Houses Will Remain Too Expensive For The Forseeable Future?

[Guest Steve Cook]

World banks are currently trying to monetarily inflate debt away, thus passing the poison chalice onto the creditors. Presumably, this is because there are fewer creditors to vote a government in or out than there are debtors. In other words, the loss is born by the creditors as a result of being repaid in a debased currency due to increased monetary supply.

This may fail...

If it does, then one might expect a 1930s style contraction of the monetary supply as money is extinguished as a result of debt default.

However...

Fossil fuels (of which oil is the primary one) are going inexorably up in price. This is due to a peaking of supply and/or an increase in demand from emerging world economies such as China and India.

The above being the case, we could find ourselves in the unfortunate potential position of having less money to go round whilst at the same time facing a commodity supply driven increase in prices.

This will be particularly the case for essential commodities such as food and fuel. However, one might expect a crash in the prices of non essential commodities (ipods....etc). Alternatively, non-essential commodities might go through the roof in price and become the preserve of the very rich only.

How might this affect house prices?

Well....a contraction of the money supply might suggest a reduction in price. However, this would only be a nominal reduction since people would have less money to spend and so the burden of the debt would be just as great even if the headline price is lower.

An increase of the money supply might suggest that house prices could stagnate or even go up a bit in order to retain their value against a debased currency. This would likely represent a real reduction in price though if there is not a 1 to 1 increase in prices relative to the monetary supply. As mentioned in the first paragraph. The real term reductions in real estate value would be borne by the creditors as a consequence of being paid in an ever debasing currency. For the debtors, it would presumably be a good thing.

However...

Since the cost of all other commodities will be rising in price as a result of rising energy prices, house prices might still fall in both nominal and real terms as a result of falls in demand because people are having enough trouble paying for the everyday stuff (food, fuel etc).

This then raises the question of whether houses can be seen as being an essential commodity. At first glance you would think so. I am not so sure though. At least as far as the market stands at the moment. If things get really tight for everyone, they will stay at home longer. They will share houses more. They might rent more. This last point relates to the fact that it is going to be a lot harder for people to borrow money. Also, interest rates might start to rise again as a result of the lenders trying to offset the currency debasement.

So...

• A massive rise in the price essential commodities
  
• An initial monetary inflation followed by a contraction of the money supply due to a failure of this policy
  
• House prices nominally stagnate with a possible real terms drop (in monetary terms)
  
• However, because of the cost of other essential commodities, any drop will be insufficient and so houses will remain unaffordable for many people.
  

Any thoughts people?

Steve

Edited February 27, 2008 by Steve Cook

[IMHAL]

Any thoughts people?

Steve

1] Unless we have rampant wage inflation then people are going to get foreclosed due to the escalating prices of everything essential to life - the liabilities they have to service [mortgage, car loan etc] will be unmanageable.

House prices will crash period.

2] Unless of course the Fed/BoE starts essentially forgives this debt by sending everyone a cheque to cover their outstanding loans - then the real fun will begin as social order evaporates, people lose trust in fiat and everyone pulls their money out of the bank and buys whatever they can.

I suspect that they are trying to tread a line between 1 and 2 - currently they know that 1 is happening and fast and they are trying to ease the situation (in the states using fiscal policy and everywhere else using the IR string pushing method) with 2 but soon the laws of unintended consequences will kick in to make them think twice.

It is time the Arabs woke up and demanded more devalued money for their oil - that would send a shock wave through the globe - of course it may also send a couple of nukes their way too.

HAL

[bigsmelly]

I very much agree

and it scares me

[ParticleMan]

Any thoughts people?

Three.

The analysis presupposes a monopoly of supply. Houses have no price until BID and ASK cross on the day of exchange. And BID is mostly supported by borrowed capital - one month's wage, geared to a 25-30 year term. The gearing ratios available (to BID) have drastically fallen and will continue to do so throughout.

The analysis also presupposes zero counterparty (in this case, specifically default) risk. Clearly this will not be true. How do mortgagee defaults fit within your model of pricing dynamic?

Finally - the assumption of rising commodity prices derives from the assumption of rising consumption of those same commodities. And this will not occur in a recession (nor a depression) - where growth outlook is nil (or negative). As a tangentially related note - cost plus inflation (ie, assuming that energy pricing dynamics will feed through to commodity prices) is an interesting assertion, too.

[The Spaniard]

World banks are currently trying to monetarily inflate debt away, thus passing the poison chalice onto the creditors. Presumably, this is because there are fewer creditors to vote a government in or out than there are debtors. In other words, the loss is born by the creditors as a result of being repaid in a debased currency due to increased monetary supply.

This may fail...

If it does, then one might expect a 1930s style contraction of the monetary supply as money is extinguished as a result of debt default.

Only old debt can be "inflated away" by increasing the money supply.

Without monetary reform, any increase in the money supply must be borrowed into existence by someone, somehow.

This means that new debt will (more than) replace the old, and the debt unservicability problem will recur eventually, only much worse.

The alternative of debt default means a loss of wealth to the unfortunate creditors who hold that debt.

The money that originally came into existence with the (now defaulting) debt does not dissappear and the money supply does not contract as a direct result of debt default.

It is the banks ability to lend that contracts as their (debt-based) assets dissappear, and it is this that results in less new money entering the system.

[beefheart]

1. The general deflation has started. - credit tightening...affecting first pwoperty.

2. the oil price has risen primarily due to the iraq war.

In 2001 oil war around $25 barrel. Futures markets indicated 10 years of similar price.

The price rise is NOT because of peak oil.

3. Commodities are in a bubble now. this will burst.....biflation short-medium term.

As the west slows down so to does chinas export market ...hence demand for these commodities.

I still expect their internal markets to grow as the west falters.

4. When the asset bubbles have burst (houses and commodities...furthur down the line)

our currency will be so devalued and we will be a poorer nation.

5. Houses will see large nominal falls over the next 4 years. 2008-2010 being the worst.

None of this takes into account war with iran/russia/china.

[haggis]

Steve,

I think anything bought with credit will deflate. It'll be harder to get credit and the amounts made available will be reduced. This will reduce the pool of buyers and curtail what they can pay for property.

Your thoughts on commodity increases and how that pans out seem very likely. In the short term commodity prices may actually experience curtailed demand due to recession, but the long term trend is that there are more economies bidding for finite resources. Perhaps they're not necessarily finite in absolute terms but there are limits on production. For example, many will debate the whole concept of peak oil but what seems evident is that cheap oil is becoming scarcer. When the economic decision becomes heating your house and keeping the lights on, the priority will shift from pumping oil into autos to keeping the critical systems in place.

Housing is essential but it takes a lot of energy to build, maintain and in suburban situations, to provide infrastructure (that includes the homeowner running & maintaining a car).

[ARIMA]

And BID is mostly supported by borrowed capital - one month's wage, geared to a 25-30 year term. The gearing ratios available (to BID) have drastically fallen and will continue to do so throughout.

Very nicely put. I think that those quoting salary multiples ad nauseum, would be wise to recognise it's all about what one month's earnings can buy for you.