Vanguard News Network

[from Daily Reckoning]

“Project Sunrise,” they call it.

Yes, we begin today’s reckoning where we think we might all end up – in Zimbabwe.

The wretched country is suffering the highest inflation rates in the world – over 1,000%. But don’t worry, the government and central bank that caused the inflation have now decided to do something about it. Lucky Zimbabweans.

Project Sunrise is billed as part of a fresh government drive to stop inflation and black market trading. As of today, you can no longer use your old Zimbabwean dollar bills. You have to use the new bills, with three fewer zeros.

Billboards advertised the facts as though it would save consumers money. “More bang for your buck,” is one slogan. And, an advertisement shows a loaf of bread with the caption: “Was $85,000, now only $85.” You can imagine the glee with which the typical housewife anticipated the changeover.

But the program got off to a rocky start. This weekend, there were reports of chaos…scuffles. People tried to spend their old money on anything and everything they could get their hands on, which wasn’t necessarily much. Inflation and price controls have made many consumer items vanish already. But people were desperate to get rid of the old currency before today, because the government had limited the amount that could be traded for new currency to no more than $400 U.S. per transaction, per week.

In the new currency regime, there will even be one-cent notes we are told. Students at the local university calculate that it will be cheaper to heat your house burning bundles of the new notes than using coal or wood.

We turn to the “Dark Continent” not to laugh, but to weep. For there are we bound…

Empires are expensive. Bread and circuses at home…foreign wars. Eventually, the bills grow so large they can’t be paid. After the Roman Empire peaked out in the second century, its emperors repeatedly staged financial schemes like Project Zimbabwe. Until then, their monetary system had been based on gold and silver coins, which acted as a restraint on inflation – the mints could turn out only a limited supply of coins. But then, Emperor Aurelian decreed that his coins were two and a half times as valuable as their actual worth, effectively jacking up the money supply by 250% overnight!

With more than $70 trillion in the hole and most of that money owed – in the form of Social Security and Medicare benefits – to voters at home (and the rest to nervous foreigners), the American government might want to consider Aurelian as a model. For, as in Rome or Harare, the financial authorities can get away with almost anything. And now, the temptation to inflate has grown just too great…irresistible, in fact.

But is it that simple? If it were, wouldn’t it be easy for you to know what to do, dear reader? Just take out the biggest mortgage over the longest period possible…and wait for inflation to reduce it to nothing. We remember how we envied people with old 6% mortgages in the 1970s. When inflation rates headed over 10% in the late ’70s, they practically got their houses for free. Could the same thing happen again?

Corporate America seems to be thinking along those lines. A Wall Street Journal piece tells us that businesses are taking on more and more debt. Money is cheap, they reckon. Get it while you can.

Bonds are going up. The yield on the 10-year T-note is only 4.83%. Mortgage rates, too, have gone down over the last four weeks.

Declining lending rates are not usually a sign of inflation, but deflation, which is why the strategy of taking on more debt now may be premature. Yes, in the long run, inflation may lighten your debt load and make you feel like a financial genius. But in the short run, the load could grow a lot heavier…making you feel like the village idiot.

Orange juice is at a 16-year high, but most commodities seem to be trending downwards – along with bond yields. Housing prices, too, are beginning to soften. Gradually, people are coming to realize that they don’t have as much money as they thought.

What’s worse, people with ARMs are getting their financial legs knocked out from under them. As much as a half trillion worth of adjustable rate mortgages are to be reset in the coming year, says the Los Angeles Times. Many of these were Neg Am contracts, meaning that the principal amount is larger now than it was when the mortgage was taken out. The L.A. Times report:

“In order to head off potential problems, the largest mortgage originator in the United States, Countrywide Home Loans, has begun sending out letters to thousands of borrowers who have been making only the minimum payments on the company’s popular PayOption adjustable-rate mortgages.

“The letters explain that ‘this is an early message to alert you that, based on your current payment trends and potential future interest rate changes, the monthly payment you will be required to pay may increase significantly.’

“A model letter provided to me by Countrywide includes this hypothetical example of what could be ahead for a California homeowner currently making only minimum payments monthly on a $402,000 loan.

“The current full interest rate on the loan is 7.6%, but the borrower has been paying only $1,348.47 monthly, far less than what’s needed to fully amortize the mortgage over its 30-year term.

“If the loan reset at today’s rates, the letter explains, the full payment required would be $2,887.50 – more than double what the homeowner has been paying. Future reset rates could be even steeper, making the payment crunch much worse.”

Yes, dear reader, inflation could eventually wipe out much of the real value of those loans, but in the meantime, there are mortgage payments to be made. And many people will not be able to make them. They will walk away…or go belly up. Mortgages will be worked out, re-negotiated, stretched out or foreclosed. House prices will fall. At the margin, people will stop spending so much money and push the economy into a slump. Jobs will be lost and overtime curtailed. Payments on debt will be even harder to make. Debtors will default and go bust.

In short, there will be a dark night of reckoning before the “Sunrise Project” comes to America. Borrowers are likely to deeply regret their mortgages, before they wish they had bigger one.