Patterns in asset prices

Dr Marc Faber - Thu 24 Mar, 2005

...Patterns in asset prices...What caught my attention was a recent piece by Byron Wien in the December issue of US Strategy, ‘The Inflection Point’, in which he discusses how, over the past 50 years, the United States went from being and economic, scientific, political, and military leader “to something less powerful.”...

Patterns in asset prices

Let us assume that a family lives in the same house today as they did 30 years ago. The house has certainly appreciated in value, but it is nevertheless the same house. As a result of the price appreciation, the standard of living of the family hasn’t improved unless it’s leveraged the house and used the proceeds for some profitable investments.

Note that buying a more luxurious car is likely to be only a temporary standard of living improvement, unless home prices rise constantly at a faster clip than CPI inflation — which is not very likely. Furthermore, property taxes and maintenance costs on the house would have risen considerably over the last 30 years.

Now, let us assume a family that’s held a house since the mid-1970s sells their property. This family will now have to rent or buy a new house. The rental fee or price of the new home - provided it is similar in size and location to the family’s original home - will also have increased significantly over the same period.

Therefore, it is difficult to argue that this family is any richer, based on housing price inflation alone, than it was 30 years ago. Only if that family decided to move from, say, Central London or the San Francisco Bay area to the Midwest United States or somewhere in Africa or Southeast Asia would it have realised a true, but nevertheless inflationary, gain. Moreover, whereas the household’s sector wealth has risen, so have the system’s overall debts.

Patterns in asset prices: Non-financial debt

In 1975, total domestic US non-financial debts amounted to $2.26 trillion. For that year, total non-financial debt grew by $192.7 billion. In 2004, total non-financial debt reached $23 trillion, and annual non-financial borrowings ran at an annual rate of around $1.8 trillion. Household total debt as a percentage of personal income has risen from 60% in 1975 to 120% at present. In the meantime, total debts (including financial borrowings) have increased from 120% of America’s GDP to more than 300% of GDP, while, the US net international investment position has collapsed from around 10% of GDP to -25% of GDP in 2004.

But hey, what is there to worry about? The deterioration in the net investment position of the United States is due to the current account deficit, which, according to the outgoing chief economic advisor to the president, Greg Mankiw (also a Harvard professor), to some extent “reflects the fact that the United States is growing much faster than the rest of the world...Our demand for their goods has been growing more rapidly than their demand for ours.”

I am a director of a company. When I ask questions at board meetings, the chairman of the company occasionally responds by saying first that my question is the stupidest he has ever heard in his life. I am greatly relieved, therefore, that the chief economic advisor to the president also makes really bizarre (to put it politely) statements, since it should be obvious to anyone that Asia ex-Japan, a region that has economic growth rates around twice that of the United States (and not driven by debt and asset inflation), actually has rising trade and current account surpluses with the United States.

But the point here is, although US household assets have increased considerably since the mid-1970s, I cannot shake the impression that, based on the rise in debts, the horrendous and deteriorating net investment position, and the unfunded social security, health, and pension fund liabilities, the United States as an economic system is actually poorer today than it was 30 years ago.

Patterns in asset prices: "Something less powerful"

But let us look at another aspect of the inflated asset values. What caught my attention was a recent piece by Byron Wien in the December issue of US Strategy, ‘The Inflection Point’, in which he discusses how, over the past 50 years, the United States went from being and economic, scientific, political, and military leader “to something less powerful.”

Symptomatic of this shift, he writes, “When I got out of college a half-century ago, it was easy to find a job and only true incompetents got fired. The concept of downsizing was essentially unknown. We all wanted to prove our independence, and the way to do that was to take no money from your family. Today many college graduates have a tough time finding the job they want. When they do, it rarely pays enough to live as they would like to. Most have no qualms about getting family help or drawing on a trust fund if they have one.

“Some lose their jobs for various reasons and some are out of work for years. With houses and apartments suitable for a family in and around many urban areas costing high six-figure sums, many cannot consider home ownership without family support. As a friend put it, ‘My children are in their forties and I am still part of their lives emotionally and financially.’”

Wien’s piece struck a cord with me. For one, I have a daughter who is studying psychology. I am convinced that the income she will earn from this career won’t allow her to enjoy the same lifestyle that I have enjoyed. But not only that! If I compare my lifestyle with that which my grandparents and father enjoyed, then it would be difficult for me to make the case that my lifestyle is far better than theirs was, even though my assets are worth far more than they ever possessed. Of one thing I am sure, however. In the homes of my grandparents and parents, we ate superb food. By ten o’clock each morning, my grandmother would already be in the kitchen with her full-time housekeeper, where the two of them would essentially spend the whole day cooking. (My grandparents weren’t even “rich” people, but upper middle class.)

Patterns in asset prices: Quality of lifestyle

When I compare the food I ate at my family’s table with the food I usually eat in hotels, restaurants, and private homes in the United States, I am convinced that at least the quality of my culinary lifestyle has plummeted. In fact, were I to live in Switzerland, I’m not sure that I would be able to afford my late parents’ lifestyle. I might add that most of my friends from school also have a more modest lifestyle than their parents enjoyed, unless they had the good fortune to inherit substantial assets. The point is simply that income gains have lagged asset inflation, and that housing affordability for first-time homebuyers with a median income has become an issue. And this is the case not just in the United States, but also in Western European countries!

But in the fictitious economy of rising US asset prices, it only gets better in 2005. In January, home prices in the San Francisco Bay Area soared 20% from a year ago and sales reached the highest level for the month since 1989. Specifically, in San Francisco, a typical single-family home increased in price to $713,000, a 23% rise from last January’s $580,000. The typical Bay Area buyer committed to a monthly mortgage payment of $2,344 in January, up from $1,940 one year ago.

According to DataQuick’s research, the median price for a single-family home has hit a record in nine of the past twelve months. That’s only part of the story. Essentially, there have not been any price declines during these three years. In many cases, little or no money was put down on these homes. The return on investment has made the Dow, NASDAQ, and the S&P 500 look like junkyard dogs. It gets better again. As the price of the home increased, more borrowing against the value of the home was possible. Hence, establishing one’s home as an ATM cash machine.

See what Greenspan’s record low interest rate and accommodative policy helped produce from January 2002 to January 2005...?


Regards,

Marc Faber
for The Daily Reckoning

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