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by Eric
Englund
Over
time, under a 100% gold standard, a house would gradually
depreciate in value. A house, after all, is nothing more than
a durable consumer good – it is a capital good if it
is a rental property. However, when living under a fiat-currency
regime, perceptions can be radically altered. For example,
not only is a house believed to be an appreciating asset,
it is considered to be an investment. Additionally, under
conditions of rapid money and credit growth (which, for a
period of time, leads to artificially low interest rates),
people will come to think of themselves as real estate entrepreneurs
– wisely "investing" in a house, to live in,
with the confidence that a big payday looms ahead upon sale
of same house. Presently, with lending standards so low –
to keep credit flowing – the housing boom has become
an outright speculative bubble in many parts of the U.S. I
would argue, in fact, that a hyperreality has emerged in which
real estate is perceived to be a one-way street to wealth.
The bust will come, inevitably, and millions of Americans
will be wiped out financially – and only the Austrian
School of economics provides the correct explanation as to
why the housing boom contains the seeds of its own destruction.
As
Roger Garrison explains in The
Austrian Theory of the Trade Cycle,
the boom-bust cycle emanates from the Federal Reserve:
The
Austrian theory of the business cycle emerges straightforwardly
from a simple comparison of savings-induced growth, which
is sustainable, with a credit-induced boom, which is not.
An increase in saving by individuals and a credit expansion
orchestrated by the central bank set into motion market
processes whose initial allocational effects on the economy's
capital structure are similar. But the ultimate consequences
of the two processes stand in stark contrast: Saving gets
us genuine growth; credit expansion gets us boom and bust.
We
certainly know, today, that Americans are saving little if
any money. Thus, America’s housing boom has emerged directly
as a result of Alan Greenspan’s easy-credit policies, not
from savings.
For
the time being, the real estate party is in full swing. Americans
are clamoring to participate in this ride to "Easy Street."
People are willing to take on punishing mortgage debt loads,
"knowing" that houses will always appreciate in
value and that the higher the leverage, the higher the rate
of return. Moreover, as a house appreciates, home equity loans
can be taken out to purchase consumer durables such
as high-end kitchen appliances, granite countertops, a hot
tub, and even a kit to build a backyard barbecue. Once these
consumer durables are "attached" to a house, they
magically become investments that add value to, and appreciate
with, the house. With Alan Greenspan at the helm of the Federal
Reserve, Americans have discovered investment Nirvana. Indeed,
the house has been transformed into a perpetual wealth creation
machine.
To
be sure, a house is a more enjoyable investment to own than
a dot.com or a telecom stock. Just imagine, you can throw
a Super Bowl party in your investment. You can sip on champagne
while relaxing in your hot tub investment. Neighbors can compete
as to who throws the best barbecue bash on the block (oh,
it was so wise to invest in that bricks-and-mortar backyard
barbecue). It is important, naturally, to keep the yard manicured
in order to have the best looking investment on the block
– which is important, for curb appeal, should one decide
to sell for the highest profit possible. Finally, you can
even procreate in your housing investment – try that
in your stock portfolio. All the while, the hottest topic
of conversation in the neighborhood pertains to how everyone’s
house is increasing in value. Every homeowner is brilliant
and, in a sense, has become a real estate entrepreneur.
In
the boom phase of the trade cycle, it is not predictable as
to where the fiat money and credit will flow. In the late
1990s, we saw "Easy" Alan’s money and credit flowing
into internet-related companies such as the dot.coms and telecoms.
Correspondingly, individual "investors" threw trillions
of dollars into the tech-laden NASDAQ with the belief that
the internet would lead us into a bold new cyber-world where
wealth would be created simply by sharing and transferring
information. When this mania ended (as bank credit and venture
capital dried up), the NASDAQ bubble burst – in early
2000 – and the once high-flying dot.com and telecom companies
came crashing down to earth. It was all an illusion fueled
by the Federal Reserve’s loose money and credit – with
a notable clustering of entrepreneurial and investor error
associated with internet-related companies. Hence, in 2000,
the economic bust (recession) descended upon the U.S.
Alan
Greenspan, of course, would not tolerate a recession. Accordingly,
the Federal Reserve went on a money and credit creation binge
and eventually brought short-term interest rates down to 1%
(in 2003). The Federal Reserve, in total, cut interest rates
13 times between 2001 and 2003. With interest rates so seductively
low, Americans went on a borrowing and spending spree which
pulled Uncle Sam out of the recession – at least for
now.
As
Murray Rothbard explains, in The Austrian Theory of the
Trade Cycle, America’s debt-driven "prosperity"
is a mirage built upon the opiate of easy credit. Alan Greenspan’s
multiple interest rate cuts, as Dr. Rothbard conveys, is nothing
new in the field of central banking:
… the
point is that the credit expansion is not one-shot;
it proceeds on and on, never giving consumers the chance
to reestablish their preferred proportions of consumption
and saving, never allowing the rise in costs in the capital
goods industries to catch up to the inflationary rise in
prices. Like the repeated doping of a horse, the boom is
kept on its way and ahead of its inevitable comeuppance,
by repeated doses of the stimulant of bank credit.
Sadly,
there will be a comeuppance. In this case, a clustering of
errors will be exposed on the part of the high-flying housing
developers, lenders, and homeowners. Mortgage lenders, eventually,
will find that homeowners cannot handle such crushing debt
loads, especially as rising interest rates cause defaults
on interest-only and adjustable rate mortgage loans. As mortgage
payment delinquencies and defaults rise, bankers and other
mortgage lenders will begin to see the error of their easy-credit
ways. This is where boom turns to bust, as described by Dr.
Rothbard:
It
is only when bank credit expansion must finally stop, either
because the banks are getting into a shaky condition or
because the public begins to balk at the continuing inflation,
that retribution finally catches up with the boom. As soon
as credit expansion stops, then the piper must be paid,
and the inevitable readjustments liquidate the unsound over-investments
of the boom…
Not
to forget the housing developers: at this juncture, they will
be caught with too much inventory on hand right when housing
prices and demand are on the decline.
Just
as night follows day, bust follows boom – as long as
central banks exist. The housing bubble is merely another
manifestation of the Federal Reserve’s reckless manipulation
of money and credit. Presently, most Americans believe that
houses are a sure-fire investment while adherents of Austrian
economics know they are nothing more than consumer durables
caught up in a speculative frenzy. When the housing bubble
bursts, millions of Americans will find themselves buried
alive in debt while living in their financial tombs.
June
8, 2005
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