We’ll poke a stick at property and inflation today.
Inflation, if mixed with deflation is fine. Prices rise, then prices fall.
But inflation by itself, well, that isn’t good at all. If you look at the chart below, you can see perfectly how the value of money has been devalued almost without break for the last fifty years:
According to the Reserve Bank of Australia (RBA) numbers on Money Aggregates, the M3 money supply has increased from the equivalent of $6.7 billion in 1959 to $1.19 trillion by the end of 2009.
In other words, the value of money over the last fifty years has fallen by 99.4%. To put it another way, the equivalent of a dollar held in 1959 is almost worthless if still held today.
Now, I know it’s not likely that you’ll have kept the same currency unit in your pocket or your bank account for fifty years, but the point is, thanks to inflation your wealth is being eroded on a daily basis.
Even if we look at a shorter time period, 1990 to 2009, you can see the M3 money supply has increased from $207 billion to $1.19 trillion:
That’s a depreciation of your dollar by 82.5%. And that’s just within the last thirty years.
The reason I bring this up is to try and settle an argument we’ve scoffed at but which the property spruikers are convinced is true. That is that property is a hedge against inflation.
That if you buy a property today it will rise in line with the prices of everything else and therefore your debt will be paid off easier because of inflation and you’ll be left with a higher priced house.
Our argument has been, “Where’s the proof that inflation and property prices are directly correlated?” And furthermore, we constantly warn anyone not to believe that inflation is your friend. By itself, inflation is always your enemy.
So far, the spruikers haven’t come up with anything to back their argument. So, our only course of action is to try and refute our own argument. We’re happy to try, it keeps us on our toes.
Below is a chart we knocked together using data from the Australian Bureau of Statistics (ABS) and the Reserve Bank of Australia (RBA). It compares the index values of ‘8 Capital City House Prices’, the Consumer Price Index (CPI), and the M3 money supply:
Now, before I go into too much detail, a quick note on the dates.
You’ll see it only runs from 1986 to 2005. Just to make it clear, we haven’t cherry-picked that timeframe for any particular reason. The only reason we’ve done that is the ABS changed the index calculation for house prices in 2005 and we didn’t want to mess around with trying to marry up the two sets of numbers.
Anyway, the dates aren’t as important as the comparison of the data sets over the same timeframe.
As you’ll note, using a logarithmic scale, the green and blue lines move almost in tandem.
In index number terms, the 8 Capital City House Prices index has risen from 61.3 in June 1986 to 251.9 in June 2005. That’s a 310.9% increase.
Over the same period, the M3 money supply increased from $125 billion to $678.5 billion. An increase of 442.8% in the money supply, or a decrease of 81.5% in the value of your money.
In percentage terms that’s a pretty big gap, but on the chart, well, it’s hard to see any difference. But, as we’ve pointed out before, you can’t just put two different data sets on a chart and claim there is or isn’t a correlation.
But in this instance, whether there is a correlation or not is irrelevant. We don’t need to prove or disprove it, we can simply look at the data and draw a simple conclusion. And that is, between 1986 and 2005 the M3 money supply increased by a greater amount than the value of the 8 Capital City House Prices index.
Therefore, we can say that during that period, house prices did not provide a complete or perfect hedge against inflation.
The divergence is more obvious if we use a linear scale:
The interesting point to note is by how much the official CPI number understates the impact of the devaluation of your money.
If you just take the 8 Capital City House Prices index and compare it to the CPI then you’d be left with the false impression that property is an inflation buster.
Whereas the truth is that the CPI number masks the real story. And that is the value of the dollar has fallen to such an extent that even the so-called housing boom has failed to maintain the value of your dollars.
In fact we can go even further than that and say that between 1986 and 2004, the real price of property would have dropped as the value of your dollar fell faster than the price of homes rose.
Look, we’re sure the property spruikers won’t like that, and they’ll set their Phasers from stun to kill, but those numbers speak for themselves.
If you accept the fact that creating more money has a devaluing effect on the money already in circulation, then you must also accept that you need to take the real rate of inflation into account when valuing an asset after a specific time period.
In this case the value of the 8 Capital City House Prices index has failed to keep pace with the increase in the money supply – M3.
Of course, articles such as this one from Peter Boehm over at Yahoo! Finance prefer to use the CPI when he claims, “Combine this with a return to stable economic conditions and relatively low and stable interest rates and you have the necessary ingredients for home prices to increase well ahead of inflation.”
He’s referring to the growth rates required to make the median house prices in Sydney, Melbourne and Brisbane $1 million by 2019:
The trouble is, by 2019, if the increase in the money supply is anything like it’s been over the last ten years, then the 117.8% increase for Brisbane will have been dwarfed by the 184% increase in the money supply:
Simply put, the increase in property prices won’t have kept pace with inflation.
We’ve heard plenty about “Property Millionaires”, yet the reality is that they don’t exist in the way the spruikers would have you believe.
What they should really be called are “Property Debt Millionaires.” $1.1 million of assets and $1 million of liabilities. Waiting for the so-called ‘equity’ in the home to increase and then withdrawing more cash to take out more debt.
Isn’t there a saying about ‘credit’ being the only difference between the hobo on the street and the majority of home owners?
So, when the spruikers talk about the median house price reaching $1 million in 2019, just remember a couple of things…
First, a million dollars in 2019 won’t be worth what a million dollars is today or ten years ago.
And secondly, if you look at the chart below:
If owner-occupied housing loans increase at the same rate as they have over the last ten years, then even though the median house price very well could be $1 million by 2019, odds are the median mortgage won’t be far behind.
The upshot is, by these numbers you can argue property prices have already fallen. But that’s only the half of it. So far, the insidious effects of inflation have meant borrowers are suffering a silent ‘debt-death’.
The realisation and the pain will be more obvious when borrowers experience an actual fall in the price of housing in dollar terms. Contrary to mainstream belief about Australia missing the housing crash, the facts are it’s likely to happen sooner than we all think.