If you have a regular w two day job, you are taxed at the highest rate of anybody. And if you rent, and if you don’t own income property, you basically have no real tax deductions. I mean, you can donate money to charity, but you still, unlike the beauty of depreciation, you still have to write a check for that, right? If you have your own business, or you’re an independent contractor, you can spend more money On your business and get a tax deduction for that, but you don’t get to take advantage of the non cash write off for the Phantom write off. So commodities are the typical hedge for the gold bug inflation, mindset people, right? So we here’s the what I call the ultimate investing equation. Basically what we do is we acquire a package of commodities because I call it packaged commodities investing, right? When you buy a single family home or an apartment complex, you’re buying all of these commodities that are traded globally, the copper wire, the glass, the steel, the lumber, the the labor that goes into it, the energy that goes into all of these commodities that have universal need and are traded globally not indexed anyone currency. That’s important, because they have intrinsic value outside of any given currency. All right, so you acquire the commodities. That’s the house and the land is also covered. And then you go to the bank and you say, look, I want to buy these commodities, but I only want to put in a small portion of the money to acquire them. So the bank says, Okay, well, if you’re an investor and you’re going to rent these commodities, they don’t refer to it this way, of course, to somebody else, then we want 20% down. So the bank now gives you 80% of the money. And your leverage ratio is now four to one. Okay, so you’re already four times bigger than you otherwise would be, because the beauty of leverage, right, so so far, that’s the first part the first two steps of the ultimate investing equation, you buy the package commodities already assembled for you, by the way, in the form of a house or an apartment building. You use, you use 80% of somebody else’s money to acquire them. And then you say, Well, look, you know, this Jason Hartman guy tells To me that debt is great when it’s used properly. But I don’t want to pay my own debts that would be really burdensome to pay my own debts. So I’m going to outsource the debt obligation to somebody else. And I’m going to call them a tenant. Okay. And in addition to telling that tenant to pay my debt for me, I’m going to tell them to pay me a little extra every month. And that’s called positive cash flow. Right. So now, think of what we’ve done in the ultimate investing equation. We acquired a package of commodities not indexed to anyone currency that has intrinsic universal need. Every human on Earth needs these commodities, and they have certain scarcity limitations to them, right. And then we use 80% of somebody else’s money. And we get that money at three decade long fixed rate loans. So if we borrow this money today, in 2016, we won’t make The last payment or really our tenants won’t make the last payment on that mortgage until 2046. That is absolutely a spectacular idea. Okay. Because in 2000 byte by the time we go through the next three decades, do you think things will change? Do you think with all the debt The country has, and the unfunded entitlements? The what’s called the when I had Laurence Kotlikoff, the economist on the show twice, he talked about it and called it the 200 and $20 trillion dollar time bomb, trillion with a T, okay, the 200 and $20 trillion time bomb. And with that, I mean, there is no possible way we can pay for this stuff. It’s impossible to pay for it by taxing the rich as all the liberals would say, you know, let’s just tax the rich, the rich don’t have that much money. We can’t possibly tax tax the rich enough to pay for the problem. And if we did I would simply make the economy smaller anyway, right? So that’s impossible. Okay. So where are we in the ultimate investing equation? We bought the commodities we borrowed 80% of the money, we outsource the debt obligation to somebody else. But wait, there’s more as they say on that late night infomercial, right? You get an extra Ginsu knife included, right? Well, it gets better, because then we say, look, the largest expense in any of our lives, are taxes. And if we can eliminate or dramatically reduce the largest expense any of us have in our lives, we can build wealth so much more quickly. And so we go to the government and we say, hey, look, I’m doing exactly what you’re incentivizing me to do. I’m providing rental housing to people. And the real estate world has this giant lobby and this huge amount of special interest and so they give it very favorable treatment, making Get the most tax favored asset class in America. So we want to save money on life single largest expense, the government says okay, we’ll let you depreciate the value of your improvement on the property over 27.5 years. And we went over that yesterday in depth, we talked about real estate professional, we talked about qualifying for that, and how it does phase out and so on and so forth, and how you might be able to get it back if you can qualify as a real estate professional. But let’s say we can’t take advantage of depreciation immediately. And over time the asset appreciates in value like the refi till you die scenario I talked about earlier, or Michelle’s great video talked about really, then we can 1031 exchange that asset and sell it tax deferred. So we get to reinvest all of the money over again into a new asset. And as the cash flow dynamics change as properties appreciate what happens, the rent to value ratios get out of whack right there. rents lag appreciation always. It’s always rents that come up the slowest. And appreciation happens more quickly in the cycles where you have appreciation. So that’s the ultimate investing equation. It’s pretty beautiful. And that’s why we’re all interested in this asset class. But just to finish the gold story, so as I’m heckling, that telemarketer guy that’s selling me the gold, just to finish the gold story, I tell them, Look, I want to rent out the gold. He says, nobody does that. I tell him I want to finance the gold for three decades, it historically low fixed rate interest rates that are arguably below the cost of inflation. And since every gold bug is an inflation bug, he has to believe this right? Because he thinks the hedonic adjustments and the weighting and the substitution adjustments that they make to do the consumer price index are BS. Of course he does. He’s a gold bug, right. And then I say two more look. Another great thing I love about my income properties is they’re very tax favored. Right. So, you know, certainly can i depreciate my gold coins? Huh? What’s that? No, you can’t do that. Well, what about when I sell them? Can I sell them and exchange them for silver coins without paying the gain? And he tells me no gold actually has far inferior tax treatment, because it’s a collectible. And collectibles pay an even higher tax rate. Okay, so it gets even worse, right? So this is not the answer. Look, remember, part of my teaching? Is that anything that and this is worth writing down if you haven’t been to my creating wealth program, right. Anything that does not produce income is not an investment. Anything that does not produce income is not an investment. It’s just a speculation. It’s got to produce income. That’s why instead of calling it real estate, I try to catch myself and call it income property, because there’s a difference. Okay. So the mortgage gets devalued over time with inflation induced at destruction. And we’ve talked about that a lot. So I won’t cover here, the value of the real estate because it’s a commodity is hedged to inflation. But if you look, historically, real estate doesn’t really go up that much in compared to inflation. It sort of tracks it pretty, pretty close. You know, it’s, it’s not that great. If you didn’t have the leverage, the leverage is what makes it phenomenal. But even if you didn’t have any leverage, and you paid cash for it, it’s still much better than really any other asset because it produces the income and the potential tax benefits and certainly not potential, the potential tax benefits or just on depreciation, their real tax benefits when it comes to 1031. Exchange. Okay, so, that’s phenomenal, the best things in the inflationary environment, the strength of the investment versus inflation, gold, but very limited one dimensional asset class, the mortgage and the value of real estate when you split those two components up, very powerful. The income from your job medium strength, hopefully you’ll get cost of living adjustments from your job income. Hopefully your rental income will increase at about the rate of inflation, that’s probably pretty likely. Okay. And then your stocks will hopefully keep pace with inflation. Hopefully you don’t even own stocks after we’ve talked about this because Wall Street is the modern version of organized crime. Okay, so then what has really low strength against inflation? Well, certainly cash, cash gets destroyed by inflation, it gets devalued. Because if you take out and you know, take, take some money out of your wallet, right? And let’s see what we have in here. I’m not much of a cash person, but here I’ve got what is this called? Can you see it from here? $5 It’s called $5. Today, what was it called 100 years ago. Lots of money. That’s good. No, no, it’s one penny now compared to years ago, right? Yeah. Yeah, you, you you I know you understood that loss. But the $5 was called $5 100 years ago, the name has not changed. That’s the difference between nominal dollars in name only. That’s the meaning of nominal versus real dollars, which is the value of the dollars today, right? So cash gets destroyed by inflation. And that’s why they call inflation a pickpocket. Because literally the money in your bank account in your wallet, okay, is constantly being attacked, you’re being pickpocketed because the value of it is being debased by inflation. So it’s terrible. bonds, terrible in inflation, pension income, awful in inflation, because there’s no adjustments to it. Bonds are just alone. Okay, let’s go back to bonds for a second. Bonds are alone. So remember, to take and take advantage of an inflationary environment even if it’s modern. In low if it’s two or 3%, or if it’s 10%, or 13%, or if it’s hyperinflation, and it’s 50, or 100%, which we’ve never seen in the US, we have seen significant inflation from the wonderful policies, former President Jimmy Carter. That’s sarcasm, by the way, just so you know. Probably a very good man but a terrible president. Okay. So bonds are just alone, you’re on the other side of the loan, you’re the lender. So the value of bonds gets massively debased by inflation. Taxes are interesting. The IRS does not account for inflation. And this can work for you or against you. And it can be beautiful or it can be terrible. people that do not have tax advantaged event investments like we do, they are getting destroyed on taxes. But the IRS in the tax code, you can just see it through and through. And, you know, we could go off on a really long tangent, talking About this one, it does not account for inflation. And it’s really good for us as investors but bad for most people. Okay, so let’s look at it versus deflation in a deflationary environment and I’ll make this one a little quicker. Cash actually goes up in value in a deflationary environment. So do bonds, so does pension income. So if your pension income says that, okay, you have this pension and it will pay you $5,000 a month. Well, if you have deflation, that $5,000 is going to become more valuable. So the value of that pension income performed very well and had a lot of strength against deflation. It was wonderful, right? And taxes pretty good because the IRS doesn’t account for inflation, okay. So job income kind of medium because it will usually deflate in a deflationary environment. You’ll have actual pay cuts that It’s no fun, rental income will probably stay about the same or even deflate a little bit in a deflationary environment in less you consider and this is what we don’t necessarily know what I was talking about this morning when I talked about the three dimensions of real estate, right. So that rental income adjust first of all very slowly because most rents are set up on one year releases, right. That’s the first thing to understand. But the second thing to understand is that when the value of the properties deflates, and as long as the population is stable or increasing, people never have incentives to move from the renter pool to the homeowner pool. And therefore rents can actually strengthen in that deflationary environment. And I’ve certainly seen that happen before in my lifetime and my time in the business. I saw it happen not too long ago, actually. Okay. So gold terrible. The mortgage is terrible. Because the value of the debt increases, right, the burden actually becomes higher because you have to pay it back in more valuable dollars. versus what we talked a lot about is inflation induced death destruction, you pay the debt back in less valuable dollars later. The idea being in 2046, the dollar today will still be called $1. But it will be a lot less valuable. So you pay it back and cheaper dollars over time. And that’s a beautiful thing. But in a deflationary environment, the debt becomes more of a burden. It’s worse for you, right? And so this can theoretically crush you. But wait, there’s more. Because what really happens in real life is this in real life, the implicit what I’ll call nuclear option. The backdoor option is that people just default, they strategically default. We saw millions and millions of millions of people Do that on the last cycle. We saw him do it on the cycle before. And guess what? It’s unfair. We all agree it’s philosophically wrong. But it is the way it is. It is reality. The people with the highest loan balances, got all the bailouts. They got all the loan modifications. They walked away. They lived in their house in Florida for sometimes three and a half years and didn’t make a payment. They live there for free. And then the lender came along and said, some in some cases by countrywide be evaded, we will pay you we will literally pay you to do what’s called a cooperative short sale. You don’t have to supply any documents, just put your house on the market and sell it and we’ll pay you between 3000 and get this $32,000. Okay, too, help us sell the house. Because if we take it back, it’s going to class. And remember, that’s just what the contract says. The contract the deal is when someone gets a mortgage is exactly this. Either the borrower will pay the mortgage, or give them the collateral. That’s the deal. That’s what the contract says. So you have those two options. One option is pay the mortgage. And if you decide you don’t want to pay the mortgage, or you can’t pay the mortgage, then give them the property back. That’s what the contract says. Okay? And that’s the way it’s worked for a long, long time. So the mortgage gets more burdensome with the exception. The little asterisk is the nuclear option. All right, the value of real estate becomes lower because in a deflationary environment, those commodities become less expensive, right? I don’t want to say less valuable. You notice I was about to say less valuable, and I caught myself and I said less expensive. in real dollars, okay, so there you have it, the mortgage really moves up into the medium category, I think, maybe even the high category. So that’s kind of the investment matrix. Now what about taxes? Okay, so with taxes, it’s a funny thing, and I don’t have a lot of time to go into the tech stuff, unfortunately, because we’ve got to talk about man property managers versus self management, and do a whole bunch of other things today and, and have Michelle finish out the property tracker segment as well. But the mortgage highly valuable, because it’s tax deductible, right? It’s a beautiful thing, but it’s not nearly as good as depreciation or 1031 exchanges. And there is actually a another tax benefit that I pretty much never even mentioned, because it’s pretty small, but it’s a little perk and it’s not bad with your real estate that you own in different parts of the country. Remember, you can travel to visit your properties and take deductions on those expenses. Now Remember, we had this one speaker come in, and I really just railed on him after he spoke. Because he was basically saying, well buy properties in places you like to visit because then you can go there and deduct your trip. And I said, Are you joking? You’re telling my audience to to buy a property and make $100,000 property decision to deduct a $400 airline ticket. Talk about the you know, what’s the car driving the horse, sir? What’s the right? I say? Yeah. We’ll get that thing backwards. Right. Don’t shoot yourself in the shoe. All right. So it’s just a little perk. It’s a little side perk. It’s not a big deal. Okay, cash medium in the taxation world. rental income medium. Of course, you have to declare it obviously, your job income, terrible performance against taxes, get slaughtered against taxes. All of you need to have your own business. I know the vast majority of this room, you know, we got a lot of Silicon Valley people, all of you pretty much in this room have corporate type jobs. few of you have your own businesses, right. But the corporate type job is just the worst deal ever tax wise. You’ve got to have some little small business on the side, do anything. You know that person that’s bugging you to join their network marketing program. Just join it so you can have something to have tax deductions with. Right? Okay. Don’t buy too much soap though or anything like that. Right? Or wine. Just buy enough to consume right? Okay, so bonds terrible in the inflationary environment. No benefit there at all. Gold, or sorry, we’re talking about taxes versus taxes. Gold is awful. Stocks are absolutely awful. You sell one stock. You got to pay the tax before you buy another. When I sold my last company. I went to so many advisors, you know really high level advisors. I said this there anything I can do? Look, I will buy another business. Okay, I will not call this my retirement and, you know, I will just buy another business in real estate. Can I do a 1031 exchange? I’ll reinvest all the money into another business. Nope. pay taxes. That’s it. That’s it. Nothing. Income property the most tax favored asset in America. So that’s that. Okay. So I just want to present that to you. Thank you.

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