After the Fall

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So the mining tax, among other issues, has cost Kevin Rudd his job. As an economic matter, investors might now revalue the miners as if the tax itself is dead, or at least dormant until after the next Federal election. But as fascinating as the domestic political scene is, today’s Daily Reckoning begins with an old foe, the U.S. housing market.

Why? The current direction of U.S. home prices (down) has been brought about by many of the same economic management principles applied here in Australia. In fact, the whole Keynesian effort to support aggregate demand and “bring forward” demand through tax credits and handouts has been used the world over. And its effects are the same the world over – a temporary spike in economic activity giving the illusion of vitality…and then a crash to earth.

Nowhere is this process more advanced than in America’s housing market. In first decade of this millennium, it was the prime beneficiary of the cheap money policies of both Alan Greenspan and Ben Bernanke. Bank and non-bank credit creation found its way into an asset class everyone could profit from – residential real estate.

But yesterday America’s Commerce Department reported that new home sales in the United States fell 33% in the month of May from April. Just over 330,000 new homes were sold across the great land for the entire month. It was the lowest and slowest rate of sales since 1963. And since their peak in 2005, new home sales are down 78%.

The good news is that U.S. home prices reaching a clearing level. The median price on a new U.S. castle is just over US$200k. Even without the $8,000 Federal tax credit, the price is just under four times the median U.S. household income of $52,000. So how come no one’s buying?

Because they’re all in! That is, at the peak of the market, homeownership levels in the States reached 70%. When seven out of ten households own a home or have mortgage, there aren’t many buyers left. Does this mean there is some theoretic level of homeownership that’s achievable AND sustainable in a market?

Well, no. But it does mean that when you “bring forward” demand so much in a credit boom, you rob from future demand. That’s what’s happening now in America. And we suspect that is what will happen too in Australia, when all the various ways of bringing people into the market with grants and tax deductions are exhausted.

But what does this have to do with the big picture? There is a good argument to be made that what artificially low interest rates did to America’s housing market…they have done to many of the world’s stock, commodity, bond, and real estate markets. With the Fed, the Bank of Japan, the European Central Bank, and the Bank of England all setting historically low short-term interest rates, they’ve provided huge support to markets.

And if that support fails? The lack of gimmicks to prop up U.S. house prices is making it likely that there will be a second fall in that market. The knock-on effects on U.S. employment won’t be pretty. But the destruction of bank collateral will be uglier still, and that’s what poses the biggest risk to the financial system.

Yet it’s not just America we’re talking about. Stock market veteran Richard Russell, who edits the Dow Theory Letter, writes that, “We’re now in the process of building one of the largest tops in stock market history. The result, I think, will be the most disastrous bear market since the ’30s, and maybe worse.” Russell argues that the Fed and its central bank cronies have pumped up stock, commodity, and real estate markets and that they are all now primed for a big fall.

He suggests that the disintegration of fiat currencies is what will spark the fall in asset markets. But – assuming you agree with Russell’s primary thesis that global stock prices have been pumped up by a sea of central bank liquidity – the catalyst for that fall is anyone’s guess. And the timing is unknowable.

In theory, though, you CAN know that when interest rates are manipulated lower for the sake of achieving politically mandated GDP growth (or growth for its own sake), they invariably create a bubble somewhere. What we’ve had – really since 1974 – is a series of ever larger bubbles encompassing more asset classes and more national economies.

Finance has aided and abetted this process. So has technology. The digitisation of finance has facilitated global capital flows, making it possible for cheap money borrowed in one currency to charge into assets in another. What all these micro-bubbles have in common is that they inflate asset prices…and when those assets increase household net worth on paper (house and stock prices) it seems like a good thing.

What we’re about to find out – after all the bad debts are liquidated and asset values – is whether all that money printing has actually created a lasting prosperity, backed by good investments in capital assets or industries with demand not propped up by ever-larger amounts of credit. Or whether we’ve just enjoyed a one-off period of global growth based on cheap energy and cheap credit that will never be repeated and must now, as credit and money shrink, contract.

Incidentally, the Federal Open Market Committee in the US decided to leave rates low. In its statement, the FOMC said, “Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad.” Europe?

But all of these things are connected. And to stretch the thematic connections…the central error of central bank control over interest rates (a non-free market price for money, or the cost of capital) is probably the same error Kevin Rudd made. One man doesn’t know better than a market.

In a complex system, there are too many moving parts, too many variables, for one man or a small group of men to know what they need to know in order to devise a plan. The Austrian Economist Friederich Hayek called this problem a “knowledge” problem and pointed out no one is ever given enough total knowledge to wisely make a grand plan.

Nor, we would humbly suggest, should any man presume to know enough that he tries to put his grand plan in the place of the private plans of millions of others, making their own private calculations based on factors unknown to The Man. It’s a big ask. And you set yourself up for a fall when you do it.

Of course, in the end, we’re all headed for a fall of at least six feet under. But what you do between now and then is a matter of choice. And returning to financial markets, we’d still choose not to be a buyer at these levels. Aussie stocks may get a bounce from the demise of Kevin Rudd and the shelving of his mining tax until after the election.

But the larger global issue – as you can see from the fall in U.S. new home sales – is that economic activity supported by credit growth isn’t sustainable. Nor are the asset price gains based on easy credit. So what will lead to the Fall? More on that tomorrow…

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Bill Bonner reports, and not for the first time, that “Capital Economics calculates that the M3 money supply in the US has been contracting over the past three months at an annual rate of 7.6pc”.
    And I don’t get it – maybe some DR readers can explain this to me… if the US Fed has been printing money at unprecendented rates (monetizing debt or QE or whatever you call it), how come the money supply is shrinking? It seems to me that by giving the banks truckloads of cash and then the banks buying US bonds with it, thereby passing the money back to the Fed, there would be no net change in the money supply. But as the banks all seem to say they have repaid those bailouts now, then they’ve bought bonds AND repaid debt – is that sucking up the money supply? I’m confused – maybe I should be an economist.
    Thanks for a consistently great read.
    Regards
    Bob

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  2. This is my position too. But the bottom of any enterprise is determined by earnings as long as it doesn’t get nationalised. The bottom for a bubble asset physical, commodity or currency may be far deeper.

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  3. Doom and gloom merchants… all of you. This whole website is a magnet for those wanting stock and house prices to fall so they can profit – therefore most people blogging here try to talk the markets down. I bet you all have photos of Roubini and Steven Keen sitting beside your PC. How about a bit of balance?… nothing but negativity.. just a warped view of reality. If you are so convinced of a fall, go short on stocks and rent a house. Your glass-half-empty view of the world will create its own reality.

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  4. Brian,

    it’s not negativity, it’s reality. If you think hope is going to help pay down the bloated mortgage of the average aussie, then that’s your prerogative.

    We need more websites like this that are willing to offer real answers so that people can cope with the pending reality, rather then act like a deer in the lights when the proverbial hits the fan.

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  5. “Doom and gloom merchants… all of you.”
    Brian,

    Not moi, i’m a realist and optimist. My glass is half full. When property prices halve it will be full glass for me.

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  6. I am with you NV.!
    Property is sooo overvalued in Oz it makes your head spin.
    The government cannot pump prime our market forever, when it stops and you see all the first home owners on the street that is the time to buy.
    Till then, gold and silver for me :)

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  7. “Doom and gloom merchants… all of you.”
    Brian,

    Hardly… When the storm has passed we will have sunny days again… I am optimistic for the future.. Just have a bad bit to get through first

    Stillgotshoeson
    June 26, 2010
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  8. Brian, learn to laugh at The Dark Side of DRA. If you intend to visit, do so in the sure and certain knowledge that the majority of respondents are banking on a major property crash. For many, it’s their _only_ hope of getting either a home, or a head… . :)

    If you intend to visit, bring with you a sense of humour and a sense of perspective. For many years most here have predicted the GAPC, but no crash has occurred. Their guru has spiralled downward in flames, yet you’ll note his link remains prominent here. It’s critically needed.

    And, during that time, virtually everything else _has_ crashed… except the very things he forecast. Let these folk have hope… and let them rent. And encourage them to buy gold. At the end of the day, they may well have kept pace with property. Gold is pretty _cool_ stuff, Brian. They’ll trade it for the warmth of a home soon enough.
    I mean, what else would you do with it? ;)

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  9. Problem is Brian that house prices have escalated faster than wages. The trend has to stop. Its self limiting. If govs downsize immediately and reduce the tax burden a lot I’ll change my view. On the other hand if it turns out true that govs can spend without consequence then everyone should be very afraid. Our future will become more of what someone else wants it to be every day and less of what you wish for… until 1984 comes to pass. But your in the land of optimists here and those who have come to accept the world can never be perfect.

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  10. Brian you say

    “nothing but negativity..”

    The fact is we are the ones being Positive,

    Us young Australians have the right to be angry that we don’t have the same opportunities you had when you were our age

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  11. Even when property prices in countries do “crash”, it doesn’t necessarily mean that every man and his brown dog ends up owning one perhaps? Home ownership was 50% in Tokyo in 2003. Although anywhere up to 80% in the sticks. (No idea what they were pre-crash though?)

    The home ownership rates in the UK and the US are down a couple of percentage points off their peaks apparently. (Even vaguely recall reading a while back that there was a trend in the US when marriages break up towards both parties saying No, no, you keep the house darling – ‘Cause I don’t want the bloody thing!)

    Germany is a funny one with home ownership only being about 42% (in 2002?) – With me tending to think of them as having one of the better economies overall.

    And when I look at countries where the ownership rate is significantly above Oz’s 70%, I can’t help but get the general impression that to support that, you might by and large need either an especially sound economy or an especially crappy one:

    Singapore – 89%
    Spain – 85%
    Greece – 83%
    Slovenia – 82%
    Italy – 78%
    Ireland – 77%
    Norway – 77%

    Although fully expect that impression is way too superficial.

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  12. So much for life being like a box of chocolates I guess.

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  13. “Us… have the right to be angry…”

    Us listened to our lessons but us still don’t have the same opportunities.
    Us blame our state education system and us are pretty mad at the property morons, us are.

    Us young Australians want it all and us want it all NOW! ;)

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  14. Lachlan: “If govs downsize immediately and reduce the tax burden a lot I’ll change my view. On the other hand if it turns out true that govs can spend without consequence then everyone should be very afraid.”

    The trick is to vote for the Best Party, Lachlan!~

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  15. Once again Biker nice to see you sticking to the subject

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  16. HaHa… ! Maybe if _you’d_ paid attention to the subject… ;)

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  17. Doom and gloom at DR? Perhaps.

    But it’s a nice foil to all the overly optmistic bulldust out there. And there’s usually some good laughs woven in to the grim analysis.

    I wish some doom-and-gloomer was there to kick my arse before I put my house deposit money into Australian stocks in 1986.

    I lost almost everything in the 1987 crash. Fresh out of school, I asked my investment broker as we stood in the elevator: “Will the market keep going up? Some people are talking about a big crash.”

    “It will keep going up,” he said. “Ignore those doom-and-gloomers, they are just crazy people,” he said, or words along those lines.

    The mainstream press is reporting a lot of bad economic news right now. It’s hard to see prosperity coming out of this current set of economic circumstances, and we have some pressing environmental matters sitting on top of it all.

    Economic failure, global warming, energy crisis, overpopulation … is it all coming to a head, or is this just some sort of modern, misplaced paranoia I am feeling?

    I just wish I knew, for my children’s sake.

    I’m tempted to buy a nice little farm where it rains regularly, but that’s a bit extreme, isn’t it? That would be just silly, wouldn’t it?

    AnnoyingOrange
    June 27, 2010
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  18. Not extreme, just perfectly good sense.

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  19. Comment by AnnoyingOrange on 27 June 2010:

    Doom and gloom at DR? Perhaps.

    But it’s a nice foil to all the overly optmistic bulldust out there. And there’s usually some good laughs woven in to the grim analysis.

    I wish some doom-and-gloomer was there to kick my arse before I put my house deposit money into Australian stocks in 1986.

    I lost almost everything in the 1987 crash. Fresh out of school, I asked my investment broker as we stood in the elevator: “Will the market keep going up? Some people are talking about a big crash.”

    So did you panic and sell out at a loss only to see those stocks 20 years later at a far greater multiple than they were back then…. or did you buy into companies that are no longer here?

    Stillgotshoeson
    June 27, 2010
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  20. The ’87 Crash gave us our nice little farm where it rains regularly. We’d sold all our shares in _October;_ and our home a year later. The property’s owner, ASXed to the teeth, went down in September and put the property on the market. Having made sufficient profit from beach lots and our house sale, we were among the very few with a full cash payment.

    It’s possible to benefit from a crash, in this case shares, but it was _never_ part of our plan. You can say we were just lucky getting out a month before the crash, but we’d ‘set a sell when we set a buy’ and our one ‘penny stock’ had doubled, from 10c to 22c. It was a record high, we had shiploads of it and it hit 22c before we could sell at twenty.

    Yes, there’s a mix of optimism and pessimism here. A few don’t know the difference. Optimism doesn’t need to SHOUT, nor does it bitterly complain that previous generations ‘got all the good stuff’. And it’s a strange plan which utterly depends on high unemployment, crashed stock markets and falling property prices for personal success. Optimism is the feeling that “all is going to turn out well”; to “expect the best in all things.”

    Footnote: Twenty years sounds a little too much like Japan. We’re patient, but that’s a l-o-n-g time for a return, Shoes… . ;)

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  21. Steve’s quote of the day

    “Steve is very happy that the Prime minister will be cutting back on immigration”

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  22. Probable Interpretation: A fiscally incompetent fibber who is desperate for votes, is more than willing to tell voters whatever she figures might get her some votes?

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  23. “Problem is Brian that house prices have escalated faster than wages. The trend has to stop” – Maybe Lachlan. But I’m a bit reluctant to make black and white statements about what “has to” happen – Given that there probably are numerous different possibilities. Better to bear in mind the Life is like a box of chocolates yarn perhaps?

    I have a suspicion your progeny aren’t likely to end up marlelade AO; Yunno – on Toast?

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  24. Did her lips move, Steven?

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  25. And herein ‘lies’ the problem Biker – If she doesn’t run high immigration, some rather reluctant current Oz youngies are going to get to pay their mas ‘n pas pensions. T’is a conundrum no? Well, not really – When has one ever seen a democratically elected pollie resist the temptation to kick the can – Leastways for as long as she can.

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  26. Comment by Biker on 27 June 2010:

    Footnote: Twenty years sounds a little too much like Japan. We’re patient, but that’s a l-o-n-g time for a return, Shoes..

    Has not been 20 years for a return though.. 20 years of returns is different..
    Remember reading an article a couple of years ago that said if you had invested $10000 in Shares (Top 50 from memory) you would have had something like $100000 then.
    $10000 in shares the day after the crash.. something like $300000.

    And it’s a strange plan which utterly depends on high unemployment, crashed stock markets and falling property prices for personal success

    Not sure if you are referring to me here.. it is not my “plan” per se.. however it is something I think is going to occur and I am trying to set myself up to best protect myself and indeed profit from it when it occurs.
    It does not HAVE to happen for me to achieve my goals.. doing ok so far with out it crashing.

    Stillgotshoeson
    June 27, 2010
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  27. Comment by Steve on 27 June 2010:

    Steve’s quote of the day

    “Steve is very happy that the Prime minister will be cutting back on immigration”

    I have no problem with immigration, the country needs more immigrants… infrastructure needs to keep pace with it though, at the moment that is not happening, we need more dams, highways, schools, hospitalsm power staions etc to cope with this higher population

    Stillgotshoeson
    June 27, 2010
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  28. Immigration is a positive thing, the reasoning for it can be varied and some of them can be short sighted. I have argued strongly for less immigration since I heard the core reason s to why the former “Krudd” government wanted the “BIG Australia”.

    The whole premise of this mass immigration policy was to prop up taxable incomes to support retiree’s and to baulster health services. It is simplistic at best, i can only assume they were getting these immigrants from a land far away where thy do not retire and do not require medical services. It is a very short term solution that would fall on its face in 20-30 years as the next cycle of citizens, including those who immigrated here earlier, begin to also retire.

    We have a nation that does not have one single capital city capable of being fully sustainable with legitimate room for “manageable” growth.

    Like stillgotshoeson has said above, it is hard to imagine how the city will function with its current population and its current infrastructure, the thought of belting in 50% more people in under 50 years with current miss management is nothing short of frightening.

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  29. Go to 0.12 on this video and listen to what she says Biker even Tony Abbott agrees with her

    http://www.youtube.com/watch?v=BNZ3a843aIg

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  30. “i can only assume they were getting these immigrants from a land far away where thy do not retire and do not require medical services” – Spoken like a true citizen of the world Realist. But not like a realist perhaps? Leastways until we all do get balanced out as best we can across the globe in a sustainable way. And come to a mutual agreement to try and keep things sustainable. It’s good fun watching the West resisting the process though! :)

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  31. If we allow more immigration while spending/deficits remain imbalanced with GDP then the reason for the immigration is apparent.

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  32. “And it’s a strange plan which utterly depends on high unemployment, crashed stock markets and falling property prices for personal success…”

    General comment. You appear to have a plan.

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  33. “Go to 0.12 on this video and listen to what she says Biker even Tony Abbott agrees with her”

    Ah, well then, that makes it right, Steven. (Did he put it in _writing_?)

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  34. “…miss management is nothing short of frightening…”

    Well she can’t be all _that_ bad, Realist. Steven thinks she’s OK!~ ;)

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  35. generally I respect the attitude at DRA, and I would like to see most of the bullshit (economy) come to pass (away)….. my main concern is the degree to which there are elite powers that manipulate it all (not even for moneys sake, they would have enough of it already). the wasted opportunities for self realisation, too much waste on smoke and mirror effects, too much at risk from risky (even sadistic) behaviour of probably psycopathic persons… no proof, just seems to make a lot of sense. its a far cry from the town village. note : the propaganda includes a lack of sensibilities for any welfare issues – so that too is part of the problem – divide and conquer, dog eat dog.
    as for the inevitable crash – the preconditions have been there for a long long time and yet,…… never underestimate the power of the machinery to paper over the cracks (they are doing robotic mining remotely now) . Includes paper money as wallpaper?…
    currently tending towards selling my farm (has water), middle aged owner has old man’s knees which market (or science) cannot replace (yet). must reestablish faith in the system’s trend to plod along, as ever, and hope there is systemic reform by necessity (and maybe without so much system) , and usually panic (rather than process) driven. hope nature will give us a few kicks in the butt rather than just turf us all out. anyway, thats one glass too many, and more to go this lovely afternoon…… happy crashing…..

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  36. In AlcatrOZ it’s mostly every man for himself, and its been that way for a while now. Which suggests we are already feeling the heat, but not fully admitting it and rather acting collectively like the proverbial frog that doesn’t jump out when it should.

    bearamundi
    June 30, 2010
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  37. Australia is a shining beacon
    Wayne Swan said something like this so it must be true….

    Truly we are far better off then the rest of the first world, including Norway. I wonder how much of their oil and gas wealth has been invested in loans to sovereign countries that may be able to repay in 100 years? If ever?

    Neither a borrower nor a lender be. Clearly the Australian RBA is well run. The Australian banks have weathered the storm well, but not perfectly. Sites like this are very useful, a corrective to mainstream thinking where the contrarian view is welcomed and appreciated. But eventually, reality intrudes. The Au$ is like gold as it reflects the ease with which we can sell our ores. When the gold rush declines, so will commodities? In twenty or more years!

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  38. I am a recently married 25 year old with a 345k mortgage which allowed me with Rudd’s bonus to get me into the BOTTOM end of the market. Like most people my age that I know that have done the same as me, things are not that great financially with us. My wage I suppose is ok at 65k a year and my wife earns around 50k so you would think that should be ok to live, yes it is, it’s just that now my wife is pregnant and expecting in Nov I am really scared of what will happen to us financially. Interest only is around $450 a week which is more than half my take home pay.
    Should I sell the house or live on two minute noodles for the next 25 years with no holidays and hoping for some decent promotions at work to keep our heads above water. ALL my friends are feeling the same way especially the ones that have borrowed more…..

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  39. Pangit, a good mate of mine here recommends a 25-year diet of rice.
    I’d recommend, instead: 1.) Seeing your bank to discuss… 2.) …renting your home to someone else… and 3.) …renting a smaller home yourself. Your write-offs, tax-wise, will surprise you.

    A few here will counsel you instead to _sell at any price._ Without getting really good independent advice, you’d be silly to either sell, or change your diet. Few Aussies know the _full_ list of claims you can make on rentals. Getting that information… and financial advice… should be your first steps.

    And if you do decide to sell, you may consider selling your home _yourself_. No-one knows it as well as you do… . It’s worth walking around your area and jotting down, from For Sale signs, addresses and realtors’ phone numbers, to get a good idea about asking values of very similar homes.

    If ALL your friends are in the same boat, there’s a very, _very_ simple financial solution you should ALL consider simultaneously. You’re on $65K per year, so a bright bloke like you should be able to figure it out well before the two-minute noodles are done… . :)

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