Debtwatch No. 25: How much worse can “It” get? [Archive]

View Full Version : Debtwatch No. 25: How much worse can “It” get?

FRED

08-04-08, 01:45 PM

http://www.itulip.com/images/keenabcau080408.jpgDebtwatch No. 25: How much worse can “It” get?

by Steve Keen

Editor's Note: Since our last interview with Dr. Steve Keen (http://itulip.com/forums/showthread.php?t=3631), he has made a number of Debtwatch updates to his excellent Debt Deflation blog (http://www.debtdeflation.com/blogs/) where he chronicles the over-expansion and collapse of the Australian debt bubble. Read his update below and listen to his interview on ABC here and you'll swear he's talking about the US, except for the part about the resources export boom – and the Australian accents, of course. Steve's economic philosophies can be distinguished from the mainstream in two vital ways. First, they account for the critical role that private sector debt plays in creating demand, a factor of demand that most economists prefer to regard as ancillary and insignificant. Second, events tend to unfold the way his theories predict, which puts him completely at odds with most economists.

We are believers in Steve's debt deflation theory, and in fact named our 2008 bear market call after it. I'm interviewing Steve today to get back to the crux of the issue: how does debt deflate in the US, via monetary inflation or deflation? Now that the debt deflation is here, is the demand loss caused by debt deflation responsible for recent declines in commodity prices? Will they continue or will the US government monetize debt and send the dollar reeling again, deflating dollars against hard assets? Stay tuned. We'll make the interview available later this week. - Eric Janszen

Last month closed with some far from comforting news about the state of the US housing market (sales and prices still falling), US financial institutions (Fannie Mae and Freddie Mac in need of rescue), Australian banks (NAB’s 90% write-down of its US CDO portfolio). Then ABS figures showed that retail sales had fallen “unexpectedly” by one percent in June. The recent rally in stock markets came to a sudden end, and after a brief period of renewed confidence, the question “how much worse can “It” get?” is once again doing the rounds.

My answer is: a lot worse. The empirical grounds for this assessment are:

The ratio of asset prices to consumer prices–or the inflation-adjusted asset price index;
The ratio of private debt to GDP; and
Japan

In short, global asset markets have a lot further to fall, and a serious recession–the worst we have experienced since the Great Depression–is inevitable. Let’s first look at what the recent drop in retail sales implies for the economy.

http://www.itulip.com/movies/20080804-latebiz-keen.wmvInterview with Dr. Steve Keen on ABC July 4, 2008
(You must be a Registered User (http://itulip.com/forums/register.php) to see the video)

The USA: Double Bubble

While the Dow has fallen substantially in the last year, its inflation-adjusted value is still three times its long-term average, and more than 4 times its average prior to the start of this bubble. Even if the index falls merely to its long term average, it still has another 62% to go (in real terms) from its current level. If it reverts to its pre-bubble average, it has another 73% to go.

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0014_46638031.PNG
Figure 1

If those figures seem ludicrously pessimistic and unrealistic to you, take a look below at the CPI-adjusted Nikkei–which fell 82% from its peak at the end of 1989 to its low in 2003. At the time, most commentators blamed Japan’s Bubble Economy and subsequent financial crisis on the opaque and anti-competitive nature of its financial system. We were assured that nothing so ridiculous could happen in the transparent, competitive and well-regulated US financial system.

Yeah, right.

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0017_46638062.PNG
Figure 2

The story for the US housing market is little better. The index has already fallen 23% from its peak in 2006. A reversion to the long term mean implies a further 38% fall in the average house price in America; while reversion to the pre-Bubble mean implies a further 41% fall.

Write-downs by US financial institutions certainly haven’t yet factored in that degree of possible fall in housing values, and as Wilson Sy, the cheif economist at APRA, pointed out recently in two brilliant research papers (1 (http://www.apra.gov.au/RePEc/Home.cfm?ArrayProcessed=True&FileItemID=wp2008-03&SeriesName=Working%20Papers) 2 (http://www.apra.gov.au/RePEc/Home.cfm?ArrayProcessed=True&FileItemID=wp2007-01&SeriesName=Working%20Papers)), the banks’ “stress test” modeling greatly under-emphasizes the impact of such asset price falls on their financial viability. House price falls in the USA are far from over, and likewise “unexpected” write-downs by US financial institutions.

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0020_46638125.PNG
Figure 3

Overall, if US markets fall back to their pre-Bubble levels, the stock market will plunge about 80% from its peak (much the same degree of fall as applied in Japan) and the housing market will fall 55% (rather more than happened in Japan, where average house prices fell 44%–but less than Tokyo, where they fell over 70%).

The unique feature of this US asset bubble is that it affects both stocks and houses. There have been three Stock Market Bubbles in the USA in the last century: the “usual suspects” of the 1920s and 1980’s, but also one that doesn’t normally rate a mention: a ’60s Bubble that peaked in 1966, and was followed by a slump that only ended in mid-1982 (see Figure 6).

As Figure 6 indicates, this dual bubble has no precedent. Not only is it a bubble in both asset markets, both bubbles dwarf anything previously experienced. Even the great Roaring Twenties stock market bubble barely pokes its head above the long term average, compared to the 2000s Stock Market bubble–and in the 1920s, as Figure 4 shows, the housing market was relatively undervalued. The over-valuation of today’s housing market far exceeds the now comparatively minor bubble when Keating (Charles, not Paul) was on the loose in the USA.

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0023_46638125.PNG
Figure 4

While the Australian Stock Market is not as severely overvalued as the American, it is still substantially over its long term trend. Even after the recent falls, the inflation-adjusted All Ordinaries Index exceeds its level before Black Tuesday in 1987. It has another 30% to go before it will have reverted to the mean of the last 25 years (see Figure 5).

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0026_46638140.PNG
Figure 5

The prognosis for the Australian housing market is substantially worse. Even on short term data–covering only the last 22 years–the market could fall 40% if it reverted to the mean, and 50% if it reverted to the pre-bubble mean. Nigel Stapledon’s research into long term house prices in Australia–which is not shown here–implies an even greater potential for a fall in house prices.

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0029_46638156.PNG
Figure 6

Of course, such talk can seem nonsensical and alarmist. Especially if you ignore what happened in Japan.

Japan: the world’s most recent debt-deflation

Japan clearly underwent a debt-deflation after its “Bubble Economy” spectacularly burst in 1990. In its aftermath, house prices across Japan fell on average by 42%, and by over 70% in Tokyo (though they have since recovered slightly).

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0032_46638156.PNG
Figure 7

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0034_46638171.PNG
Figure 8

What has happened there can happen in Australia, the USA, and the rest of the OECD–especially since our Bubbles, while smaller than the Tokyo bubble, are larger than that for Japan as a whole (see Figure 9).

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0037_46638171.PNG
Figure 9

The killer behind the Bubble: Debt

The level of over-valuation of asset markets reflects the unprecedented scale of private debt, both here and in America–since the vast bulk of that debt was undertaken to finance “Ponzi” speculation on shares and housing. This is the reason that this recession will be so severe–as will the asset market bust.

Every “recovery” from a debt-induced recession since 1970 has involved resumption in the tendency for debt to grow faster than GDP (see Figure 12, where the once seemingly major debt crisis of the late 80s is now just a pimple on the upward trend of the debt ratio to its current unprecedented level).

Yet today the debt to GDP ratio is more than twice that of the Great Depression. It is simply cannot go any higher. Who else, after all, can banks lend to, now that they have exhausted the “subprime” market?
The only way for the debt to GDP ratio now is down (unless we’re unlucky enough to experience deflation, in which case the ratio will rise further, as in the Great Depression), and as it heads down, so will output and employment. A serious recession is inevitable.

Welcome to “the recession we can’t avoid”.

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0044_46638187.PNG
Figure 10

An “unexpected” fall in retail sales

Retail sales fell sharply in June, taking most economic commentators by surprise. Even perennial optimists, such as Shane Oliver, were forced to consider that the odds of a recession were “at least 40 percent”.

In reality, the fall in retail sales was inevitable. Spending in Australia has been driven by the biggest debt bubble in our history, and when that bubble peaked, spending had to fall. Since households had taken on a far larger share of debt than business during this bubble, the impact was bound to be seen first in retail sales, rather than investment spending, as I pointed out in November 2006: “If households reduce their debt levels smoothly, they will have less disposable income to spend and retail sales will slump. If bankruptcies become widespread, the sales downturn will be overlaid with a financial crisis.” (Debtwatch, November 2006, p. 18;
See http://www.debtdeflation.com/blogs/pre-blog-debtwatch-reports
The suddenness of the turnaround is also no surprise, when you look at the data from a financial point of view. Just as your personal spending each year is the sum of your net income plus the change in your debt, aggregate spending for the economy is the sum of GDP plus the change in debt. As debt rises, the contribution made to spending by any change in debt also rises. Private debt–and household debt in particular–has risen so much in Australia that, at its peak, the change in debt was responsible for almost 20 percent of aggregate demand.

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0005_46637968.PNG
Figure 11

As is obvious in Figure 1, debt’s contribution peaked at the end of 2007, and it has been falling ever since. The monthly figures make this even more obvious (Figure 1 records change in debt over a whole year). The monthly increase in total private debt peaked at $30 billion in mid-2007, and trended up to $27 billion by the end of 2007. It has since fallen to a mere $5 billion in the month of June (see Table 1 and Figure 12).

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0008_46637984.PNG
Table 1

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0011_46638000.PNG
Figure 12

At some point, it will turn negative, and change in debt will therefore substract from aggregate demand rather than adding to it. Given that at its peak, debt financed almost 20 percent of demand, even stabilising debt at its current level–$1.85 trillion, compared to a GDP of $1.1 trillion–would result in a 20 percent fall in aggregate demand.

This hit will be felt by both asset and commodity markets: asset prices will fall, as will output and employment. The government’s attempts to counter this–by running a deficit rather than a surplus–will initially be swamped by the sheer scale of the turnaround in debt-financed spending. Even if the government runs a deficit of A$20 billion–the same scale as this year’s intended surplus–it will make up for less than a tenth of the fall in debt-financed spending.

The current “credit crunch” is, therefore, only the first act in a long-drawn out process of reducing debt levels. The second act will be “the recession we can’t avoid”. That recession–which will affect most of the OECD, since all major OECD nations bar France have suffered a similar blowout in private debt levels–will only add to the current decline in asset prices.

iTulip Select (http://www.itulip.com/forums/showthread.php?t=1032): The Investment Thesis for the Next Cycle™
__________________________________________________

To receive the iTulip Newsletter or iTulip Alerts, Join our FREE Email Mailing List (http://ui.constantcontact.com/d.jsp?m=1101238839116&p=oi)

Copyright © iTulip, Inc. 1998 - 2007 All Rights Reserved

All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Nothing appearing on this website should be considered a recommendation to buy or to sell any security or related financial instrument. iTulip, Inc. is not liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. Full Disclaimer (http://www.itulip.com/GeneralDisclaimer.htm)

Spartacus

08-04-08, 04:02 PM

Fred and/or Eric, how is iTulip distiguishing

disappearing fictitious value

from

debt deflation

and do you have a guesstimated relationship?

I'm assuming the relationship is much tighter with real estate than it was with the Internet collapse, where several trillion in fictitious value was written off, but there was little debt deflation because

1. it was not the banks doing the writing off
2. FED rate reductions / new bubble blowing

Debtwatch No. 25: How much worse can “It” get? (http://www.debtdeflation.com/blogs/2008/08/04/how-much-worse-can-it-get/)

by Steve Keen

whitetower67

08-05-08, 12:48 AM

So how does this relate to potential commodity price deflation, i.e. oil, metals (especially gold), foodstuffs, etc?

ddk

08-05-08, 05:40 AM

Oh my. I had a sudden insight into how bad it had gotten when I was skimming the filled-in graphs in Fig 3, and realized I had to squint to see if the data stopped or went vertical to zero on the right edge. My brain never used to consider "suddenly plunging vertically to zero at the right edge" as a plausible reading of a graph.

FRED

08-05-08, 05:57 AM

So how does this relate to potential commodity price deflation, i.e. oil, metals (especially gold), foodstuffs, etc?

We explain that in the interview done yesterday and published later this week.

netdance

08-05-08, 11:13 AM

There's one problem that I see with one of the charts - the Nikkei chart only goes back to 1980 - the start of the boom. Since the Nikkei goes back to 1950, the chart is meaningless.

Not saying that the premise isn't valid, its just that that chart does nothing to support your thesis, and the mistake makes me question the rest of the article.

Easily fixed - just get a Nikkei chart that goes back to 1950, and draw a new line - I'd be interested in seeing that.

tombat1913

08-05-08, 12:35 PM

jimmygu3

08-05-08, 12:53 PM

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0014_46638031.PNG

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0020_46638125.PNG
Figure 3

Overall, if US markets fall back to their pre-Bubble levels, the stock market will plunge about 80% from its peak (much the same degree of fall as applied in Japan) and the housing market will fall 55% (rather more than happened in Japan, where average house prices fell 44%–but less than Tokyo, where they fell over 70%).

The unique feature of this US asset bubble is that it affects both stocks and houses. There have been three Stock Market Bubbles in the USA in the last century: the “usual suspects” of the 1920s and 1980’s, but also one that doesn’t normally rate a mention: a ’60s Bubble that peaked in 1966, and was followed by a slump that only ended in mid-1982 (see Figure 6).

Has Steve Keen heard about how manipulated the US CPI is? Note how both charts shoot up after the 1982 changes were made. And then they really take off after the mid-'90s changes. Why do we use government CPI on iTulip? It's apples and oranges and we all know it.

By my calculations, pre-1982 methodology (thanks to bart and shadowstats) puts the real CPI at about 2.7x the official CPI. The Dow level of 888 in the top chart would really be 329, 36% above the pre-bubble (and pre-CPI-rigging) average. The current housing index level would adjust down to just 65, 37% below the average of 103.

The housing bubble is over as far as fictitious value and speculative pricing. However, tight credit markets, recession and unemployment will continue to pull housing prices down, but it's not because they're higher than historical norms. As the real CPI indicates, and as I will show you in the example below, they are lower.

I picked 1955 randomly, as it was about 50 years ago, but just about any year would tell a similar story. In 1955, you could get a median, 1200sf home for $10,950. That's about 313 oz. gold, 3,950 barrels of oil, or 2.65 years' salary. 50 odd years later, you can get a median, 2352sf home for $213,000. That's 240 oz. gold, 1775 barrels of oil, or 4.6 years' salary. Much better value in gold or oil terms, but you have a higher percentage of income going to housing than in 1955. No worries, you can always opt for that cute '50s ranch for $108,675- only 123 oz. gold, 905 barrels of oil, or 2.35 years' salary! Cheaper than it was 50 years ago by any standard (except the ridiculous government CPI).

Jimmy

dbarberic

08-05-08, 02:12 PM

how does debt deflate in the US, via monetary inflation or deflation?

Interesting mind twist which I never considered before. Inflation/deflation of debt are two sides of the same coin. Both accomplish the same thing, elimination of bad debt. Deflation simply marks the true value of bad to market, while monitary inflation maintains the nominal value of the debt, but the real value is slowly eliminated.

orion

08-05-08, 02:49 PM

netdance

08-05-08, 03:11 PM

Why do we need a longer timeframe on the Nikkei chart? Well, that depends on what period was used to compute the average level - if it was computed starting at a "normal" level, like the other charts, then fine.

If, on the other hand, it was computed using just the bubble prices and the resultant crash, then it doesn't actually say anything - of course it's currently trading at below the average, it's not using any non-bubble distorted data. You could draw a line in housing starting at, say, 1995, and see much the same thing.

If you want to prove the point that prices revert to a mean, you need to pick a mean that actually makes your point. Starting the Nikkei price at the beginning of the bubble doesn't do that. Starting it at 1950 would - which is why the other charts start so far back in history.

Oh, and in case it's not obvious which chart I mean, I'm referring to chart 2.

netdance

08-05-08, 03:22 PM

Jimmy -

First, we agree completely regarding the point of CPI - though keep in mind that the way the CPI used to be figured included housing costs, and now they don't - so all you're really doing by reimposing the old standard is deflating housing costs by the difference in housing costs, which is kinda circular, and may not lead to the results that you were looking for.

And while it's true that the housing bubble may be over for some portions of the country (much of Florida, Sacramento, etc), don't forget that in many parts of the country (Silicon Valley, LA, NYC) housing is still way, way off from historical norms. For instance, that 1200sf 1950 bungalow you mentioned is still selling for $500k 'round my parts - after being only $300k 8 years ago. Not exactly the $100k that you're proposing.

The point being that there's a lot further down to go nationally than you think.

jimmygu3

08-05-08, 03:48 PM

Jimmy, That is a great issue about whether true CPI vs government numbers are used in the graphs. When you say that the housing bubble is over though I question that as other historical trends (like Case-Shiller) and analyst like Ms. Meredith Whitney call for further falls like 10 to 50%. This also makes me wonder if CPI (using true value) evaluations square with other metrics such as P/E (for stocks), X times salary = house price, etc.

The currency in the ratios you referenced cancels out, so CPI has no effect. A stock's P/E is the same in 1955 dollars, 2008 dollars or Zimbabwe dollars. The ratio of your income to your home price is also a ratio that is independent of the currency used, as long as the same is used in the numerator and the denominator.

When I said "housing bubble is over as far as fictitious value and speculative pricing", I in no way meant that prices will not fall further. That's why I immediately followed up with "tight credit markets, recession and unemployment will continue to pull housing prices down". My point was that we are now in the overshoot phase of the process, having passed the historical mean. My data shows that the current price of 2.9 gold grams per sq ft is lower than any point in the last century, other than the top of the 1980 gold bubble. Anyone who expects gold to rise and housing to fall should realize that pushes the ratio further into uncharted territory. It will eventually correct toward the historical average of 5.7 gg/sf.

Doesn't mean it won't get a lot uglier, just means the deals will be even better at the bottom. When production picks back up, I expect it to be geared toward smaller, energy-efficient homes.

Jimmy

jimmygu3

08-05-08, 03:56 PM

c1ue

08-05-08, 04:01 PM

netdance

08-05-08, 04:06 PM

08-05-08, 04:24 PM

They're referencing a specific asset hyperinflation which occured within that period of time shown in the chart. Why do we need a longer time frame?

Thank you for the kind words.

Dr. Keen is a rigorous and careful researcher. His knowledge of economic history is encyclopedic. Conversing with him is a treat, although you have to be ready to be interrupted every ten minutes because while Steve is not well known outside Australia he is highly sought after by the press there.

To your point, if you extend the NIKKEI time frame back to 1950, indeed all that happens is that you find that the average price that Dr. Keen shows, holds; standard academic practice is to display the minimum relevant data necessary to accurately convey your point. This is not standard practice among the economics hacks we often come across on the Internet, so I can understand the other reader's question.

The internet with respect to economic debate is like watching a pool tournament comprised of professionally trained masters who have been playing all of their lives up against children who hold the cue like a fork and poke at the balls like they were checking on a fire. The difference is that in pool when a child knocks a ball into a pocket everyone knows it was luck, but in the Internet arena of economic opinion competition a master like Keen can get all the balls in at one run but lose to amateurs who are ideologically more popular who are viewed as displaying streaks of genius for getting a single ball in by random chance.

jimmygu3

08-06-08, 10:34 AM

" Of course, the people living in $500k bungalows generally make a lot more than $46k, too."

Actually, you'd be surprised. Prop 13 means that nobody sells a property unless they're flush - because property taxes are only set at time of sale. Thus, many of those neighborhoods are chockablock with folks who could never, and I mean never, afford to purchase those homes.

Near where I live, the $1.2 million dollar homes mostly have families making $80-100k living in them. Not sure about the $500k homes, but I suspect that you'll find most families living in them make $50k.

BTW - this is Silicon Vally, though I'm told LA is just as insane.

People bought houses for 10x-15x income? Insane is right. :eek: I have a friend who used to be in the mortgage biz who says, "You'd be amazed at how much money people don't make."

I'll correct my earlier statement: The NATIONAL housing bubble is over as far as fictitious value and speculative pricing. However, tight credit markets, recession and unemployment will continue to pull housing prices down, but it's not because they're higher than historical norms, EXCEPT IN SOME AREAS WHERE PEOPLE ARE CRAZY.
I just did a quick search here in my home city of Atlanta and found a 3br 2ba ranch for $110,000 (http://www.metrobrokers.com/listings/flyer.asp?mlnum=2319887) in a convenient in-town location. The average American family making $46k can easily afford this home. Year built? 1956. :)

Smaller, more affordable homes for all!

Jimmy

jimmygu3

08-06-08, 11:24 AM

JG,

The analysis you are doing with respect to g-AU/sq. foot is interesting, but you have to keep in mind that gold was basically a fixed price commodity up until 1973.

This skews the value of longer term historical precedents.

Furthermore having gold as a fixed reference reduces the value in your assumptions because there is no longer a fixed reference point.

We could have a commodity bust where gold drops to $500 of inflated US$, but housing stays the same. We could have a 'peak oil/peak food' scenario where housing stays the same due to government efforts, but gold prices shoot up.

In an era where the convertability of fiat currency to gold is a variable, I caution you to rely on historical precedent.

After all, even the values post 1973 for gold could be said to be a wild oscillation as gold attempted to find an equilibrium value, and it is equally safe to say that such a level - if it exists - has not yet been found.

I don't see how gold being a fixed-price commodity makes the data any less relevant. The gold standard essentially priced everything in gold terms, which is what we are doing.

As you can see, there was a slingshot effect as the gold standard was abused through the '60s, then abandoned in 1972, shooting gg/sf past the mean and bottoming in 1980, then finding equilibrium around 4, +/-10%, during the '80s and '90s. Even with all the gold manipulation in the last century, the ratio stayed between 3.6 and 7.8 for 60 of the last 75 years. Currently we are at 2.9.

http://www.itulip.com/forums/photoplog/images/1651/1_GoldPerSF.jpg
http://www.itulip.com/forums/photoplog/index.php?n=85

JKD

08-06-08, 11:53 AM

I picked 1955 randomly, as it was about 50 years ago, but just about any year would tell a similar story. In 1955, you could get a median, 1200sf home for $10,950. That's about 313 oz. gold, 3,950 barrels of oil, or 2.65 years' salary. 50 odd years later, you can get a median, 2352sf home for $213,000. That's 240 oz. gold, 1775 barrels of oil, or 4.6 years' salary. Much better value in gold or oil terms, but you have a higher percentage of income going to housing than in 1955. No worries, you can always opt for that cute '50s ranch for $108,675- only 123 oz. gold, 905 barrels of oil, or 2.35 years' salary! Cheaper than it was 50 years ago by any standard (except the ridiculous government CPI).

Jimmy

Excellent thought experiment. Perhaps that is just telling us that gold and oil were underpriced in 1955 though (or overpriced now). Using income as a measuring stick is much more useful for obvious reasons, low volatility being just one. As you've shown, it takes much more income to purchase the median home today, but the median home is much larger.

This brings me to my main point, I don't think square footage is as important as one might think at first blush when comparing the two periods. In my neck of the woods (north of Chicago), a very large percentage (over 100% in many areas that have become tear-down zones) of real estate appreciation from 1996-2006 can be attributed to land price increases. I believe this goes for most metro areas that have participated in this bubble.

I have no idea what the standard deviation of this series is but 4.6 years of salary vs. 2.65 years of salary seems like a very significant diversion from the mean to me. Certainly some of it can be attributed to larger home sizes but I am skeptical that it is very much. I do not think there are very many bubble areas in the US where the average 2,000 sf house costs anywhere near as much as twice the average 1,000 sf home. Again, due to the high levels of land price appreciation in these areas.

This has been much more of a land bubble than a house bubble, and downplaying the size of the bubble (as measured by income) by discounting it by house-size will understandably lead you to believe that it has already deflated more than it actually has. IOW, I think there is a good bit more fictitious value to come out of this bubble before we get into the overshoot.

John

Aerius

08-06-08, 12:21 PM

I agree with jimmygu3's comment about using different measures of CPI over time. For example, if you assume that "real" inflation was 2-3% above the official rate since they changed the way it was calculated in the mid 90s, that would have a compounded effect of around 40% today.

Using Japan as a proxy for the real estate market is also suspicious at best. Japan has a declining population and the US has a growing population - that is a huge difference considering every person/family only needs 1 house. That's akin to using Detroit as the benchmark. Real estate values were dropping due to negative wealth effects and declining population even when it was booming everywhere else.

Regarding the stock indices, well.. that one is tougher but we have already had our version of that here, it was called NASDAQ in 2000. From peak to trough it dropped 75%+ which is comparable to what you are seeking. However, like Nikkei, the drop was preceded by ridiculous valuations and speculation. Compare that to a less frothy index like the DOW which only dropped 35%. Clearly outrageous valuations play a big factor and it's pretty presumptuous to peg it all on debt deflation in one broad stroke.

So basically while I found the analysis interesting, I think it is more like a "worst case scenario" rather than the likely one.

jimmygu3

08-06-08, 01:29 PM

Excellent thought experiment. Perhaps that is just telling us that gold and oil were underpriced in 1955 though (or overpriced now). Using income as a measuring stick is much more useful for obvious reasons, low volatility being just one. As you've shown, it takes much more income to purchase the median home today, but the median home is much larger.

This brings me to my main point, I don't think square footage is as important as one might think at first blush when comparing the two periods. In my neck of the woods (north of Chicago), a very large percentage (over 100% in many areas that have become tear-down zones) of real estate appreciation from 1996-2006 can be attributed to land price increases. I believe this goes for most metro areas that have participated in this bubble.

I have no idea what the standard deviation of this series is but 4.6 years of salary vs. 2.65 years of salary seems like a very significant diversion from the mean to me. Certainly some of it can be attributed to larger home sizes but I am skeptical that it is very much. I do not think there are very many bubble areas in the US where the average 2,000 sf house costs anywhere near as much as twice the average 1,000 sf home. Again, due to the high levels of land price appreciation in these areas.

This has been much more of a land bubble than a house bubble, and downplaying the size of the bubble (as measured by income) by discounting it by house-size will understandably lead you to believe that it has already deflated more than it actually has. IOW, I think there is a good bit more fictitious value to come out of this bubble before we get into the overshoot.

John

Your points are well taken. Years from now, the charts will tell at what point we truly hit overshoot. I agree it's a land boom. Prime city neighborhoods have boomed while suburbs and exurbs have lagged.

FWIW, I have been created a spreadsheet of every home sale on my street since 1975. My goal was to find a trendline and a formula for predicting home prices. I tried many combinations of weighting land value + structure value, only to find that the method with the lowest standard deviation is simple square footage.

I have found that the tear down market is a completely separate animal from the existing housing market. It provides a floor for prices of very small or run-down homes, but does not add to the value of larger ones. For example, in my area a tear-down might go for $400k, a 1500sf home for $450k, a 2500sf home for $750k, and a 4000sf McMansion for $1.2m. That's $300/sf. Logic might dictate that if the lot is worth $400k, then a lot with a 1500sf home would be worth $550k ($100/sf), and a 4000sf monster $800k, but the data do not bear it out. IMO, this is why builders choose to build McMansions, as the sales price of a home with extra square footage far exceeds the marginal cost of the additional construction.

Perhaps in Chi-town the demand for tear-downs has reached the point where it is economic to tear down larger and nicer homes than the neglected 1200sf bungalows getting torn down in my area. This makes it more and more about the land. Try this experiment: Find a set of data for home sales and square footage in your area (all must be 20%+ above the tear-down price). Calculate the Price/SF for each. Find the standard deviation. Then try to come up with a land value (LV) that you can incorporate into the equation: (Price-LV)/SF. Find the standard deviation. If your experience is like mine, the smoothest data set is the simple price/sf. If you need help, PM me the data and I'll plug it into excel.

c1ue

08-06-08, 03:36 PM

I don't see how gold being a fixed-price commodity makes the data any less relevant. The gold standard essentially priced everything in gold terms, which is what we are doing.

As you can see, there was a slingshot effect as the gold standard was abused through the '60s, then abandoned in 1972, shooting gg/sf past the mean and bottoming in 1980, then finding equilibrium around 4, +/-10%, during the '80s and '90s. Even with all the gold manipulation in the last century, the ratio stayed between 3.6 and 7.8 for 60 of the last 75 years. Currently we are at 2.9.

I merely point out that having gold artificially priced means that there is significant distortion in the pre-1968 era vs. post 1971.

Your graph actually reinforces what I am saying: are you really trying to tell me that the housing in the 1968 era was a greater bubble than in the '90s?

Also in the gold price peak - I cannot remember if there was gold price manipulation, but there definitely was PM manipulation from the Hunt Brothers trying to corner the silver market.

Lastly for the era of gold as a fixed price - you have an inherent distortion because the price of gold does not change with inflation. So you have an automatic upward bias in the price of gold vs. the price of a house as valued over any significant period of time.

jimmygu3

08-06-08, 04:10 PM

I merely point out that having gold artificially priced means that there is significant distortion in the pre-1968 era vs. post 1971.

Your graph actually reinforces what I am saying: are you really trying to tell me that the housing in the 1968 era was a greater bubble than in the '90s?

No, only that gold was more undervalued then, relative to housing. Once that artificial peg was pulled, gg/sf flew back toward the mean.

The idea around the iTulip water cooler is that gold is king and housing is shite. Gold will go to $2,500 and housing could drop another 50%. My point is to show that that would take a ratio that is already at a historical low and divide it six-fold to 0.5, 90% below the mean, a level never before seen in US history. Why is it so difficult for some to accept that after the credit crunch, real estate may actually increase in nominal dollars along with gold?

chrisk

08-06-08, 07:48 PM

Dr. Keen is a rigorous and careful researcher.
I'm not sure I agree with that. He compares the current Dow index to its CPI-adjusted long-term average, which makes no sense theoretically. Stocks on the whole clearly have a growth component above and beyond inflation alone (just like GDP grows long-term more than inflation).

If he had fitted an exponential trend to the CPI-adjusted Dow history, then compared the current Dow to that trend line, THAT would make sense (and presumably would still show the Dow as overvalued, but not by nearly as much as he claims). But a flat trend line is just plain misleading.

08-06-08, 08:04 PM

I'm not sure I agree with that. He compares the current Dow index to its CPI-adjusted long-term average, which makes no sense theoretically. Stocks on the whole clearly have a growth component above and beyond inflation alone (just like GDP grows long-term more than inflation).

If he had fitted an exponential trend to the CPI-adjusted Dow history, then compared the current Dow to that trend line, THAT would make sense (and presumably would still show the Dow as overvalued, but not by nearly as much as he claims). But a flat trend line is just plain misleading.

It's critical to understand that economics is politicized. If you are irrelevant, as a professional economist, then you can say that the CPI is fake. But if you are, like Keen, a professional you must work within the system or quickly find yourself outside of it, like Hudson or Paul.

I do not know this as a fact but suspect that Keen thinks that inflation numbers are not quite kosher.

Claim the metrics at a race as unfair or the judges influenced, well, you'd better have strong evidence.

marvenger

08-06-08, 08:41 PM

08-07-08, 10:32 AM

i don't think the exponential arguement for real growth is valid. If you had a ball of gold representing the worlds gdp a few hundred years ago and grow it exponentially at a low rate even 0.5% then the ball of gold will be much bigger than the whole world. Therefore real gdp does not grow exponentially, depressions etc take care of that over time and turn it into more of a straight line.

That is the point that Hudson makes, and we agree.

As for other reader's comments on Keen's DJIA analysis, the <big>iTulip.com Real Dow Jones Industrial Average</big> (http://www.itulip.com/realdow.htm) on our main page has for years promoted the idea of a 1.64% per year curve. At the time we posted this April 2006, it was widely viewed as far fetched and earned us a lot of hoots from the mainstream business press. The three lines show three possible projected trajectories for the DOW from mid 2006.

http://www.itulip.com/images/RealDowNotes3.gif

In the event, it appears that our worst case #1 trajectory forecast is the one that the DOW is taking.

http://homepage.mac.com/ttsmyf/RDandRJShomes.gif

Here is the chart updated to June 2008, with real home prices added.

We do not agree 100% with Keen's inflation adjusted DOW analysis, but let's not throw the baby out with the bathwater; his debt deflation analysis is valuable because it is predictive.

JKD

08-07-08, 10:33 AM

I tried many combinations of weighting land value + structure value, only to find that the method with the lowest standard deviation is simple square footage.

I have found that the tear down market is a completely separate animal from the existing housing market. It provides a floor for prices of very small or run-down homes, but does not add to the value of larger ones.
For example, in my area a tear-down might go for $400k, a 1500sf home for $450k, a 2500sf home for $750k, and a 4000sf McMansion for $1.2m. That's $300/sf. Logic might dictate that if the lot is worth $400k, then a lot with a 1500sf home would be worth $550k ($100/sf), and a 4000sf monster $800k, but the data do not bear it out. IMO, this is why builders choose to build McMansions, as the sales price of a home with extra square footage far exceeds the marginal cost of the additional construction.

Perhaps in Chi-town the demand for tear-downs has reached the point where it is economic to tear down larger and nicer homes than the neglected 1200sf bungalows getting torn down in my area. This makes it more and more about the land. Try this experiment: Find a set of data for home sales and square footage in your area (all must be 20%+ above the tear-down price). Calculate the Price/SF for each. Find the standard deviation. Then try to come up with a land value (LV) that you can incorporate into the equation: (Price-LV)/SF. Find the standard deviation. If your experience is like mine, the smoothest data set is the simple price/sf. If you need help, PM me the data and I'll plug it into excel.

I do not doubt your math at all, and I understand what you are saying. It will be particulary difficult to isolate the appropriate 'land price' to put into the equation the closer the tear-down floor is to the median home value. This is the case in my opinion in most bubble areas. There may be no appropriate floor to make the regression fit, but there is a floor when it comes to pricing the homes in the real market. And when that floor is lowered, prices will come down. That's all I'm saying. Well that, and that the floor is miles above its historical mean to which it will revert.

I do not think one could perform your analysis with any success in my area due to the high variability in (perceived) quality and certainly prices for similar sized homes. There are plent of $450k 2750sf homes on the same street as $750k 2750sf homes in my town. This is due to the fact that many are new, with better curb appeal, and are oozing faux luxury accents from every nook and cranny. You won't find any for less than $350k though because that is the tear-down floor at the moment (in my particular area of the town). That floor was $150k 10 years ago (and that $450k house was $250k 10 years ago, I know because I bought it).

All I'm saying is that the tear-down floor can very easily go back to $250k which will immediatley bring the $450k home back to $350k, IMO. What will be the impact on the $750k home? Frankly I think it will be a dissaster for these types of homes. As much as half the original price difference was builder mark-up in my opinion, and I think we will see most of that dissapear along with the land value decrease. I think they will get to $550k. That is just to get back to normal, the overshoot will depend on more macro factors.

Regards,

John

Sapiens

08-07-08, 10:47 AM

It's critical to understand that economics is politicized.

I'm glad you comprehend this. All seem to have forgotten it's called "political economy (http://en.wikipedia.org/wiki/Political_economy)."

orion

08-07-08, 11:06 AM

EJ, Would the house curve then have a 1.64 curve? I am guessing that it would and just eyeballing it would say home prices have another 15% to fall to get back on curve (or have inflation do the adjusting which is what I think Bernanke wants). If we get there via inflation I don't see how this game works if wages don't start to go up also.

jimmygu3

08-07-08, 11:17 AM

I do not doubt your math at all, and I understand what you are saying. It will be particulary difficult to isolate the appropriate 'land price' to put into the equation the closer the tear-down floor is to the median home value. This is the case in my opinion in most bubble areas. There may be no appropriate floor to make the regression fit, but there is a floor when it comes to pricing the homes in the real market. And when that floor is lowered, prices will come down. That's all I'm saying. Well that, and that the floor is miles above its historical mean to which it will revert.

I do not think one could perform your analysis with any success in my area due to the high variability in (perceived) quality and certainly prices for similar sized homes. There are plent of $450k 2750sf homes on the same street as $750k 2750sf homes in my town. This is due to the fact that many are new, with better curb appeal, and are oozing faux luxury accents from every nook and cranny. You won't find any for less than $350k though because that is the tear-down floor at the moment (in my particular area of the town). That floor was $150k 10 years ago (and that $450k house was $250k 10 years ago, I know because I bought it).

All I'm saying is that the tear-down floor can very easily go back to $250k which will immediatley bring the $450k home back to $350k, IMO. What will be the impact on the $750k home? Frankly I think it will be a disaster for these types of homes. As much as half the original price difference was builder mark-up in my opinion, and I think we will see most of that dissapear along with the land value decrease. I think they will get to $550k. That is just to get back to normal, the overshoot will depend on more macro factors.

Regards,

John

John, I think you're right all the way around.

FWIW, I have a good friend in Chicago and I love the town. It always amazes me how young, wealthy and exuberant the people there are. My friend made a killing as a RE agent during the bubble and now has literally ceased to make any money at all. It's scary.

I hope for your sake property values don't drop like you anticipate. $250k tear-down sounds low for in-town Chicago to me, but I suppose it could happen. I would think commuters in the 'burbs would be looking into moving into the city with gas prices the way they are. A potential tear-down could appeal to a wide range of buyers, whether to live in, rent out, remodel or tear down.

Cheers,

Jimmy

jimmygu3

08-07-08, 11:32 AM

It's critical to understand that economics is politicized. If you are irrelevant, as a professional economist, then you can say that the CPI is fake. But if you are, like Keen, a professional you must work within the system or quickly find yourself outside of it, like Hudson or Paul.

I do not know this as a fact but suspect that Keen thinks that inflation numbers are not quite kosher.

Claim the metrics at a race as unfair or the judges influenced, well, you'd better have strong evidence.

It's pretty cut and dry to me. If you ran a 5000-yard race every year and one year they decided to use meters instead of yards, all comparisons between the results of the old and new races would be invalid. But it's still a 5K! What's the big deal?

So it is with the CPI. It's not some tinfoil hat conspiracy theory that the CPI methodology was changed- it's public knowledge documented by the government. In order to level the playing field we can use the pre-1982 methodology to calculate CPI, as John Williams does. Or we could try to go back and apply the current standard to past years, which I haven't heard of anyone doing. But changing the rules and then wondering why the data skews precicely at the inflection points of methodology change is like wondering why nobody can beat my 1982 high school 5K record.

Jimmy

waysouth

08-07-08, 01:00 PM

We have all been patient but the end of the week approaches...

c1ue

08-07-08, 01:36 PM

No, only that gold was more undervalued then, relative to housing. Once that artificial peg was pulled, gg/sf flew back toward the mean.

JG,

Well, you clearly buy into the goldbugs' assertion that gold has intrinsic value.

Gold is purely a placemarker - the only difference between gold and a paper dollar is that gold must be mined.

However, neither itself does squat - it is the belief systems which drive the value.

To say gold was undervalued in 1971 is silly; the reason the US went off the gold standard was not because gold was undervalued, it was because the US policies created such a currency account deficit such that the US' WWI and WWII accumulation of the world's gold was being depleted to the point of violation of gold vs. currency reserve requirements agreed upon in Bretton Woods.

The value of gold rising in dollars post 1971 can as easily be laid at the dollar depreciation door as it can in gold's fundamental 'value'.

I'll put this another way: What is there to prevent the governments of the world from again fixing the price of gold?

There is no fundamental barrier to China, the EU, the US, and the Arab nations from agreeing on gold being worth $100/oz.

Why? Because even though gold is of finite supply and is physical, gold isn't necessary for hardly anything.

An advanced technology that could evaporate all of the non-industrial gold in the world would inconvenience no one outside of the jewelry and commodities businesses.

A similar attempt for food, or iron, or wood would fail because all of these have utility.

Lukester

08-07-08, 02:19 PM

C1ue - quite apart from the fact that to argue gold as "having no value" you'd have to go back five millennia and prove the "illusion of value" which it has exercised in all civilizations since the Sumerians, there is another modern day consideration you need to factor into gold's "uselessness".

It is the leader of the entire precious metals group. Yet one or two others of the precious metals have a remarkably high utility, to the point of being in fact real and true strategic assets, to modern industrialised societies. No, not Platinum or Palladium for catalytic converters, or Rhodium for flat panel displays. It's silver - which has more patented uses today than all the other metals combined, and is adding more new patented uses every year than all the other metals combined as well, therefore constantly lengthening it's lead over other metals in utility.

Silver is critical to many more industries and technology than you seem to credit. Almost 1000 ounces of silver go into the construction of a single missile (critical even in shorter range 200 Km missiles), and tens of thousands of ounces into the construction of a battleship, hundreds more ounces in a tank, etc - just in the electronic systems. The demand for silver in industry is "non-discretionary" - that means there are so many industries which require silver because literally no other metal can fulfill it's properties within their technology. I have read that silver, behind only petroleum and uranium, is the next most critical strategic mineral to any industrialised nation in the 21st century.

Yet the paradox is that Gold leads the Silver price. Your assessment of the "uselessness" of Gold is in any case dogmatic. The value of Gold is indeed sporadic, depending on the state of health of non-gold currency systems. A vehicle for the storing of the value of human labor which has been so universally adopted by literally hundreds of civilisations throughout the history of post stone age man evidently has a function which you are not grasping. Silver is merely a corollary paradox, which you are also not grasping, in the context of "utility". No-one holds your agnosticism about the value of PM's against you. That itself would be "silly".

But your reference to anyone else calling these metals "useful" as a "silly" idea is needlessly exclusionist and in fact is fairly simplistic itself. I fully understand your preference for "productive assets", but there are (regularly recurring) periods in history when Gold has fulfilled a critical disciplinary function. It's curious isn't it - how that disciplinary function always devolves back to Gold? A more inquiring mind would at any rate become more curious, as to why exactly it is Gold, rather than any other product, always seems to "inevitably" step in to fill that void.

This century the real money is of course the "black gold" - but the yellow gold has the longer pedigree, by far. When the "black gold" is gone, the yellow gold will still be around. It may indeed get phased out when we obtain a truly disciplined global monetary system - eventually. Meantime, in 2008 with the present problems in the global currencies, to call gold "useless" would be quite myopic.

jimmygu3

08-07-08, 02:28 PM

JG,

Well, you clearly buy into the goldbugs' assertion that gold has intrinsic value.

Gold is purely a placemarker - the only difference between gold and a paper dollar is that gold must be mined.

However, neither itself does squat - it is the belief systems which drive the value.

To say gold was undervalued in 1971 is silly; the reason the US went off the gold standard was not because gold was undervalued, it was because the US policies created such a currency account deficit such that the US' WWI and WWII accumulation of the world's gold was being depleted to the point of violation of gold vs. currency reserve requirements agreed upon in Bretton Woods.

The value of gold rising in dollars post 1971 can as easily be laid at the dollar depreciation door as it can in gold's fundamental 'value'.

I'll put this another way: What is there to prevent the governments of the world from again fixing the price of gold?

There is no fundamental barrier to China, the EU, the US, and the Arab nations from agreeing on gold being worth $100/oz.

Why? Because even though gold is of finite supply and is physical, gold isn't necessary for hardly anything.

An advanced technology that could evaporate all of the non-industrial gold in the world would inconvenience no one outside of the jewelry and commodities businesses.

A similar attempt for food, or iron, or wood would fail because all of these have utility.

C1ue,

How do you explain the demand for gold and the support of its current price? I explain it by the fact that gold is money that has been used as a store of value for millennia. A bushel of wheat has cost about the same amount of gold for thousands of years. And it is precisely its non-utility that makes it perfect for money. Food and wood rots, iron rusts, even silver tarnishes and gradually erodes. But nearly all the gold ever mined is still in circulation. In India and other cultures, families store the majority of their savings in gold jewelry. Demand is there and governments can't stop it with price fixing.

If governments tried to fix gold at $100, dollar-holders would immediately redeem paper for gold, depleting all US gold reserves, taking the gold to countries with free markets and exchanging for cash or goods, and quickly forcing another 1971-style removal of the peg.

The value of gold rising in dollars post 1971 can as easily be laid at the dollar depreciation door as it can in gold's fundamental 'value'.That's the point. Dollar depreciation was building up tremendous pressure but could not be reflected in the gold price due to the $35 peg. Once the gold standard was dropped, all that pent up dollar depreciation became inflation and the gold price soared.

phirang

08-07-08, 02:59 PM

C1ue,

How do you explain the demand for gold and the support of its current price? I explain it by the fact that gold is money that has been used as a store of value for millennia. A bushel of wheat has cost about the same amount of gold for thousands of years. And it is precisely its non-utility that makes it perfect for money. Food and wood rots, iron rusts, even silver tarnishes and gradually erodes. But nearly all the gold ever mined is still in circulation. In India and other cultures, families store the majority of their savings in gold jewelry. Demand is there and governments can't stop it with price fixing.

If governments tried to fix gold at $100, dollar-holders would immediately redeem paper for gold, depleting all US gold reserves, taking the gold to countries with free markets and exchanging for cash or goods, and quickly forcing another 1971-style removal of the peg.

That's the point. Dollar depreciation was building up tremendous pressure but could not be reflected in the gold price due to the $35 peg. Once the gold standard was dropped, all that pent up dollar depreciation became inflation and the gold price soared.

Guys,

the gold trade isn't done yet, but it WILL BE soon.

The key is to watch, duh, the US economy and policy: there are one or maybe two more rate-cuts coming, and after those, no mas! That is when you sell!

Ok? gold trades in the fx market: it's like another currency, and so u have to follow the fx catalysts. There's nothing magical about it.

FRED

08-07-08, 03:02 PM

Guys,

the gold trade isn't done yet, but it WILL BE soon.

The key is to watch, duh, the US economy and policy: there are one or maybe two more rate-cuts coming, and after those, no mas! That is when you sell!

Ok? gold trades in the fx market: it's like another currency, and so u have to follow the fx catalysts. There's nothing magical about it.

The gold trade is over when the ratcheting down of the dollar is over. From commentary we are working on now:

http://www.itulip.com/images/golddollarratchetNOTES.gif

The Outback Oracle

08-07-08, 04:31 PM

Lukester

08-07-08, 04:44 PM

The gold trade is over when the ratcheting down of the dollar is over.

I don't think I'd want to place a serious bet on the dollar busting out of this channel, with the US diving headfirst into a recession, Fannie and Freddie in defacto nationalisation, 90 odd banks taking the long jump, and nervousness about USD assets abroad at the highest point ever.

Just what other option is hinted at going forward in this chart, other than busting right out of the channel in a new major uptrend, eh? USD looking a little confined against the upper trend line here maybe? :rolleyes:

Meantime there sure seems to be a popular hue-and-cry going on about "commodities demand destruction" and the "huge dollar put collapsing and leading to a massive dollar rally" and so on.

Like a fox hunt - somebody yells "yoiks - Fox over there, beyond that hedgerow!" and all the panting fox hunters go chasing off in some general direction because they heard a "fox seen" noise.

Jesse Livermore quote:

"I came to learn that even when one is properly bearish at the very beginning of a bear market, it is not well to begin selling in bulk until there is no danger of the engine back-firing,"

http://www.321gold.com/editorials/degraaf/degraaf080708/4.gif

metalman

08-07-08, 05:24 PM

I don't think I'd want to place a serious bet on the dollar busting out of this channel, with the US diving headfirst into a recession, Fannie and Freddie in defacto nationalisation, 90 odd banks taking the long jump, and nervousness about USD assets abroad at the highest point ever.

Just what other option is hinted at going forward in this chart, other than busting right out of the channel in a new major uptrend, eh? USD looking a little confined against the upper trend line here maybe? :rolleyes:

Meantime there sure seems to be a popular hue-and-cry going on about "commodities demand destruction" and the "huge dollar put collapsing and leading to a massive dollar rally" and so on.

Like a fox hunt - somebody yells "yoiks - Fox over there, beyond that hedgerow!" and all the panting fox hunters go chasing off in some general direction because they heard a "fox seen" noise.

Jesse Livermore quote:

"I came to learn that even when one is properly bearish at the very beginning of a bear market, it is not well to begin selling in bulk until there is no danger of the engine back-firing,"

http://www.321gold.com/editorials/degraaf/degraaf080708/4.gif

i'm going to guess that the dollar ratchet theory says the dollar hangs out here a spell at this lower level before heading down...

http://www.itulip.com/images/dollaroilratchetNOTES.gif

commodities take a breather, too.

ratfink

08-07-08, 05:31 PM

It seems to me that the usual countercyclical antidote to an economic slowdown of this magnitude, government mandated spending, is already used up on a worldwide scale not seen before.

Debt has been run up synchronously across all sectors, public, private, and personal, at irretrievable levels. Does Dr. Keen see this as the type of system-breaking scenario that he has modeled in his debt-deflation analysis? If not, what does he see that could stand in the way of a world-wide bankruptcy?

metalman

08-07-08, 05:36 PM

Interesting mind twist which I never considered before. Inflation/deflation of debt are two sides of the same coin. Both accomplish the same thing, elimination of bad debt. Deflation simply marks the true value of bad to market, while monitary inflation maintains the nominal value of the debt, but the real value is slowly eliminated.

that point goes back to good old ka-poom theory. governments can always create money, they just can't force it to be worth anything. two ways out of debt deflation: defaults or inflate it away. governments always take plan b, except in 1930s (bad move) and japan. think about it... at this point in japan's debt deflation the bank of japan was raising rates! no wonder they went into a depression.

ratfink

08-07-08, 07:38 PM

that point goes back to good old ka-poom theory. governments can always create money, they just can't force it to be worth anything. two ways out of debt deflation: defaults or inflate it away.

I'm not sure I get this. I don't see how governments 'create' money that can be used to cover the new debt necessary to pay off the old in a deflation. A helicopter drop may be used for firewood, but not exchange if it doesn't retain it's value. And if multiple debtors are absolved by paying off in inflated currency, the bankruptcy is just passed up the chain, it doesn't go away.

I think this is the reason that every additional dollar of debt no longer carries the same value in GDP as it has in the past. What a government tries to do becomes irrelevant to the system (although it may make a world of difference in deciding relative winners and losers.) I wonder though what method inside the current system can be used to create a return to stability, if any.

Lukester

08-07-08, 09:04 PM

I'm not sure I get this. ... A helicopter drop may be used for firewood, but not exchange if it doesn't retain it's value.

They can and will get a fair amount of further mileage out of the B0nar as the senior currency despite massive abuse. It has been the anchor of the global monetary system for decades. You err in assuming that it's purchasing power will vanish abruptly in the face of even severe abuse. It can be stretched out over a decade and they can repudiate a lot of debt in the process. Not like Argentina - this is the mistake many amateur analysts have made in breathlessly suggesting the USD would go Zimbabwe style. The flamboyant claim pops up n lots of otherwise compelling sounding analyses, and is a telltale the writer is improvising his forecast and traveling by the seat of his pants. Janszen has very convincingly argued the USD is not going to follow that trajectory. So large scale helo drop proceeds, neuters a lot of debt claims, and withers the currency in the process at a much slower pace than the Argentina currency, and the Zimbabwe currency is not even a comparable.

The thesis here is that they will employ this stratagem very effectively to reduce a large chunk of the debt.

c1ue

08-08-08, 10:40 AM

How do you explain the demand for gold and the support of its current price?

Gold is viewed as a safe haven for those without the imagination to think further afield. Plus you should never underestimate the attraction of having your money literally under your thumb when times get bad.

I explain it by the fact that gold is money that has been used as a store of value for millennia.

Past performance is no indicator of future performance

A bushel of wheat has cost about the same amount of gold for thousands of years.

Please provide proof.

And it is precisely its non-utility that makes it perfect for money. Food and wood rots, iron rusts, even silver tarnishes and gradually erodes. But nearly all the gold ever mined is still in circulation. In India and other cultures, families store the majority of their savings in gold jewelry. Demand is there and governments can't stop it with price fixing.

Actually, concepts don't erode either unless they are abused. As for India, people use gold there because there aren't any reliable institutions to store value. But that demand is purely a historical artefact; as India starts its own little FIRE experiment, that jewelry demand will also slow down.

If governments tried to fix gold at $100, dollar-holders would immediately redeem paper for gold, depleting all US gold reserves, taking the gold to countries with free markets and exchanging for cash or goods, and quickly forcing another 1971-style removal of the peg.

You are assuming gold is redeemable, the government has no obligation to be able to provide gold at a fixed price. It merely has to set a price.

That's the point. Dollar depreciation was building up tremendous pressure but could not be reflected in the gold price due to the $35 peg. Once the gold standard was dropped, all that pent up dollar depreciation became inflation and the gold price soared.

You say it was gold price that was repressed, I say it was dollar value that was inflated.

But either way, the cause was poor government policies - both in causing the fall of the dollar's value and in failing (or refusing) to recognize the consequences of their actions.

I ask you this: why do you think that all those academics, administrators, and politicians fail to see what you believe? That gold is an irrepressible value?

Why would a source of 'truth' about the dollar depreciation policies not be manipulated and/or controlled?

And if this above statement is true, why then is gold such a safe investment necessarily?

Lukester

08-08-08, 11:54 AM

Quote:
<TABLE cellSpacing=0 cellPadding=6 width="100%" border=0><TBODY><TR><TD class=alt2 style="BORDER-RIGHT: 1px inset; BORDER-TOP: 1px inset; BORDER-LEFT: 1px inset; BORDER-BOTTOM: 1px inset">Originally Posted by jimmygu3
A bushel of wheat has cost about the same amount of gold for thousands of years.
</TD></TR></TBODY></TABLE>
Please provide proof

Yeah Jimmygu3 - this is a rather brazen assertion on your part. History certainly does not amply evidence it so for credibility here you need to "prove" it [ and while you are at it please re-invent the wheel for us too, by proving it's actually used somewhere - because the scuttlebutt is that this also is a popular myth! :mad: ]. :rolleyes: ... ??? ... :confused: :confused: :confused:

(Meet Mr. C1ue - taking the art of "rhetorical" debate to new heights)

jimmygu3

08-08-08, 01:45 PM

Please provide proof.

Oh, I read that somewhere once...:o

Probably not good enough proof for you, but here's a list of prices from 6th century Rome (http://www.ancientcoins.biz/pages/economy/) (gold-based currency) which I translated into 2008 dollars based on today's gold price.

Item Price Oz. Gold 2008 Dollars
1 lb. fish 6 folles 0.0037 $3.20
1 loaf bread 3 folles 0.0019 $1.60
1 wool blanket 7 folles 0.0044 $3.84
1 used cloak 1 solidus 0.1111 $96.00

Now why a used cloak cost so much when a wool blanket was relatively cheap I don't know. But a pound of fish for $3.20 and a loaf of bread for $1.60 sound a lot like prices at my supermarket.

You are assuming gold is redeemable, the government has no obligation to be able to provide gold at a fixed price. It merely has to set a price.

I expect better from you, c1ue. The government doesn't set prices on things it doesn't sell or control. In fact, the US government DID fix the gold price after leaving the gold standard, and still values the US reserves at the absurd par value of $42.2222 per troy ounce. The market doesn't seem to care what the US government says gold is worth.

I ask you this: why do you think that all those academics, administrators, and politicians fail to see what you believe? That gold is an irrepressible value?

Why would a source of 'truth' about the dollar depreciation policies not be manipulated and/or controlled?

And if this above statement is true, why then is gold such a safe investment necessarily?

I don't know what you're talking about. What 'academics, administrators, and politicians'? I think you're lumping me in with some other group you have a grudge against.

Bottom line is: It's easy for the government to make more dollars. It's harder to make real things. Real things go up in nominal value when they print (figuratively) too many dollars. There's nothing magical about gold. Gold is a real thing that has historically allowed people to hold a lot of wealth in a small place. I could put my net worth in my pockets and that's probably true for most people throughout history.

I don't think gold is a slam-dunk safe investment. If everyone decided it was worthless it would be worthless. I personally don't think that will happen any time soon. If you know of a totally safe investment, please point it out to me.

Jimmy

Chris Coles

08-08-08, 03:49 PM

http://www.debtdeflation.com/blogs/wp-content/uploads/2008/08/IMG0005_46637968.PNG

Figure 11

As is obvious in Figure 1, debt’s contribution peaked at the end of 2007, and it has been falling ever since. The monthly figures make this even more obvious (Figure 1 records change in debt over a whole year). The monthly increase in total private debt peaked at $30 billion in mid-2007, and trended up to $27 billion by the end of 2007. It has since fallen to a mere $5 billion in the month of June (see Table 1 and Figure 12).

Way back in the early 1980's Robert Beckman wrote The Downwave, which had almost exactly the same graph as above except that it was set up to illustrate classic Disaster Theory where events have a long period of good trading over a period of some 40 years or so which ends with a downturn before running up to and slightly beyond the previous top.... and then total collapse occurs taking the graph right back to the beginning. In that case, he predicted a collapse of UK house prices returning to pre-1939 levels. By so doing, he showed that we are in a quite different set of circumstances than normal. I recommend a read, if you can find a copy.

http://www.antiqbook.co.uk/boox/lbw/019585.shtml

Turning to a debate about the gold to house price ratio. Please correct me if I have erred, but before Breton Woods, the US$ was pegged at $12 to 1 UK£ and any reference to the ratio of gold to house price will surely be distorted relative to the pegged currency?

There were huge distortions in pre-1960's values for Gold versus currencies and as such, trying to take a gold to house price ratio back beyond the 1960's surely introduces grave potential for distortion of reality?

metalman

08-08-08, 05:23 PM

I'm not sure I get this. I don't see how governments 'create' money that can be used to cover the new debt necessary to pay off the old in a deflation. A helicopter drop may be used for firewood, but not exchange if it doesn't retain it's value. And if multiple debtors are absolved by paying off in inflated currency, the bankruptcy is just passed up the chain, it doesn't go away.

I think this is the reason that every additional dollar of debt no longer carries the same value in GDP as it has in the past. What a government tries to do becomes irrelevant to the system (although it may make a world of difference in deciding relative winners and losers.) I wonder though what method inside the current system can be used to create a return to stability, if any.

the trick that prevents deflation is... double entry bookkeeping.

gov't prints and gives $10b more capital to bank X
you borrow $50k from bank X under new rules... call it loan B
you use $25k to pay off loan A from bank Y you took out during the housing bubble era
you keep $25k of loan B to make a down payment on a new house under new legislation for new home buyers

there are 1000 ways to use double entry bookkeeping to create new money via loans.

the possibilities are truly endless.

phirang

08-08-08, 07:43 PM

Agency mortgages, anyone? Hello? Hellooooooo?

I'm long agency mortgages AND gold: I figure if the agency mortgages go bad, then the US defaults (basically), dollar crashes, and gold goes to a hojillion.

c1ue

08-08-08, 09:33 PM

Oh, I read that somewhere once...:o

Probably not good enough proof for you, but here's a list of prices from 6th century Rome (http://www.ancientcoins.biz/pages/economy/) (gold-based currency) which I translated into 2008 dollars based on today's gold price.

Item Price Oz. Gold 2008 Dollars
1 lb. fish 6 folles 0.0037 $3.20
1 loaf bread 3 folles 0.0019 $1.60
1 wool blanket 7 folles 0.0044 $3.84
1 used cloak 1 solidus 0.1111 $96.00

Now why a used cloak cost so much when a wool blanket was relatively cheap I don't know. But a pound of fish for $3.20 and a loaf of bread for $1.60 sound a lot like prices at my supermarket.

According to the link you posted, in the 1st century AD:
1 loaf of bread = 2 As = 1/8 denarius.

According to Wiki, a denarius was silver and around 4.5 grams.

4.5 grams = 0.145 troy ounces, and at $16/oz that makes the bread the equivalent of 29 cents.

So you have contradiction in the same page :rolleyes:

Or perhaps there was a lot of inflation between 1st century AD and 6th century AD.

In fact in the same page you see prices rising in another 500 year span - with the supposed same currency. Of course, Rome was debasing their 'hard' currency, but still...

<TABLE cellSpacing=0 cellPadding=3 width="75%" border=1><TBODY><TR><TD width="23%">Time</TD><TD width="33%">Soldier Income / Day</TD><TD width="23%">Price f. 1 Mod. Wheat
see note 3</TD></TR><TR><TD width="23%">211 - 210 BC see note 1</TD><TD width="33%"> </TD><TD width="23%">20 - 24 as</TD></TR><TR><TD width="23%">203 BC</TD><TD width="33%"> </TD><TD width="23%">4 as</TD></TR><TR><TD width="23%">200 - 150 BC</TD><TD width="33%">3 as</TD><TD width="23%">4 as</TD></TR><TR><TD width="23%">141 BC see note 2</TD><TD width="33%">5 as</TD><TD width="23%">6 as</TD></TR><TR><TD width="23%">123 BC</TD><TD width="33%"> </TD><TD width="23%">6.33 as</TD></TR><TR><TD width="23%">100 BC</TD><TD width="33%"> </TD><TD width="23%">8 as</TD></TR><TR><TD width="23%">73 BC</TD><TD width="33%">5 as</TD><TD width="23%">12 as</TD></TR><TR><TD width="23%">46 BC</TD><TD width="33%">10 as (unskilled labourer 12 As)</TD><TD width="23%">12 as</TD></TR><TR><TD width="23%">0</TD><TD width="33%">10 as</TD><TD width="23%">16 as = 1 den.</TD></TR><TR><TD width="23%">60 AD</TD><TD width="33%">16 as</TD><TD width="23%">32 as = 2 den.</TD></TR><TR><TD width="23%">170 AD</TD><TD width="33%">13 as</TD><TD width="23%">40 as = 2 den. 8 as</TD></TR><TR><TD width="23%">218 AD</TD><TD width="33%">16 as = 1 denar</TD><TD width="23%">68 as = 4 den. 4 as</TD></TR></TBODY></TABLE>

I expect better from you, c1ue. The government doesn't set prices on things it doesn't sell or control. In fact, the US government DID fix the gold price after leaving the gold standard, and still values the US reserves at the absurd par value of $42.2222 per troy ounce. The market doesn't seem to care what the US government says gold is worth.

Oh really? So what do you call the minimum wage then? Does the government sell and/or control human labor?

What about our agricultural subsidies? Is the government in the business of sugar? corn?

Furthermore your example is flawed in several ways:

1) Back then, the dollars WERE redeemable for gold. There is no reason that this must be
2) By 1941 (from Dr. Michael Hudson's Super Imperialism: The Economic Strategy of American Empire), the US had within its borders 2/3rds of the world's entire gold monetary supply. So there was a reason to keep value to the gold - who devalues what they possess to nothing?
3) The US has (still) outlawed the right to own bullion gold. What makes you think this can't be extended?

I don't know what you're talking about. What 'academics, administrators, and politicians'? I think you're lumping me in with some other group you have a grudge against.

You're assuming I am referring to you. You know what they about ass.u.me.

If instead I say, Bernanke, Paulson, and Bush - is that more clear? And note I am NOT a Democrat.

As for a totally safe investment - sure there isn't anything guaranteed in this world.

I merely point out that gold's historical role is not something unknown to our government, and furthermore point out there ARE ways of controlling this commodity as there is zero productive need for it.

Chris Coles

08-09-08, 03:21 AM

There are still two more aspects of the debate that are not being addressed. The first is that the house price reflects a price per house. But how many houses have been replaced between 1945 and say, 2005? So you must add into the equation the number of times the investment, the construction, is made. And, the number of man hours to build the house does not materially change, neither does the bill of lading for the materials. So perhaps a better ratio is that between the man hours/cost per hour/value of Gold? Rebuild the house say three times and use that as the base for your calculations?

The second is much more pernicious; the population has changed dramatically. One Ounce of Gold in 1945 was spread, as value, between a much smaller population than in 2005. But the volume of available Gold has not kept pace with the growth of the population, while at the same time, the same value is perceived by every new member of the population.

To make accurate comparisons of the base value of Gold, you must address both these additional variations.

Charles Mackay

08-09-08, 04:10 PM

Here's a data series that may be a little less politicized. This is the median exisiting house price divided by the CRB index.

http://webpages.charter.net/bigboard/houses-crb.gif

jimmygu3

08-09-08, 07:42 PM

According to the link you posted, in the 1st century AD:
1 loaf of bread = 2 As = 1/8 denarius.

According to Wiki, a denarius was silver and around 4.5 grams.

4.5 grams = 0.145 troy ounces, and at $16/oz that makes the bread the equivalent of 29 cents.

So you have contradiction in the same page :rolleyes:

Or perhaps there was a lot of inflation between 1st century AD and 6th century AD.

Check your math. .145 * $16 = $2.32 As in "That'll be two dollars and thirty-two cents for that loaf of italian bread."

Amazing, ain't it!

I'm impressed that you actually took the time to research the link, though! :D

In fact in the same page you see prices rising in another 500 year span - with the supposed same currency. Of course, Rome was debasing their 'hard' currency, but still...

You nailed it. They literally debased the currency, punching out the centers of the coins and making new ones from cheaper alloys. The market responded by raising prices. Beginning of the end of the Roman empire.

Oh really? So what do you call the minimum wage then? Does the government sell and/or control human labor?

What about our agricultural subsidies? Is the government in the business of sugar? corn?

Yes, these are examples of government interference in markets. Subsidies involve directly paying producers in order to influence their prices, not simply dictating a price. The government has a great deal of control over labor, as there are many jobs that must be done with local labor and businesses have little choice but to obey minimum wage and tax laws, or risk legal action. Jobs which can be outsourced go to countries with low or no minimum wage laws. Similarly, in your $100 gold scenario, the metal would make its way out of the country to be sold in a free market.

For example, if my 10 gold eagles could by law only be sold here in the US for $1000, but across the border or across the pond I could sell them for 6000 euros, I would want to find a way to make that happen. A US black market for gold would develop, and the whole thing would end up much like our stupid war on drugs, with a lot of money going to entrepreneurial criminal middlemen.

c1ue

08-10-08, 12:18 PM

Check your math. .145 * $16 = $2.32 As in "That'll be two dollars and thirty-two cents for that loaf of italian bread."

Amazing, ain't it!

JG,

.145 troy oz of silver for a denarius, but loaf of bread = 1/8 denarius.

Thus $2.32 for 8 loaves of italian bread.

In any case, I understand your point.

I do agree that gold will always have some value whatever the government legislates, but that value may not be more than what was originally paid for it.

I personally do have a stash of gold and silver - but it is my coin collection. I searched all accessible change my entire childhood to accumulate silver dimes, quarters, and half dollars.

It is probably worth more than an FDIC insurable at this point, and so I do have a fallback in PMs in that respect.

But if I have to flee the riots to one of my alternate countries, I doubt I'll be able to bring it with me.

raja

08-10-08, 06:31 PM

But if I have to flee the riots to one of my alternate countries, I doubt I'll be able to bring it with me.
And besides, it might be stolen from you in the riots in one of your alternate countries ;)

c1ue

08-11-08, 01:50 PM

If I have to flee, it won't be because of riots in the alternate countries...