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.
Cheers.
Kris.
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Another extensively abused ‘shonk’ of the residential property investment circus are the maintenance costs (ie: the costs involved in maintaining your asset like repairs and renewal of worn out components and elements of the building itself) They are of course tax deductible. Seems reasonable when compared to other ‘business’ costs but the system is absolutely rorted by many property investment owners. Apart from getting home improvement works performed on their own residences and then getting it billed as maintenance work to their investment properties I know a bloke who has investment apartments in each of the capital cities. He claims the cost of business class air fares and first class hotel accommodation to facilitate the ‘inspection’ of his investment property portfolio each year and happens to have a bit of a nice holiday whilst he is there. Thank you very much wage and salary slave tax payers and of course this wouldn’t also be a factor feeding in to the increase in price of houses for people to purchase as a home – where no associated ownership costs are tax deductible -now would it?
Billy J @ 35 – looks like you are correct Billy.
http://www.ato.gov.au/individuals/content.asp?doc=/content/36899.htm
My aplologies cb I have misled you.
Thanks Billy J.
cb- do you see any similarites with greeces debacle as compared to australias ?
etch – I do, but this far only in rather etchy terms.
The main similarity is this:
1. The vampire squid that is Goldman Sachs has been doing deels on the quiet with the politicians over there, and see where it got the country in a mere handful of years!
2. Greece is not a unique case by any means. More and more countries where this abominable vampire squid has been reported to have been active, is suffering similar and commensurable fate.
3. Goldman Sachs has been similarly doing deals over here, quietly, mostly behind the scene. It has been once reported that it will be a big player in securing financing for mega projects, such as the NBN, and goodness knows what else.
ERGO:
4. The country is being whiteanted as we speak. Some of it we see, such as billions and billions borrowed on the national credit card being wasted largely on unproductive, retarded government programs, but most of it, like in the case of an iceberg, remains hidden and will only come to light when the robber barrons are ready to pull the plug on us and ring the cash registers as we go down, down, down.
But probably they are not quite ready yet. First they will probably want us to borrow still more from them, for the NBN, and whatever else, and when they feel that we have been sufficiently loaded, they will sell the Aussie short and pull the plug on us. So, in essence, it will be the same as with the others, but with a few years of dealy.
We will have to get the election out of the way, to be sure. Plus, China’s goose is still being cooked, and will probably not be ready for a few years yet. But when they are sent to the bottom, it will be easiest to send us with them at the same time, with the same push. When? My guestimate would be a few years only. Possibly 2013 – 2014. But what do YOU think?
Incidentally, there is a good discussion by Steven Keen on the latest Keiser Report. They also cover the big picture stuff, plus Keen’s expectations for Australia. It is worth watching for another opinion.
http://maxkeiser.com/
@ cb-64
i think not long after the elections over ,
then early next year, i reckon they will pull the plug
unless as in ur theory maybe they want to push it mega maxxed out
PTP
etch – Yes, that is a distinct possibility – probably a 50 – 50 chance from where we stand. If Rudd stays in government and remains compliant and will keep happily borrowing and stimulating, then that will do just fine for the vampire squid, as its bloodlust will be satisfied with the monstrous fees they will be collecting from us for stitching up the big deals for this and that mad scam.
If there is a change of government, or the government’s appetite for mad adventures goes away, then they will want to cash in on crashing the economy and the currency. Plus, an unfolding crash might just get the government to change its mind again and ask them for stitching up those mad infrastructure and goodness knows what nation building and nation saving plan.
Either way, the prudent thing would be to be ready for these eventualities. I fail to see how or why the robber barrons would want to spare us, especially given the massive pile of savings we have in compulsory super. They will want to get their dirty hands on that by fair means or foul. Of that I have little doubt.
Kris,
Out of control printing presses and the assocaited inflation are not a good thing, that’s to be sure. However you haven’t convinced me that property is not a good hedge against inflation, because:
1. M3 money supply and inflation are not the same thing. An increase in M3 is only inflationary to the extent it’s not matched by a corresponding increase in goods and services. If M3 grows at the same rate as the economy, then all things being equal we have no inflation. Of course M3 has grown faster, and we have had rampant inflation as a result. But we’ve also had some economic growth over that time, so inflation is not as high as you assume.
2. Yes, with high inflation, any equity you have in property will have it’s purchasing power eroded over time. However the value of the DEBT is also eroded over time.
A simple example I challenge you to refute:
You buy a $500k rental property with 20% deposit. Rental income covers your interest costs on the $400k debt, but no more. Over 10-15 years you pay off interest only and your debt stays the same, but property price doubles to $1M – lets assume largely due to inflation. You sell your property for $1M, pay off your debt, and have $600k left. So the return on your $100k investment was 500% – likely to be higher than inflation over that time , I would have thought?
Well said Mark, and judging by the lack of a response from Kris, appears to point out the anti-property spruikers are just as guilty as the property spruikers in painting the picture. What I suspect is the truth clearly lies somewhere in between ie. while property may not be a PERFECT hedge against inflation and it’s eroding ill effects, it still beats the hell out of anything else out there, unless of course someone in money morning points out yet another great stock pick or investment fund that has outperformed everyone else in the past X years, but nevertheless has the tiny print which states “past performance is not a guarantee of future results” leaving you at a gamble at best if you’re better off or not leaving your money in property.
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