A report last week by Merrill Lynch economist David Rosenberg spoke of a housing boom that “looks finished.” Rosenberg’s broader contention was that housing has often been a leading indicator of the economy, and that a continued downturn could spell recession. The Wall Street Journal’s Jesse Eisinger picked up on the doom theme, noting that, “As housing goes, so goes the U.S. economy — and the stock market.” Yet both mistake cause and effect, and in drawing a correlation between rising home prices and a booming economy, both misinterpret what drives economic growth.
The refrain among mainstream economists and media members throughout the latest property boom was that rising real estate prices have been an economic stimulus. Homeowners have been able to borrow against their property, according to the rationale, and in doing so have driven consumer spending. And with home prices rising, sellers have seen their wealth (and consumption capacity) rise through the sale of their main assets. But neither generalization holds that much water.
If a homeowner secures a loan that enables him or her to purchase more goods, by definition there is a lender who has foregone that same consumption. There’s no direct stimulus here, just a shift of money from one person to another. The same applies to the sale of a house. There is no rise in wealth in the aggregate from the sale of a house because while the seller is wealthier due to the transaction, the buyer is commensurately less wealthy for having purchased the more expensive asset. In good part, the presumed “wealth effect” is a wash.
It also has to be remembered that when capital flows into real estate, investment into income-producing assets such as stocks and bonds that help grow the economy shrinks. When a home is purchased, capital is consumed. Conversely, when a stock or bond is purchased, the purchaser provides capital to entrepreneurs and will thus fund the very innovation that makes us more productive and creates true wealth.
Far from harming our economy, a downturn in real estate has the potential to bring more capital to the stock market. England, Australia, and New Zealand offer useful examples here in that stocks rallied 17, 28, and 38 percent respectively in the years after property booms in those countries ended around the beginning of this millennium.
Returning to the assumption by Rosenberg and Eisinger that a property downturn foretells recession, they mistake cause and effect. Stocks have been down of late, but this logically has nothing to do with a fall in property prices. If this downturn were to occur in an orderly fashion, investment would arguably shift to stocks and bonds in a way that would accrue to economic growth.
What seemingly is driving stocks down now is the market realization that inflation is worse than expected. The tax-advantages of homeownership correctly have been attributed to the strong housing market of recent years, but inflation’s role in the property boom has been largely unsung. Indeed, when the dollar went into freefall in the early 1970s, property prices boomed alongside commodities such as oil and gold. When Carter Treasury Secretary Michael Blumenthal talked down the dollar in the late ’70s, property and commodities were once again the main beneficiary. Von Mises called this a “flight to the real,” meaning capital flows to tangible goods when money is losing its value.
There is market evidence in support of the above contention. From 1997 to 2000, the Bloomberg/REIT Index rose a measly 1.2 percent (versus 79.9 percent for the S&P 500), a time in which gold fell from nearly $400 all the way to $255 an ounce. Gold has rallied since the second half of 2001, and so has real estate. Between 2001 and April 2005, the Bloomberg/REIT Index increased 19.1 percent annually against an S&P 500 that was down 3.2 percent annually.
If there is an economic slowdown on the way, it will arguably be the result of the same weak-dollar phenomenon that drove the above-mentioned property rallies in the 1970s, and which drove the most recent one. Economies and stocks loathe inflation, and so it shouldn’t be a surprise that a property boom partially driven by a falling dollar would eventually lead to some economic pain.
The lesson here shouldn’t be that we need a booming real estate market to achieve economic growth. It should be that gyrating currency values often lead to mal-investment that rears its ugly head in later years in the form of reduced economic vitality. A stable dollar would reduce these kinds of investment distortions, and would make the presumption of pending recessions much less frequent.
– John Tamny is a writer in Washington, D.C. He can be reached at jtamny@yahoo.com.