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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This is what you get. When an aussie sells an asset he buys food / beer / car / consumer goods / junk.
When a chinese sells an asset they buy a more expensive asset.
ALSO We sell china heaps of raw commodoties as well as services such as tourism / education. we use the proceeds of this to buy t.v’s /toys / and junk that is made in china.
When China sells finished goods to us, they use the money to buy aussie assets e.g. YOUR HOUSE. they do not buy aussie junk.
Have a look at that before you complain. oh and buy more junk please, we chinese want more of your assets
Hmmm … I have the fealing that we are failing to capitalise on this article. It would be good to have some specific comments, before we move on, to some of the key claims made, such as:
1. Has property been a reasonable hedge against real inflation, where inflation is defined as excess money hitting the economy relative to GDP?
2. Is Sayce right in claiming that M3 alone represents the degree to which the value of the AUD has been diluted? I suggested that this is not so, as M3 should be adjusted downwards by the GDP to get a more reliable measure of real inflation. It seems to me that the CPI adjusted growth of the economy should not be counted and considered to be inflation. But what do YOU think of this?
3. If we adjusted M3, as suggested, by a CPI adjusted GDP as a better way of calculating actual inflation, how does this affect Sayce’s numbers, and namely the gaps he says there is between house price and M3 growth?
4. Do you think that growth in M3, or more accurately, inflation (if we can gain a more accurate measure of inflation) has anything to do with house price appreciation? Or do you think that house price appreciation is due to some other, more plausible factors, and if so, what might these be?
Kevin B @ 39 – yes if a depression hits asset values will fall.
Agreed.
JC @ 35
The comment you provided from the presentation that outstanding loans to total value of housing is only 30% might be true. However, wouldn’t the more accurate and realistic measure be to count only property for which their was finance attached. It seems a little misleading to include the “value” of property for which there is no finance attached, and thus there is no debt service ratio / stress level / etc.
It seems rather convenient to count in a significant chunk of asset value with no debt attached…
PF @ 10
Your comment was “the increase in value of property is twofold, first in the inflation of the value of the property itself, and second in the devaluation of the debt by that same rate of inflation. If in the meantime rental equals interest cost then voila you have a gain.”
I am probably more than a little stupid, for investment property rental to equal interest cost, what sort of equity (eg. 20%, 30%) would you need to tip in to make this equation work. I haven’t lived in Australia for about 6yrs, but I remember it was extremely difficult to cover a mortgage payment with rental income without at least 20%-30% down.
The Wolf – ah, that is where negative gearing is used as a rationale for holding these dollar burning investments on your balance sheet. The typical reasoning goest something like this:
Instead of being taxed on your income you want to use for investment purposes at your marginal tax rate, which could be 30 or 40%, you use it to service the loan, helped by the rent you collect, on a negatively geared investment property, and thus treat that portion of your income as a tax deduction. Then, when you sell your appreciating asset at a profit, you will pay tax only on half of the capital gains you realise, which itself is further adjusted downwards by the CPI. Earning an income through capital gains, in other words, is more tax effective, than it is to pay high taxes at your top marginal tax rate. Hmmm… something along those lines, anyhow.
The Wolf – regarding the ratio of equity vs debt question, this is indeed important, and in more ways than at first would meet the eye.
Regardless of how you decide to calculate the ratio, it is subject to a great deal of uncertainty and potential volatility. In a housing crash, for example, the equity side of the equation will rapidly diminish, whereas the debt will stay the same.
And while this would be bad enough all by itself, it would also hit small business’s ability for capital formation, as I have been trying to argue earlier. You cannot secure a business loan against a property with absent or greatly diminished equity. Just how much we are going to be hurt on this front in the event of a property crash will probably surprise most people, seeing that there is virtually no discussion of this aspect of the property market.
While prices are rising, rising equity provides the economy an important avenue for small business borrowing for capital formation, but in property downturn this avenue will be cut off, and small business bankruptcies will probably go through the roof as a consequence. These in turn will hit household incomes and employment quite hard. That would be my expectation, anyhow.
Hi all, I am a fairly regular reader of these blogs, but a newbie when it comes to having a comment, although I have opinions often.
This one got me thinking which lead to me not sleeping as I remembered a sticker or something I once saw, it said “he who has the most wins” or something like that!
My question is the “most” what? The most money, property, toys or should is it something else?
This debate is great and as has been covered the CPI etc stats we are all told are rubbish and although I don’t totally agree with all of what Kris has to say I think he is making a great point with this one but maybe we should be thinking about this more simply.
If Kris or somebody has the time I would love to know the following, or similar, and maybe see it in a graph and the information would be great to see for a longer period than just 5-10 years for relevance (By the way I am a bit of a gold bug)
1. Average wage – in ounces of gold.
2. Average house price – in ounces of gold.
3. Cost of a standard new Commodore – in ounces of gold
4. Cost of a barrel of oil – in ounces of gold
5. Cost of a slab of Crown Lager – in ounces of gold
6. Cost of a families grocery bill – in ounces of gold
If it were all in AUD’s it will answer the main question of whether we are moving forwards or backwards and will take into account the exchange rates which I think needs also to be considered.
Based on cuurent figures (Gold = 1238.86 AUD/oz, AUD/USD = 0.8892), here is a start.
4. you can buy 14.019 barrels of oil for one oz of gold. (77.58 USD/barrel)
5. you can by 24.78 slabs of crown lager for one oz of gold. (49.99 AUD/slab)
And another interesting stat is it would take 3.75 oz of gold to buy the ASX200.
All this data would provide some relevance and if compared to other countries for housing, wages etc might tell us where we really are and have been.
It will also provide a guide to what’s happenng to our standard of living, which is really what is important, not the BS CPI figures we are fed!
Hope someone is interested and can help, cheers.
The Wolf @ 46 – with a 20% deposit you should be positively geared. That could vary slightly, but I’m not one who believes that negative gearing is that much of a plus. Losing money is not as attractive as gaining money IMHO.
But you need to buy well – if you don’t do that then your % return is lower and CGT may not be there for many years.
PF, thx.
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