Charts On Housing Markets & US Economy
Posted by Frugal on September 12th, 2006
In my previous post “The real losers when the housing bubble bursts”, it appears that many people did not understand what kind of inflation that I’m talking about. Apparently, you don’t read my past posts, and are not familiar with were I stand on the US economy. I’ve pulled together three charts which I thought must be seen by everyone if you are reading any other blogs. The first chart is on the historical inflation-adjusted value of US housing prices. The second chart is what US Fed Reserve has been doing to our money supply. The third chart shows you how Fed is using housing market to prop up the economy.
On the above chart (originally by Robert Shiller and thanks to financialsense), the first question that you may ask is whether the housing prices will go back down. You may argue that this is a new era, and it just won’t fall. However, human history is littered with bubbles that went bursted. Every time, the participants believe in the new era argument, and every time we may do have a new era, but the “new era” becomes old, and newer things come. The prices eventually go back to historical norm. This is true for the South Sea bubble, 1928/29 US stock market bubble, Japanese bubble in 1989, NASDAQ high-tech bubble in 2000, etc. So many times, people have said, “this time is different”, and yet things are more of the same than you can believe.
I believe in learning lessons from the economic history. Past is the only thing that we can rely on in the attempt of divining the future. I believe in the historical out-performance of stock markets at , and therefore I have fully expected a lackluster performance of stock market since year 2000. It is my expectation too that housing prices will revert back to the past norm.
The second question that you may ask yourself is that do you really believe that the housing prices in general will fall 50% outright in the terms of nominal prices? If it does happen that way, it will do a big damage to the US economy for sure. What is more likely in my opinion is that the absolute prices will not fall that much, but the inflation-adjusted prices will nevertheless fall fully by 50%. The evidence is in what US Fed has been doing in chart #2, and what they will be doing, and what they don’t want to tell you and me. What does that mean to you and me? It means that the inflation will be higher than usual almost for sure.
If you use 200% as the peak in the chart #1, and assume that it will go back to 100%, then the amount of fall in absolute prices, must be compensated by the amount of inflation. Let’s assume a fall of 25% in the absolute price. In that case, total inflation must be 50% over that period, since 200% * (1-25%) / (1 + 50%) = 100%. How long the housing prices will deflate is hard to say? If the inflation-adjusted price bottoms in 6 years, then the previous numbers are telling you that in the next 6 year, US housing prices on the average fall 25% in absolute prices, but the inflation for the next 6 years will be compounding at 7.0% (to reach a total of 50%). You can use any other sets of number, and crank out a different scenario. But I think housing prices on the average will fall, and inflation rate will be high in general.
The “smartest” player in all these is of course US Fed Reserve. To avoid to be caught in action and seen in inflating money supply to create inflation, US Fed has stopped publishing M3 money statistics right before Bernanke takes over from Greenspan. They know very well that if all their repurchase agreements (repo) are exposed, and M3 money statistics is exposed, US dollar exchange rate will start falling like a rock. So instead of letting everyone know what they are up to, they want to operate in dark. Other governments around the world are not stupid either, and have been inflating their own money supplies at a heightened pace to combat the fall in the $US and maintain a competitive export business. But you will never hear from the government or the Fed that “hey, fellow citizens, I just printed another 10 billion US dollar today freely for the profligate US government to use, but will dilute the values of all of your US dollar based assets.”
Certainly, their intent in all of these is “benign” for the US as a whole and to save all the debtors, whether it’s consumers or US government. When the real inflation-adjusted value of US dollar is reduced, the real value of debt is also reduced. While I don’t know how smooth their operation can be, but historically government’s interventions in the capitalistic system only generated bigger waves of unbalances. The recent lowering of interest rate down to 1% is probably the best example. Yes, US Fed saved the US from any setbacks from a high-tech bubble, by simply creating the biggest housing bubble in the US history. I don’t know where all of these will end, but I think hyper-inflation may be likely towards the end.
So who may be the real losers in all these mess (that are yet to happen)?
I try to look forward 10 years plus. I do know for certain that if we do reach such bottom, I will not be pessimistic at all. At such bottom when I look forward 10 years plus, I will be more optimistic than ever, because after cleaning up, it will be prosperity awaiting for us. History teaches us that things go through cycles instead of a linear development. From excess to shortage, and from shortage back to excess. I try to take the contrarian view to plan and prepare for my future.
P.S. Here is the chart that shows housing market is becoming the US economy. One day if this trend keeps going (when housing reaches 100% of the GDP, wrong, just wasn’t thinking straight) , will everyone become a realtor, and have the illegal immigrants to do all the rest of work, from house cleaning to high-tech R&D, 
? Sources taken from www.prudentbear.com.
PS2: Please check out the comment section for some more clarification on “who are the real losers”. Sorry that I didn’t make myself clear.
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September 13th, 2006 at 2:54 pm
I had a hard time following the point you were trying to make:
“I try to look forward 10 years plus. I do know for certain that if we do reach such bottom, I will not be pessimistic at all. At such bottom when I look forward 10 years plus, I will be more optimistic than ever, because after cleaning up, it will be prosperity awaiting for us. History teaches us that things go through cycles instead of a linear development. From excess to shortage, and from shortage back to excess. I try to take the contrarian view to plan and prepare for my future.”
Can you please explain this paragraph??? In what way (in a general sense) are you preparing for your future? Obviously you are saving/investing and living well below your means - is this what you meant? Are you saying you have more faith in the stock market and commodities than the real estate market?
Sorry, just trying to digest your post(s).
thanks
September 13th, 2006 at 3:50 pm
Sorry about not being clear to you.
These are the reasons for my defensive investments in precious metals.
September 13th, 2006 at 7:39 pm
First of all, congratulations on your million. That’s pretty cool. My wife sent me a link to this page, and I read some of the other posts and pages as well. I generally agree with a lot of what you’ve said here (not that that’s so controversial), but I have some comments and suggestions for you:
1) I’ve seen Chart 1 before, and I like it and generally agree with your conclusions that housing prices will probably fall in inflation-adjusted terms. However, you state that if houses fall nominally by 30% we would need 70% inflation to equal an inflation-adjusted decline of 50%. I did the math, and 200% * (1 - 30%)/(1 + 70%) = 82%, not 100%. To get 100%, you need inflation of 40%, giving 200% * (1 - 30%)/(1 + 40%) = 100%. This makes your point even stronger, since 40% inflation over 8 years means we only need 4.3% inflation per year, not 6.8%.
2) I find the second chart misleading. The average rate of growth of M3 over the 25 years in the plot is about (10,000/2,000)^(1/25) - 1 = 6.6% per year. For the last 10 years (the “steep” part of the plot), the growth rate is about (10,000/4,500)^(1/10) - 1 = 8.3% per year. This is only 1.7% higher than average, but because your plot is linear instead of log it appears visually to be a more pronounced increase. I agree that this 1.7% increase, especially combined with the hiding of M3 data, is a potential problem, but I think a log plot would give a better view of the situation.
3) Chart 3 plots debt as a percent of GDP. Why would you compare these two quantities? Comparing these numbers is like comparing apples and oranges. Household debt is a measurement taken at a specific time — it tells you how things are with your account at a particular instant. GDP is a measure over time — it’s a difference from one time (e.g. one year, one day) to the next. Expressing a measurement at an instant in time as a percent of a difference at two times makes little logical sense. As a mind game, suppose you measured GDP in days instead of years (there’s nothing magic about a year afterall). The Household debt numbers would all be the same (your debt is still your debt — we’re not talking debt *payments* here, we’re talking debt, i.e. how much you owe other people). The GDP numbers would all be reduced by a factor of about 365, since people make about 1/365th as much in a day as in a year. In this case your plot would show debt at about 30,000% of GDP. My suggestion would be to express debt *payments* as a percent of GDP, since debt payments and GDP are both measurements over time. This would show how much of our income is going to paying debt. Your chart does show that debt is generally increasing, but your comments seem to indicate that you misinterpreted the meaning of the chart.
4) I was hoping you’d propose and answer to your question about who will be the real losers in this mess. Instead you kind of ramble on about things going in cycles and stuff. Everyone’s heard the cycle story, but where are we now in the cycles of various investment opportunities? This is what I’d be interested in hearing.
In general it sounds like you have a pretty good practical handle on how to generate wealth, based on your proven track record. However, I question why you imported these charts from other websites and tried to analyze them. I think you should stick to what you know best. I’d be more interested to hear what you did and what you plan to do for the future as far as investing.
September 13th, 2006 at 8:26 pm
Juhraffe,
, WRONG! Not sure what got into me. Brain power at 11pm to 2am is probably the lowest. I will make that correction.
Thanks for your comment. Sorry, most of these posts were written between 11pm to 2am. I was doing 200% * (1-30%) = 170%,
Thank you very much.
Actually I will make a different calculation here. I think it’s probably more likely that it will fall 25% nominally over 6 years (just my best guess). So the inflation will be 7.0% which would be quite high.
I will get back to you on your other excellent comments. My baby is eating plastic bag….
September 13th, 2006 at 9:50 pm
Okay. Have a little bit more time now.
2. I agree that log chart will be much better. However, 8.3% is really high, not to mention that 6.6% is very high too. I don’t have the population statistics. But one should only expand the supply of money by as much as the population growth. The rest of the extra money will always find their way into various classes of assets, which has been stock market first until 2000, and then into real estate. Increasing money supply = heightened inflation. Remember asset inflation is also inflation. P/E ratio keeps going up = stock asset inflation.
3. I think you have a point, but I still think that using GDP as the yardstick here serve its purpose. GDP is almost like adjusting the amount of money or price by inflation (not in the exact sense of course). You can have the GDP in yen, or in euro. Or you can have a bigger GDP when you have a bigger population. The point is GDP serves a measurement of the “big”ness, or how much the economy is producing. You won’t care about how much inflation has happened up to that point. You can just use GDP as your unit measurement for measuring how big relatively speaking something has been. Such comparison simply gives you an idea of how big the debt is. For example, from wikipedia or any economists, they measure how big the debt of a country by comparing the total debt amount to the total GDP. The higher the percentage it is, the riskier the government debt is. Therefore, it makes total sense to compare the household debt to GDP. I did make a mistake in my comment. It’s not 100% of GDP, but probably much higher percentage before everyone becomes a realtor. I wasn’t thinking clearly. But qualitatively, the comment is still correct. Essentially the amount of household debt represents an indirect measurement on the real estate activities.
4. I thought it’s more clear now on the real losers. I will make it short & pithy. Hopefully it will be much more clear:
a. Housing will probably fall by about 50% inflation-adjusted according to chart #1.
b. The amount of debt owed by homeowners and US government is huge. The only way to reduce the “real” inflation-adjusted value of these debt is through higher inflation.
c. I believe Fed will print more money than usual to reduce the debt burden.
d. The bigger amount of money that will be printed most likely won’t go back into real estate. And possibly not stock market. Usually the same asset class don’t get inflated twice consecutively. That’s just the bubble dynamics for a particular type of asset.
e. With higher amount of inflation, everyone will get hurt, unless you put your money at the right place. Since I believe it’s not real estate, and not stocks, there is not many more places that money can go. I’m betting that it will be commodities. Under such scenario, most people with cash or investments in stocks/real estate will not be benefiting from inflation. Few people will be the winners, while most people will be losers.
I have been talking about my own investment in various posts, and disclosed my own networth & portfolio with a lot of information. You don’t even need to read what I write, but just look at what I am doing. I put my money at where my mouth says. But of course, I MAY BE WRONG! And that’s what I try to preach too through various posts related to market efficiency.
I do think my analysis is okay. I don’t claim myself to be a know-all. www.prudentbear.com does one of the best stock and economic research in the investment world. I have very high opinion of their website. You can find out what I did at the page of My 1st Million. And you can find out what I’m doing everyday by checking My Networth page. I am very forth-coming with everyone. You can’t miss anything.
Thanks for your input. I will go back and correct a couple of my careless mistakes. Trying to post this right before you go to work is very prone to error.
September 15th, 2006 at 1:04 pm
Thanks for the response. Some comments on your comments:
2) I think you have the right idea. The percentages (either one) both seem too high to be sustainable. I’m not an expert on money supply, but I would guess it should grow roughly at the same rate as population, GDP, or some other metric based on our economy.
3) I agree GDP provides a good backdrop to compare to debt. You’re basically showing how much we owe compared to how much we make per year, which is a reasonable comparison. However, using percents to do this seems awkward to me.
4) It sounds like you’re optimistic about commodities. I agree that owning real things (gold, oil, pork bellies, etc.) provides a hedge against inflation. However, looking at the recent run-up in commodity prices, I can’t help wondering how much inflation fears are already priced into the market. I’m thinking stocks are pretty reliable over the long term, so that’s a good option if you have some time. Also, bonds could do OK in the near term if the interest rates start dropping again in an attempt by Bernanke to save the housing bubble. Overall, it’s a tough call, though.
September 15th, 2006 at 5:33 pm
Inflation Hedges: REAL ESTATE & PRECIOUS METALS (Keep it simple)