After the Fall

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So the mining tax, among other issues, has cost Kevin Rudd his job. As an economic matter, investors might now revalue the miners as if the tax itself is dead, or at least dormant until after the next Federal election. But as fascinating as the domestic political scene is, today’s Daily Reckoning begins with an old foe, the U.S. housing market.

Why? The current direction of U.S. home prices (down) has been brought about by many of the same economic management principles applied here in Australia. In fact, the whole Keynesian effort to support aggregate demand and “bring forward” demand through tax credits and handouts has been used the world over. And its effects are the same the world over – a temporary spike in economic activity giving the illusion of vitality…and then a crash to earth.

Nowhere is this process more advanced than in America’s housing market. In first decade of this millennium, it was the prime beneficiary of the cheap money policies of both Alan Greenspan and Ben Bernanke. Bank and non-bank credit creation found its way into an asset class everyone could profit from – residential real estate.

But yesterday America’s Commerce Department reported that new home sales in the United States fell 33% in the month of May from April. Just over 330,000 new homes were sold across the great land for the entire month. It was the lowest and slowest rate of sales since 1963. And since their peak in 2005, new home sales are down 78%.

The good news is that U.S. home prices reaching a clearing level. The median price on a new U.S. castle is just over US$200k. Even without the $8,000 Federal tax credit, the price is just under four times the median U.S. household income of $52,000. So how come no one’s buying?

Because they’re all in! That is, at the peak of the market, homeownership levels in the States reached 70%. When seven out of ten households own a home or have mortgage, there aren’t many buyers left. Does this mean there is some theoretic level of homeownership that’s achievable AND sustainable in a market?

Well, no. But it does mean that when you “bring forward” demand so much in a credit boom, you rob from future demand. That’s what’s happening now in America. And we suspect that is what will happen too in Australia, when all the various ways of bringing people into the market with grants and tax deductions are exhausted.

But what does this have to do with the big picture? There is a good argument to be made that what artificially low interest rates did to America’s housing market…they have done to many of the world’s stock, commodity, bond, and real estate markets. With the Fed, the Bank of Japan, the European Central Bank, and the Bank of England all setting historically low short-term interest rates, they’ve provided huge support to markets.

And if that support fails? The lack of gimmicks to prop up U.S. house prices is making it likely that there will be a second fall in that market. The knock-on effects on U.S. employment won’t be pretty. But the destruction of bank collateral will be uglier still, and that’s what poses the biggest risk to the financial system.

Yet it’s not just America we’re talking about. Stock market veteran Richard Russell, who edits the Dow Theory Letter, writes that, “We’re now in the process of building one of the largest tops in stock market history. The result, I think, will be the most disastrous bear market since the ’30s, and maybe worse.” Russell argues that the Fed and its central bank cronies have pumped up stock, commodity, and real estate markets and that they are all now primed for a big fall.

He suggests that the disintegration of fiat currencies is what will spark the fall in asset markets. But – assuming you agree with Russell’s primary thesis that global stock prices have been pumped up by a sea of central bank liquidity – the catalyst for that fall is anyone’s guess. And the timing is unknowable.

In theory, though, you CAN know that when interest rates are manipulated lower for the sake of achieving politically mandated GDP growth (or growth for its own sake), they invariably create a bubble somewhere. What we’ve had – really since 1974 – is a series of ever larger bubbles encompassing more asset classes and more national economies.

Finance has aided and abetted this process. So has technology. The digitisation of finance has facilitated global capital flows, making it possible for cheap money borrowed in one currency to charge into assets in another. What all these micro-bubbles have in common is that they inflate asset prices…and when those assets increase household net worth on paper (house and stock prices) it seems like a good thing.

What we’re about to find out – after all the bad debts are liquidated and asset values – is whether all that money printing has actually created a lasting prosperity, backed by good investments in capital assets or industries with demand not propped up by ever-larger amounts of credit. Or whether we’ve just enjoyed a one-off period of global growth based on cheap energy and cheap credit that will never be repeated and must now, as credit and money shrink, contract.

Incidentally, the Federal Open Market Committee in the US decided to leave rates low. In its statement, the FOMC said, “Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad.” Europe?

But all of these things are connected. And to stretch the thematic connections…the central error of central bank control over interest rates (a non-free market price for money, or the cost of capital) is probably the same error Kevin Rudd made. One man doesn’t know better than a market.

In a complex system, there are too many moving parts, too many variables, for one man or a small group of men to know what they need to know in order to devise a plan. The Austrian Economist Friederich Hayek called this problem a “knowledge” problem and pointed out no one is ever given enough total knowledge to wisely make a grand plan.

Nor, we would humbly suggest, should any man presume to know enough that he tries to put his grand plan in the place of the private plans of millions of others, making their own private calculations based on factors unknown to The Man. It’s a big ask. And you set yourself up for a fall when you do it.

Of course, in the end, we’re all headed for a fall of at least six feet under. But what you do between now and then is a matter of choice. And returning to financial markets, we’d still choose not to be a buyer at these levels. Aussie stocks may get a bounce from the demise of Kevin Rudd and the shelving of his mining tax until after the election.

But the larger global issue – as you can see from the fall in U.S. new home sales – is that economic activity supported by credit growth isn’t sustainable. Nor are the asset price gains based on easy credit. So what will lead to the Fall? More on that tomorrow…

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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39 Comments on "After the Fall"

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Bob Bridger
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Bill Bonner reports, and not for the first time, that “Capital Economics calculates that the M3 money supply in the US has been contracting over the past three months at an annual rate of 7.6pc”. And I don’t get it – maybe some DR readers can explain this to me… if the US Fed has been printing money at unprecendented rates (monetizing debt or QE or whatever you call it), how come the money supply is shrinking? It seems to me that by giving the banks truckloads of cash and then the banks buying US bonds with it, thereby passing… Read more »
Ross
Guest

This is my position too. But the bottom of any enterprise is determined by earnings as long as it doesn’t get nationalised. The bottom for a bubble asset physical, commodity or currency may be far deeper.

Brian
Guest

Doom and gloom merchants… all of you. This whole website is a magnet for those wanting stock and house prices to fall so they can profit – therefore most people blogging here try to talk the markets down. I bet you all have photos of Roubini and Steven Keen sitting beside your PC. How about a bit of balance?… nothing but negativity.. just a warped view of reality. If you are so convinced of a fall, go short on stocks and rent a house. Your glass-half-empty view of the world will create its own reality.

Daren
Guest

Brian,

it’s not negativity, it’s reality. If you think hope is going to help pay down the bloated mortgage of the average aussie, then that’s your prerogative.

We need more websites like this that are willing to offer real answers so that people can cope with the pending reality, rather then act like a deer in the lights when the proverbial hits the fan.

nv
Guest

“Doom and gloom merchants… all of you.”
Brian,

Not moi, i’m a realist and optimist. My glass is half full. When property prices halve it will be full glass for me.

JJ
Guest

I am with you NV.!
Property is sooo overvalued in Oz it makes your head spin.
The government cannot pump prime our market forever, when it stops and you see all the first home owners on the street that is the time to buy.
Till then, gold and silver for me :)

Stillgotshoeson
Guest

“Doom and gloom merchants… all of you.”
Brian,

Hardly… When the storm has passed we will have sunny days again… I am optimistic for the future.. Just have a bad bit to get through first

Biker
Guest
Brian, learn to laugh at The Dark Side of DRA. If you intend to visit, do so in the sure and certain knowledge that the majority of respondents are banking on a major property crash. For many, it’s their _only_ hope of getting either a home, or a head… . :) If you intend to visit, bring with you a sense of humour and a sense of perspective. For many years most here have predicted the GAPC, but no crash has occurred. Their guru has spiralled downward in flames, yet you’ll note his link remains prominent here. It’s critically needed.… Read more »
Lachlan
Guest
Problem is Brian that house prices have escalated faster than wages. The trend has to stop. Its self limiting. If govs downsize immediately and reduce the tax burden a lot I’ll change my view. On the other hand if it turns out true that govs can spend without consequence then everyone should be very afraid. Our future will become more of what someone else wants it to be every day and less of what you wish for… until 1984 comes to pass. But your in the land of optimists here and those who have come to accept the world can… Read more »
Steve
Guest

Brian you say

“nothing but negativity..”

The fact is we are the ones being Positive,

Us young Australians have the right to be angry that we don’t have the same opportunities you had when you were our age

Ned S
Guest
Even when property prices in countries do “crash”, it doesn’t necessarily mean that every man and his brown dog ends up owning one perhaps? Home ownership was 50% in Tokyo in 2003. Although anywhere up to 80% in the sticks. (No idea what they were pre-crash though?) The home ownership rates in the UK and the US are down a couple of percentage points off their peaks apparently. (Even vaguely recall reading a while back that there was a trend in the US when marriages break up towards both parties saying No, no, you keep the house darling – ‘Cause… Read more »
Ned S
Guest

So much for life being like a box of chocolates I guess.

Biker
Guest

“Us… have the right to be angry…”

Us listened to our lessons but us still don’t have the same opportunities.
Us blame our state education system and us are pretty mad at the property morons, us are.

Us young Australians want it all and us want it all NOW! ;)

Biker
Guest

Lachlan: “If govs downsize immediately and reduce the tax burden a lot I’ll change my view. On the other hand if it turns out true that govs can spend without consequence then everyone should be very afraid.”

The trick is to vote for the Best Party, Lachlan!~

Steve
Guest

Once again Biker nice to see you sticking to the subject

Biker
Guest

HaHa… ! Maybe if _you’d_ paid attention to the subject… ;)

AnnoyingOrange
Guest
Doom and gloom at DR? Perhaps. But it’s a nice foil to all the overly optmistic bulldust out there. And there’s usually some good laughs woven in to the grim analysis. I wish some doom-and-gloomer was there to kick my arse before I put my house deposit money into Australian stocks in 1986. I lost almost everything in the 1987 crash. Fresh out of school, I asked my investment broker as we stood in the elevator: “Will the market keep going up? Some people are talking about a big crash.” “It will keep going up,” he said. “Ignore those doom-and-gloomers,… Read more »
Lachlan
Guest

Not extreme, just perfectly good sense.

Stillgotshoeson
Guest
Comment by AnnoyingOrange on 27 June 2010: Doom and gloom at DR? Perhaps. But it’s a nice foil to all the overly optmistic bulldust out there. And there’s usually some good laughs woven in to the grim analysis. I wish some doom-and-gloomer was there to kick my arse before I put my house deposit money into Australian stocks in 1986. I lost almost everything in the 1987 crash. Fresh out of school, I asked my investment broker as we stood in the elevator: “Will the market keep going up? Some people are talking about a big crash.” So did you… Read more »
Biker
Guest
The ’87 Crash gave us our nice little farm where it rains regularly. We’d sold all our shares in _October;_ and our home a year later. The property’s owner, ASXed to the teeth, went down in September and put the property on the market. Having made sufficient profit from beach lots and our house sale, we were among the very few with a full cash payment. It’s possible to benefit from a crash, in this case shares, but it was _never_ part of our plan. You can say we were just lucky getting out a month before the crash, but… Read more »
Steve
Guest

Steve’s quote of the day

“Steve is very happy that the Prime minister will be cutting back on immigration”

Ned S
Guest

Probable Interpretation: A fiscally incompetent fibber who is desperate for votes, is more than willing to tell voters whatever she figures might get her some votes?

Ned S
Guest

“Problem is Brian that house prices have escalated faster than wages. The trend has to stop” – Maybe Lachlan. But I’m a bit reluctant to make black and white statements about what “has to” happen – Given that there probably are numerous different possibilities. Better to bear in mind the Life is like a box of chocolates yarn perhaps?

I have a suspicion your progeny aren’t likely to end up marlelade AO; Yunno – on Toast?

Biker
Guest

Did her lips move, Steven?

Ned S
Guest

And herein ‘lies’ the problem Biker – If she doesn’t run high immigration, some rather reluctant current Oz youngies are going to get to pay their mas ‘n pas pensions. T’is a conundrum no? Well, not really – When has one ever seen a democratically elected pollie resist the temptation to kick the can – Leastways for as long as she can.

Stillgotshoeson
Guest
Comment by Biker on 27 June 2010: Footnote: Twenty years sounds a little too much like Japan. We’re patient, but that’s a l-o-n-g time for a return, Shoes.. Has not been 20 years for a return though.. 20 years of returns is different.. Remember reading an article a couple of years ago that said if you had invested $10000 in Shares (Top 50 from memory) you would have had something like $100000 then. $10000 in shares the day after the crash.. something like $300000. And it’s a strange plan which utterly depends on high unemployment, crashed stock markets and falling… Read more »
Stillgotshoeson
Guest

Comment by Steve on 27 June 2010:

Steve’s quote of the day

“Steve is very happy that the Prime minister will be cutting back on immigration”

I have no problem with immigration, the country needs more immigrants… infrastructure needs to keep pace with it though, at the moment that is not happening, we need more dams, highways, schools, hospitalsm power staions etc to cope with this higher population

Realist
Guest
Immigration is a positive thing, the reasoning for it can be varied and some of them can be short sighted. I have argued strongly for less immigration since I heard the core reason s to why the former “Krudd” government wanted the “BIG Australia”. The whole premise of this mass immigration policy was to prop up taxable incomes to support retiree’s and to baulster health services. It is simplistic at best, i can only assume they were getting these immigrants from a land far away where thy do not retire and do not require medical services. It is a very… Read more »
Steve
Guest

Go to 0.12 on this video and listen to what she says Biker even Tony Abbott agrees with her

http://www.youtube.com/watch?v=BNZ3a843aIg

Ned S
Guest

“i can only assume they were getting these immigrants from a land far away where thy do not retire and do not require medical services” – Spoken like a true citizen of the world Realist. But not like a realist perhaps? Leastways until we all do get balanced out as best we can across the globe in a sustainable way. And come to a mutual agreement to try and keep things sustainable. It’s good fun watching the West resisting the process though! :)

Lachlan
Guest

If we allow more immigration while spending/deficits remain imbalanced with GDP then the reason for the immigration is apparent.

Biker
Guest

“And it’s a strange plan which utterly depends on high unemployment, crashed stock markets and falling property prices for personal success…”

General comment. You appear to have a plan.

Biker
Guest

“Go to 0.12 on this video and listen to what she says Biker even Tony Abbott agrees with her”

Ah, well then, that makes it right, Steven. (Did he put it in _writing_?)

Biker
Guest

“…miss management is nothing short of frightening…”

Well she can’t be all _that_ bad, Realist. Steven thinks she’s OK!~ ;)

89peterg
Guest
generally I respect the attitude at DRA, and I would like to see most of the bullshit (economy) come to pass (away)….. my main concern is the degree to which there are elite powers that manipulate it all (not even for moneys sake, they would have enough of it already). the wasted opportunities for self realisation, too much waste on smoke and mirror effects, too much at risk from risky (even sadistic) behaviour of probably psycopathic persons… no proof, just seems to make a lot of sense. its a far cry from the town village. note : the propaganda includes… Read more »
bearamundi
Guest

In AlcatrOZ it’s mostly every man for himself, and its been that way for a while now. Which suggests we are already feeling the heat, but not fully admitting it and rather acting collectively like the proverbial frog that doesn’t jump out when it should.

Pat Donnelly
Guest
Australia is a shining beacon Wayne Swan said something like this so it must be true…. Truly we are far better off then the rest of the first world, including Norway. I wonder how much of their oil and gas wealth has been invested in loans to sovereign countries that may be able to repay in 100 years? If ever? Neither a borrower nor a lender be. Clearly the Australian RBA is well run. The Australian banks have weathered the storm well, but not perfectly. Sites like this are very useful, a corrective to mainstream thinking where the contrarian view… Read more »
Pangit
Guest
I am a recently married 25 year old with a 345k mortgage which allowed me with Rudd’s bonus to get me into the BOTTOM end of the market. Like most people my age that I know that have done the same as me, things are not that great financially with us. My wage I suppose is ok at 65k a year and my wife earns around 50k so you would think that should be ok to live, yes it is, it’s just that now my wife is pregnant and expecting in Nov I am really scared of what will happen… Read more »
Biker
Guest
Pangit, a good mate of mine here recommends a 25-year diet of rice. I’d recommend, instead: 1.) Seeing your bank to discuss… 2.) …renting your home to someone else… and 3.) …renting a smaller home yourself. Your write-offs, tax-wise, will surprise you. A few here will counsel you instead to _sell at any price._ Without getting really good independent advice, you’d be silly to either sell, or change your diet. Few Aussies know the _full_ list of claims you can make on rentals. Getting that information… and financial advice… should be your first steps. And if you do decide to… Read more »
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