House Prices: It’s Always Darkest Before Dawn?
Housing prices have just set another record year-over-year decline: They fell 15.9 percent from June 2007 to June 2008.
Ah, but never fear! The monthly fall (from May to June) was only 0.5 percent, which is the lowest monthly drop since July 2007.
Because of this last fact, the headlines read, “House Prices Show Signs of Stabilizing,” “Housing: Is the Worst Over?” etc.
Is it just me, or has the financial press been telling us “We’ve finally hit bottom!” for about 8 months now?
In terms of policy recommendations, it’s simple: The government should stop leading people on with hopes of ever more generous taxpayer assistance to the housing sector. People can’t just cut their losses, slash prices and move on with their lives, if they think the government might announce yet another unprecedented bailout next month.
Fisher Says 50-50 Chance of High Inflation
Perhaps the most sensible voting member, Dallas Fed President Fisher thinks there is a 50-50 chance our recent inflation spike is a “one-off” event:
“The real concern I have as a central banker is whether or not [inflation] begins to affect the mentality of spending patterns by consumers [and] pricing patterns by producers,” Fisher told Dow Jones.
“I don’t know the answer to that question – it’s sort of 50-50” whether the inflation gains will prove a “one-off event,” or something more persistent, Fisher said.
I realize Fisher is in a tough spot politically, and the above is probably the most controversial statement he can make without ruffling too many feathers.
As I will explain in forthcoming posts, I think there is a very real danger–I won’t insult you by assigning it a meaningless numerical likelihood–that the official CPI will grow by more than 10% during calendar 2009, at least if they calculate it the way they are now. (I.e., I’m saying that if the figures were supposed to be that high, the BLS might tweak the hedonic measures to bring the numbers down into more reasonable territory.)
David Friedman on House Prices
My previous post on oil and stock prices naturally leads to the in-between case of houses, which provide immediate services and are a durable asset. Thus, when house prices go down, it’s not as obvious whether this is a good or a bad thing (as opposed to the cases of oil and shares of stock). On the one hand, falling house prices means that housing is more affordable; some people can buy houses who previously couldn’t, and others can afford bigger houses than they previously could. (In the extreme case, intelligent termites who bought houses for food would be ecstatic that the Case-Shiller index keeps falling.)
Of course, the downside to falling prices is that existing owners were counting on their houses as part of their financial wealth. Even if you are planning on living in your current house until the day you die, even so it probably makes you worse off if its market value plummets. This is because you always had the option of selling your house and moving into more humble quarters, if (say) your kid needed an operation, or you get accused of a homicide and need to hire some high-priced attorneys.
For years I have been poking fun at an argument David Friedman (son of Milton) advanced in his books, wherein he claimed that when a person buys a house, then whether prices go way up or way down after the purchase, the new owner benefits either way. Friedman’s case is based on a static model, where the consumer makes one decision–on how to allocate his given income between housing and “everything else”–after seeing the new house price, and then that’s it. In this setup, yes, the consumer can only be helped by a change in house prices. After all, the consumer can always retain his existing house, and so (according to Friedman’s assumptions) changes in price can’t possibly hurt. And indeed, they will in fact help: If house prices go up, then the owner can sell his new home for a gain, move into a slightly smaller house, and then buy more of “everything else” with the leftover money. And if house prices go down, then the consumer can buy fewer units of “everything else,” and use the freed up money to buy a bigger house. Win-win.
There is something fishy with this analysis; I spell out the fallacies in this piece. But for the present post, I want to report an email with David Friedman. With all the mess in the housing market, I wondered if he still clung to his argument. (I.e., why aren’t we all rejoicing that we can now afford more square footage than we could in 2006?) Specifically, I asked him if he had any comments about his argument from years earlier, in light of the current housing debacle. Here is his response, quoted with permission:
Not really. The argument is specifically about people who have bought the house that, if nothing changes, they will want to live in more or less forever. That doesn’t describe all that many people. For that case, the argument is correct–although you need the additional assumption of zero transaction costs to get from “are no worse off” (because they can do what they would have done if prices hadn’t changed–stay in the same house) to “are better off” (because they can now adjust their housing consumption up if prices are lower, down if higher).
But I do find it amusing that when house prices are high, people complain about how high they are, and when they come down, people complain about falling house prices.
One final point: PLEASE PLEASE believe me, that I understand Friedman’s argument. I am not saying that he’s wrong, inside his model. My point is that his model assumes away the very reasons that, in the real world, owners hate it when house prices fall. So it’s not a very useful “counterintuitive” result, since it is only true in an alternate universe. And if you go and read his exposition (in the link above), you’ll see that he made it sound as if real people in the real world were wrong when they complained about falling house prices.
Why Do We Want Low Oil But High Stock Prices?
The short answer is that (usually) oil is quickly consumed while corporate stocks are pure assets. When the price of oil drops, it allows people to consume more oil and get more benefits from it–they can drive more, produce more oil-based products, etc. In contrast, if the price of Fannie Mae drops 10%, nobody says, “Great! Now I can use the stock certificates to wallpaper the baby’s room! The wife told me last month that it was a ridiculously expensive notion, but she can’t say that now!”
Of course, for people who do own large stocks of oil, then rising oil prices are a good thing. And countries that are net oil exporters do well when world oil prices skyrocket. But since the US is a net oil importer, the country as a whole is worse off with high oil prices.
What’s really amusing about all the hand-wringing over speculators is that they allegedly can do whatever they want with prices. We are told that the evil hedge funds aggressively buy oil futures, which itself pushes up oil prices and earns them huge profits. At the same time, we are told that the evil speculators short-sell (sometimes without even wearing undies) financial stocks, again in a self-fulfilling prophecy that guarantees them money. Meanwhile, Joe Sixpack has to pay $4 per gallon, and his bank collapses.
Do you see how truly despicable these speculators must be? Why can’t they have the decency to make their guaranteed profits by pushing down oil prices and boosting up financial stocks? What jerks!
(To avoid confusion: I am being sarcastic. The answer of course is that the speculators can’t drive prices against fundamentals, in the long run. Oil is up because demand has outgrown supply, and financial stocks are getting hammered because of the bad loans made during the housing bubble.)
Nobel Laureates Endorse Marxism
My title is a bit of an exaggeration. (Isn’t it?) Monday’s WSJ has an article, “Nobel Laureates Say Globalization’s Winners Should Aid Poor” (sub req’d). The more I read of this article, the more grateful I became that I was never awarded the (pseudo-)Nobel Prize in economics.
The entire premise of the article is that “[g]lobalization and technology have increased income inequality around the world,” and that governments need to sop up some of the admitted gains from globalization in order to compensate the losers.
Yet I challenge step one in this argument. It is certainly possible that globalization has increased income inequality in the richest, most capital intensive nations (such as the US). But my strong hunch is that global inequality has gone down because of globalization. Yes, a measly few million capitalists in the West have gotten much richer because they could move factories to China, employ call center operators in India, and so forth. But the bigger story is that billions of the world’s poorest people are now earning higher wages than they were before foreign investors came to town. I would be interested to see a calculation (however rough) where someone plugged in the various incomes from around the world to see what the global Gini coefficient was in, say, 1988 versus 2008. (A quick search shows me [pdf] that the world Gini apparently went up from 1988 to 1993, but since then China and India have grown much faster than their richer peers. My guess is that the Gini went down from 1988 to 2008.)
As Ludwig von Mises would often observe, Western workers are all about redistribution, until you point out that by global standards, blue collar workers in the US are among the richest of the population. So if they are serious about taking from the filthy rich and giving to the neediest, they should send 75% of their paychecks to African orphans every month.
One final quote from the WSJ article to reassure the reader that I am not being unfair to these Nobel clowns. Here we pick up where the reporter quotes Finn Kydland:
“Globalization ought to be good for all countries,” though it isn’t unless government policies are up to the challenge, he said. Look at Brazil and Argentina over the past two decades, he added. In Brazil, global growth has boosted low-wage workers’ income levels more than the levels of higher earners. Argentina, by contrast, saw its per capita GDP slide by some 20% in the 1980s as a series of government administrations piled on a debt load that eventually became crippling. Since then, real wages have fallen and the gap between rich and poor has widened.
What made the difference? “Bad economic policy,” said Mr. Kydland. “If there’s not a mechanism for redistribution, it probably won’t happen.”
Wow. I initially read this passage at the gym–my superior physique is not natural, my friends–and thought it was dumb. But now I see that it is D-U-M dumb. Yes Mr. Laureate, if a government piles on a crippling debt load that caused per capita GDP to slide by 20%, then that can seriously harm an economy–and one of those harms is that the poor typically will get hit harder during such a calamity. But what the heck does this have to do with lower tariffs and costs of transportation, foreigners investing capital in your country, etc.?
It is true that in some South American countries, brutal thugs seized control and implemented–at gunpoint–Chicago-style economic reforms. But Naomi Klein notwithstanding, that doesn’t prove that market forces are a bad thing, anymore than the Spanish Inquisition* proves the case for atheism.
In conclusion, let me concede that it is theoretically possible for an entire country to become poorer due to globalization. (All you have to do is take the group of people who are losers from globalization, and put them into one country. Voila!) However, for the world as a whole, globalization raises per capita living standards, because it increases productive efficiency–humans as a race churn out more stuff per period, when production is concentrated in those areas with the highest return. And empirically, even though some capitalists do very very well in the new system, much of the benefits of the higher output is showered on the masses. I explain more fully in this article.
* I bet you weren’t expecting a reference to the Spanish Inquisition…
I Have a T-Bone to Pick…
Over at Crash Landing (the “2nd best blog in the world,” according to one noted economist) I criticized the Pickens Plan for its awful economic analysis. (Note that I am heeding the conservationists’ pleas and have thus recycled my incredibly cheesy post title.) Pickens says:
As imports grow and world prices rise, the amount of money we send to foreign nations every year is soaring. At current oil prices, we will send $700 billion dollars out of the country this year alone — that’s four times the annual cost of the Iraq war. Projected over the next 10 years the cost will be $10 trillion — it will be the greatest transfer of wealth in the history of mankind.
In that previous post, I responded by saying: Importing oil doesn’t represent a wealth transfer. In exchange for our $10 trillion in cash, the rest of the world is giving us oil. And how much oil, you ask? Why, $10 trillion worth. Ain’t that grand!
Today I can now add to this critique. While driving to the office just now (and right before skirting death from a school bus), I heard the familiar drawl on AM radio, talking about the need to end our “dependence on foreign ahhl.”
When listing the advantages of his plan, Pickens said something like, “And switching to natural gas for our vehicles will provide us the one thing money can’t buy: time.”
Huh? If you have money, you can stockpile barrels of oil, which buys you time to adapt if foreign imports get cut off for some reason. As of early August, the government had about 73 days’ worth of net crude imports stockpiled in the Strategic Petroleum Reserve.
I confess I haven’t done even a back-of-the-envelope comparison, but I bet it would be far, far cheaper to bridge the interval from now until electric cars (or whatever) are cost-effective, by stockpiling crude rather than converting the entire US fleet to run on natural gas. Keep in mind, the relevant cost isn’t the upfront price of a barrel of oil. Rather, the relevant issue is the storage cost per unit of time, which includes only interest on the upfront price of the barrel.
(On a side note, I have wondered why the private sector hasn’t been accumulating larger crude inventories, especially as tensions heat up with major oil exporters [Venezuela, Iran, and now Russia]. But it’s really no surprise, because the government would either slap a huge windfall tax on domestic “evil profiteers” who were selling their inventories at $200 per barrel during an OPEC embargo, if they didn’t just confiscate their oil outright. With that kind of risk, it would be ludicrous to make purely speculative investments in physical crude stocks, at least for investors in US jurisdiction.)
Pickens is plain wrong when he says that money can’t buy “time,” meaning time to deal with a disruption in oil imports. Not only can money buy extra time through stockpiling crude, but it would probably be much cheaper than Pickens’ proposal.
For more criticisms of the plan–especially to see the pitfalls in wind power–see this IER analysis.
A Classical Mechanics Question to Break Up the Monotony
A quick puzzle before plunging back into the dreary financial news…
So I’m sitting in the left turn lane, the first car in line waiting on the turn signal. A school bus is turning left, coming from my right; i.e. it is making its turn in front of me. At first the driver is cutting it too hard, so that the bus (for a few moments) is literally heading right for me.
Question: If I really thought the driver wasn’t going to correct, should I have put my foot on the brake as hard as I could? (If so, should I also have applied the emergency brake?) I’m thinking yes, because then some of the bus’s kinetic energy would get transferred to my brake pads (as heat), meaning my car has to accelerate less, meaning the seat belt has to press against my chest with less force to get my overweight body moving at the same velocity as the drunk bus driver.
Does your answer depend on whether there is a vehicle behind me in the turn lane?
Anonymous Surveys Worse than Free Advice
“The U.S. economy may have avoided a recession but will grow below trend for some time as firms face higher prices for a range of goods that will cut into profits, according to a panel of economists surveyed,” we learn in a CNBC article this morning. As Nassim Taleb demonstrates in his book The Black Swan
What really bugs me about these forecasts–which never really give you new information, they’re always adjusting the forecasts in light of news that everyone in the market already knows about–is that we have no quality control on the survey respondents. For example, this particular news story is referring to “101 NABE members.” Well how accurate have these 101 people been in the past? Just because they have a PhD–do we even know if they all have PhDs to be called “economists”?–doesn’t mean they are good at predicting economic growth six months from now. I would much rather hear the forecasts from, say, “10 economists who predicted the financial sector was in real trouble by late 2006.”
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