Monday, January 17, 2005

Ignore Warnings of a Real Estate Bubble

Charles Stampul
Monday, Jan. 17, 2005
Viewers of CNBC and other business programs are increasingly hearing that the national real estate market may be cresting.

Real estate is on a run comparable to the run of stocks in the mid to late 1990s, but for very different reasons.

The bull market of the '90s was driven by credit expansion, which prompted business of all kinds to expand. It was spurred, as well, by a surge in the number of individuals planning for retirement, which increased the overall demand for equities, causing most stocks to rise.

Add to this the emergence of the Internet, and the difficulty CEOs and analysts faced in accessing and predicting its long-term economic impact. The result was a speculative bubble that anyone could spot.

The rise in home prices, in contrast, is essentially inflationary. The business journalists, however, fail to see this. The primary reason is a government statistic called the Consumer Price Index, or CPI.

When journalists say that inflation is low, they are saying that the CPI is rising only minimally. What they fail to recognize is that the rate of increase in this index can easily be minimized by excluding inflation-sensitive items and including goods with prices that are either stable or falling as a result of excess inventory, increased productivity, and other factors. (1)

Many journalists also claim that inflation is low because interest rates are low. But interest rates are strongly, if not entirely, influenced by rates set by the Federal Reserve on loans to and between member banks.

At one time inflation was understood as an increase in the money supply. Now it is understood in terms of its primary effect: rising prices. It would stand to reason, therefore, that the closest measure of increasing price levels is the rate of currency expansion. However, the process of increasing the money supply is complex, as is the way in which monetary expansion is tracked.

If prices are to remain stable and not decrease, some expansion of the money supply is necessary. Unfortunately, there is no way to determine the degree of monetary expansion required to keep pace with economic expansion.

The problem of measuring economic growth is the same as that of measuring inflation: We rely on a government statistic, in this case Gross Domestic Product, or GDP. GDP is the figure most economists, journalists and politicians use to measure expansion and contraction of the national economy. But a rise in GDP is not necessarily an indication of economic growth.

Roughly one-third of GDP is government spending. (2) It makes no difference whether the government spends money it already has or whether the spending is done on deficit. All government spending is considered an investment and included in GDP figures. But government spending is not, in most cases, investment, but merely expenditure. GDP, as a result, can rise while the national economy actually contracts.

Traditionally, the level of inflation is measured by the dollar value of the world’s only enduring currency, gold. The closest measure of inflation, however, may be the price of real estate.

Like gold, real estate has an intrinsic value. But for the purposes of measuring inflation, real estate differs from gold in one important way. Gold is primarily a currency or asset; owning gold does not directly satisfy any significant and universal need.

Gold, therefore, is and will remain relatively low in value as long as there are alternative currencies – the dollar, the euro, the yen, etc. As long as it competes with fiat currencies, gold’s value as a unit of exchange will not be fully represented.

Though an asset for many, the primary function of real estate is to provide shelter. Therefore, there is a demand for it apart from being an investment and store of wealth. It is a more accurate measure of inflation for this reason.

Many believe that we are seeing the same type of bubble in real estate as we saw in stocks. But real estate, we should keep in mind, has been rising steadily for many more years than stocks. Stocks only began to skyrocket when the largest segment of society began in earnest to invest for retirement, and has since time fallen.

The rise in home costs may be due in part to rising demand, with respect to both people seeking a home to live in (affected by a growing population) and those fleeing overvalued or under-performing stock markets. But this alone cannot account for such a sharp and steady increase. Nor can the presence of low mortgage rates.

The sharp and steady rise in real estate is instead the result of inflation.

The dollar, by law, cannot be discounted. It must be accepted at face value. The only way the market can adjust to money and credit expansion, therefore, is through higher prices. But market forces, such as unprecedented productivity growth, are driving most prices down. As a result, the federal government is able to debase the currency with impunity.

Inflation lowers the standard of living. But the gains resulting from technological innovation and expanding markets have been so great that not all have felt the effects. Things, unfortunately, are changing.

The rate of personal savings is near an all-time low. Where families could once get by on one paycheck, many are now struggling to get by on two or three. With an aging population causing the percentage of workers to decline, the situation can only get worse.

With record debt and taxation reaching a point where further increases, by sending jobs and capital overseas, can actually reduce overall tax revenue, further and greater expansion of money and credit is likely.

It will be the only way to continue to fund Social Security, Medicare and other entitlement programs. Voters will pressure government to continue current spending patterns in the face of falling revenue, regardless of the consequences.

Facing the prospect of an inflationary depression, the safest thing people can do is to put their wealth into hard assets such as real estate.

But the business journalists caution against it. Ironically, it is many of the same people who failed to see the stock market bubble who are now dissuading prudent individuals with talk of a bubble in real estate.

They continue to misguide individuals because, instead of embracing figures and a school of economics that enables people to effectively prepare for the future, they continue to follow statistics and a school whose primary function is to justify government wealth confiscation and mask its consequences.


1. “What’s Wrong with the CPI,” William L. Anderson, Ludwig von Mises Institute (, August 2001

2. “Beyond GDP: A Breakthrough in National Income Accounting,” Mark Skousen, Ideas On Liberty, April 2001