A *Macroeconomic Overview
Back in April, I ran a post called "Real Estate & Inflation" that isolated wage growth as the key to whether any inflationary outbreak would help or hurt real estate (incidentally, that post is now ranked 18th in the world, according to Google).
Specifically, if inflation spilled over into workers' wages, it would drive up real estate; absent that, inflation would hurt real estate.
That's because static wages plus rising prices for everything else (food, gas, health care, etc.) would "crowd out" consumers' ability to spend on housing.
Six months later, how do things look?
Clearly, there is no inflationary pressure on wages. In fact, with unemployment at about 10% nationally and still rising, there is more downward pressure on wages than upward.
However . . . two other developments have come into clearer focus.
Coming Into Focus
The first is the Fed's apparently indefinite commitment to an easy (free?) money policy -- at least to banks that borrow from it.
Second, while wage inflation is nowhere to be found, asset and commodity inflation -- at least outside of housing -- appears to be rampant. (Hmmm . . . maybe the two are linked).
The Dow Jones is well over 10,000, gold smashed through 1,000 an ounce weeks ago, and oil appears to be poised for another run at $100 (and beyond). Meanwhile, the dollar is plumbing record lows against the Euro, yen, and other major currencies.
So, to return to the original question, what will an outbreak of inflation mean for real estate -- and specifically, the housing market?
Based on the foregoing, I've shifted into the camp that believes that rising inflation elsewhere in the economy will ultimately spill over into real estate, as well -- even if wage growth is flat (or negative).
If the economy can simultaneously experience recession and inflation -- a phenomenon dubbed "stagflation" in the '70's -- there's no reason why houses can't appreciate in a lousy economy, given what's happening to other asset prices.
P.S.: Peter Lynch has a famous line that if you spend 15 minutes a year trying to figure out macroeconomic factors . . . you've wasted 13 minutes.
Showing posts with label inflation's effect on real estate. Show all posts
Showing posts with label inflation's effect on real estate. Show all posts
Tuesday, October 20, 2009
Wednesday, June 3, 2009
China, cont.
"Geithner Says China Has Faith in U.S."
--headline, The New York Times (6/3/09)
[Editor's Note: Sorry, I'm on a China kick -- just one more in that vein. And yes, it does bear on real estate. In fact, whether China keeps buying U.S. debt -- and therefore whether mortgage rates stay low -- is probably the single biggest variable affecting U.S. housing prices right now.]
Just two thoughts on the above headline:
One. Wouldn't it be more reassuring if it read, "China says China Has Faith in U.S."??
Two. Actions speak louder than words.
Some of the most flattering things you'll ever hear about a publicly-traded company are analysts and major stockholders praising it as they seek cover to dump their shares (or recommend same). Or buy credit derivatives that appreciate as company shares tank, which is effectively the same thing.
You'd think that the Securities and Exchange Commission ("SEC) would police that (and a lot of other things), but there's plenty of evidence that they don't.
"Over a Barrel"
So here's what you're left with: don't listen to what Chinese leaders say, watch what they do.
Of late, they've been pushing to have their own currency, the renminbi, included in a basket of world currencies to serve as a meta "reserve currency." That's significant because it would supplant the U.S. dollar as the de facto world reserve currency.
Why does that matter?
A key difference between, say, Albania, and the U.S., is that the latter's debts are denominated in its own currency. If the U.S. debt becomes unmanageably large -- one of the big concerns at the moment -- it always has the option of printing more money. For now, at least.
One last quote regarding China, which already owns a trillion-plus in U.S. debt: 'if you owe your bank $1,000, they've got you over a barrel; if you owe them a couple trillion, you've got them over a barrel.'
Unfortunately, there's a crucial difference between dumping what you already have -- and buying more.
--headline, The New York Times (6/3/09)
[Editor's Note: Sorry, I'm on a China kick -- just one more in that vein. And yes, it does bear on real estate. In fact, whether China keeps buying U.S. debt -- and therefore whether mortgage rates stay low -- is probably the single biggest variable affecting U.S. housing prices right now.]
Just two thoughts on the above headline:
One. Wouldn't it be more reassuring if it read, "China says China Has Faith in U.S."??
Two. Actions speak louder than words.
Some of the most flattering things you'll ever hear about a publicly-traded company are analysts and major stockholders praising it as they seek cover to dump their shares (or recommend same). Or buy credit derivatives that appreciate as company shares tank, which is effectively the same thing.
You'd think that the Securities and Exchange Commission ("SEC) would police that (and a lot of other things), but there's plenty of evidence that they don't.
"Over a Barrel"
So here's what you're left with: don't listen to what Chinese leaders say, watch what they do.
Of late, they've been pushing to have their own currency, the renminbi, included in a basket of world currencies to serve as a meta "reserve currency." That's significant because it would supplant the U.S. dollar as the de facto world reserve currency.
Why does that matter?
A key difference between, say, Albania, and the U.S., is that the latter's debts are denominated in its own currency. If the U.S. debt becomes unmanageably large -- one of the big concerns at the moment -- it always has the option of printing more money. For now, at least.
One last quote regarding China, which already owns a trillion-plus in U.S. debt: 'if you owe your bank $1,000, they've got you over a barrel; if you owe them a couple trillion, you've got them over a barrel.'
Unfortunately, there's a crucial difference between dumping what you already have -- and buying more.
Sunday, May 31, 2009
Weighing the Risk of Inflation
Rebutting Paul Krugman on Inflation
If you don't know whether to worry more about inflation or deflation -- economists seem to be evenly split at the moment -- a good technique is to parse the arguments being made by the two camps.
Here is the case made by Paul Krugman, a leading proponent of the "worry more about deflation" school ("The Big Inflation Scare"). As you'll see from my rebuttals (in parentheses), I don't find him persuasive.
PK: At the moment, all the leading price indices show that inflation is quite modest. If anything, the direction of prices is deflationary (especially home prices).
Rebuttal: Three days before Katrina hit, the weather in New Orleans was sunny. Simply extrapolating from current conditions doesn't constitute rigorous forecasting.
PK: Historically, very few countries have purposely used inflation to pay off a runaway national debt. For example, France after WWI. On the other side of the ledger, countries such as Japan, Canada, and Belgium have serviced national debts that, relative to the size of their economies, were even bigger than the U.S. debt is soon projected to be.
Rebuttal: Canada? Belgium? How does the experience of these countries -- literally a fraction of the size of the U.S. -- portend anything for the U.S? Even Japan's experience is a dubious precedent for the U.S.: it is a nation of savers, and traditionally has run huge trade surpluses. The U.S. is by far the world's biggest economy, and now has the dubious distinction of being the biggest debtor nation -- by far -- in history.
PK: At the moment, all the money stuffed into banks to repair holes in their balance sheets is just sitting there, rather than funding new loans. So, at least at the moment, the Fed's decision to "monetize" the banks' bad debts isn't inflationary.
Rebuttal: So what? A warehouse full of dynamite isn't safe just because there aren't any matches around at the moment.
Echoes of LTCM
Ultimately, what I find most unsettling about the arguments advanced by Krugman et al is their assumption that, simply because something is historically rare, therefore, it's unlikely.
That sounds a lot like the thinking baked into the models used at Long-Term Capital (Mis)Management ("LTCM"), the Nobel laureate-advised investment fund that famously blew itself up in 1998 -- and threatened to take the U.S. financial system with it.
Or, much more closer to home (pun intended), the arguments economists made to justify perpetually rising housing prices, or at least a long-term plateau.
As recently as 2006, they argued -- correctly -- that U.S. housing prices had never fallen in aggregate on an annual basis since The Depression.
So much for that one . . .
If you don't know whether to worry more about inflation or deflation -- economists seem to be evenly split at the moment -- a good technique is to parse the arguments being made by the two camps.
Here is the case made by Paul Krugman, a leading proponent of the "worry more about deflation" school ("The Big Inflation Scare"). As you'll see from my rebuttals (in parentheses), I don't find him persuasive.
PK: At the moment, all the leading price indices show that inflation is quite modest. If anything, the direction of prices is deflationary (especially home prices).
Rebuttal: Three days before Katrina hit, the weather in New Orleans was sunny. Simply extrapolating from current conditions doesn't constitute rigorous forecasting.
PK: Historically, very few countries have purposely used inflation to pay off a runaway national debt. For example, France after WWI. On the other side of the ledger, countries such as Japan, Canada, and Belgium have serviced national debts that, relative to the size of their economies, were even bigger than the U.S. debt is soon projected to be.
Rebuttal: Canada? Belgium? How does the experience of these countries -- literally a fraction of the size of the U.S. -- portend anything for the U.S? Even Japan's experience is a dubious precedent for the U.S.: it is a nation of savers, and traditionally has run huge trade surpluses. The U.S. is by far the world's biggest economy, and now has the dubious distinction of being the biggest debtor nation -- by far -- in history.
PK: At the moment, all the money stuffed into banks to repair holes in their balance sheets is just sitting there, rather than funding new loans. So, at least at the moment, the Fed's decision to "monetize" the banks' bad debts isn't inflationary.
Rebuttal: So what? A warehouse full of dynamite isn't safe just because there aren't any matches around at the moment.
Echoes of LTCM
Ultimately, what I find most unsettling about the arguments advanced by Krugman et al is their assumption that, simply because something is historically rare, therefore, it's unlikely.
That sounds a lot like the thinking baked into the models used at Long-Term Capital (Mis)Management ("LTCM"), the Nobel laureate-advised investment fund that famously blew itself up in 1998 -- and threatened to take the U.S. financial system with it.
Or, much more closer to home (pun intended), the arguments economists made to justify perpetually rising housing prices, or at least a long-term plateau.
As recently as 2006, they argued -- correctly -- that U.S. housing prices had never fallen in aggregate on an annual basis since The Depression.
So much for that one . . .
Tuesday, April 28, 2009
Real Estate & Inflation
Inflation's Effect on Housing
[Note to Readers: please also see the update to this piece, posted Oct. 20]
One of the big questions in the (financial) air is whether all the money that's been pumped into the system (the various TARP's, the Fed Reserve's serial loan guarantees, government purchases of bank equity, etc.) the last six months or so will ultimately be inflationary.
In turn, that begs the question: if in fact inflation is on the horizon, how does that affect real estate?
Traditionally, anything that makes paper money (currency) less valuable makes hard assets more valuable. And assets don't get any harder than real estate.
Another factor that cuts in real estate's favor is the effect on debt as money becomes less valuable.
Because mortgages are calculated in constant ("nominal") dollars, repaying a fixed debt with increasingly cheap dollars benefits borrowers. If everything doubles in price, your $50k -- or $500k -- mortgage suddenly becomes smaller by comparison.
The key is whether "everything" includes wages.
"Crowding Out" Effect?
If wages increase along with the general cost of goods and services, real estate comes out ahead.
However, if static wages must be spread over household expenses bloated by inflation, it stands to reason that there will be less left over to spend on housing.
Diminished purchasing power spells weaker housing demand . . . which means lower housing prices.
Of course, one of the principal tools to fight inflation is raising interest rates. Because more than 80% of the money used to buy housing is borrowed, more expensive money equals more expensive housing. To correct for that, housing prices would have to fall.
So how do all of the foregoing factors net out?
If you're keeping score, two benefit housing, two harm it.
Call it a draw, 2-2.
[Note to Readers: please also see the update to this piece, posted Oct. 20]
One of the big questions in the (financial) air is whether all the money that's been pumped into the system (the various TARP's, the Fed Reserve's serial loan guarantees, government purchases of bank equity, etc.) the last six months or so will ultimately be inflationary.
In turn, that begs the question: if in fact inflation is on the horizon, how does that affect real estate?
Traditionally, anything that makes paper money (currency) less valuable makes hard assets more valuable. And assets don't get any harder than real estate.
Another factor that cuts in real estate's favor is the effect on debt as money becomes less valuable.
Because mortgages are calculated in constant ("nominal") dollars, repaying a fixed debt with increasingly cheap dollars benefits borrowers. If everything doubles in price, your $50k -- or $500k -- mortgage suddenly becomes smaller by comparison.
The key is whether "everything" includes wages.
"Crowding Out" Effect?
If wages increase along with the general cost of goods and services, real estate comes out ahead.
However, if static wages must be spread over household expenses bloated by inflation, it stands to reason that there will be less left over to spend on housing.
Diminished purchasing power spells weaker housing demand . . . which means lower housing prices.
Of course, one of the principal tools to fight inflation is raising interest rates. Because more than 80% of the money used to buy housing is borrowed, more expensive money equals more expensive housing. To correct for that, housing prices would have to fall.
So how do all of the foregoing factors net out?
If you're keeping score, two benefit housing, two harm it.
Call it a draw, 2-2.
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