Magazine article The American Conservative

Bringing Down the House

Magazine article The American Conservative

Bringing Down the House

Article excerpt

Why home prices won't rise again

THE FINANCIAL MEDIA and government officials are looking for a recovery in the housing market to "restart the economy." The entire world - or at least every exporter from Shanghai to Bonn who is desperately dependent on the free-spending American consumer - is hoping that housing is about to reascend to its glorious bubble-era heights. But that is not going to happen - not this year, not even in ten years, for several fundamental reasons.

1. Bubbles do not re-inflate in the asset class that just popped. Tulipbulb valuations did not rise again to stratospheric heights after the Tulip Craze went bust, nor did the NASDAQ dot-com bubble re-inflate, for the very good reason that bubbles are never based on rational valuations. They are the result of a psychological state of mania that cannot be reinstated once lost.

Consider tech stock Cisco Systems, a well-managed "real company" that continues to make profits providing goods and services. Having replaced the bankrupt General Motors in the Dow Jones Industrial Average, Cisco currently trades at around $17 a share, down from its dot-com bubble valuation of about $81 per share.

To recover its bubble-era valuation, Cisco would have to rise fivefold. That's highly unlikely. Now that the hysteria has dissipated, Cisco is valued on more rational metrics like earnings, profits, and cash flow.

Mania always moves on to a new asset class. After the dot-com bubble, speculators turned to housing. Once the housing bubble collapsed, the mania shifted to the bond market. Now that the bond bubble is bursting - that spike to nosebleed territory in December 2008 was the dead giveaway - the only asset class that hasn't already been blown into a bubble is precious metals and gold.

2. Inflation sets the "recovery" target ever higher. While we are in a deflationary period right now, a serious amount of inflation occurred between Cisco's peak in January 2000 and the present. According to the Bureau of Labor Statistics' inflation calculator, $81 in 2000 is $100 in current dollars. So Cisco would have to rise by that much more to match its bubble-era valuation. The same is true for housing.

Let's say a house that sold for $100,000 in 1995 was valued at $400,000 at the housing-bubble peak in 2006. If history is any guide, then housing will retrace to its pre-bubble valuation, as that is the usual progression of bubbles and their demises.

Now if inflation ramps up and ravages the value of the dollar, the price of a tangible good like a home might well rise more or less along with inflation, as people will be trying to turn their rapidly devaluing dollars into some tangible good as a means of preserving capital. But if inflation is clipping along at 10 percent a year, and the house returns to its bubble-era value of $400,000, that $400,000 doesn't retain the same purchasing power as it did in 2006.

Consider the stock market in the inflationary period of the 1970s. While the market wobbled from 1,000 in 1966 to 1,000 in 1982 16 years later, inflation destroyed two-thirds of the value of the dollar. According to the Bureau of Labor Statistics, which tends to understate inflation so as not to alarm the masses unnecessarily, $1 in 1966 was worth 34 cents in 1982. Thus people who held stocks for those 16 years did not retain their wealth as the Dow Jones retouched the magic 1,000 mark - they lost two-thirds of their investment.

It is easy to foresee the same thing happening in housing should inflation ignite. Over the next 16 years, the house that sold for $400,000 in 2006 may well rise once again to that nominal price, but the inflation-adjusted value could well be closer to $100,000 when priced in (pre-housing bubble) 1995 dollars.

This is why nominal prices in stocks, housing, and bonds are essentially meaningless. All assets have to be valued in terms of purchasing power, and as imperfect as any inflation/deflation gauge might be, it's still a better guide to purchasing power than nominal price. …

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