Housing Prices Follow GDP Growth and Inflation

The next big trend, dear reader…

It’s coming. Consumers – especially the baby boomers – are about to change their way of looking at things. And when Bernanke & Co. realize what is happening, they will greet the new trend like the citizens of Atlanta welcomed Sherman.

“War is hell,” said the yankee general, before burning the city down. So is a correction.

Wednesday’s news brought more details. The Dow rose 40 points. Oil remained where it was. Gold lost $3. And the dollar seems to be strengthening a little against the euro. You can now buy a euro for only $1.56.

“Retail sales stall,” is the word on the street, coming from Bloomberg. Of course, we already knew it. Restaurants are serving fewer meals. Malls are losing tenants. U.S. automakers are desperate to move their vehicles off the lots.

“Big three face bankruptcy fears,” is the headline from CNN/Money.

There are two ways to play a correction, as we mentioned yesterday. (Or forgot to mention?) You can look for bargains as investors sell off their losing positions. Or, you can take a vacation. Read War and Peace…in Russian.

Here at Markets and Money, we’ll take Option #2. We like doing nothing. It gives us time to think.

Many investors, on the other hand, are sure they are looking at the Opportunities of a Lifetime. They see Fannie and Freddie, for example, and remember when the stocks were trading over $60. “What a bargain they are now!” they say to themselves. Or look at Wall Street. J P Morgan, Lehman Brothers, Bear Stearns…they’re all selling at big discounts.

And don’t forget the nail bangers. The housebuilders were the first to get nailed. Their stocks got sold off; investors lost billions in just a few months. But take a look at the builders now – hey, maybe they’re coming back! ‘No guts, no glory!’ ‘Go for it!’

Yesterday, one of the biggest builders, DR Horton, reported a $400 million loss for the third quarter. While it is possible that we’ve seen the worst in the housing sector, it is also possible that the sector will never bounce back – at least, not in our lifetimes. Nor will Wall Street. The bargains, in other words, could turn out to be traps for the unwary.

How could that be? We’ll explain.

Over most of the last century, housing prices followed GDP growth and inflation. Nothing more. And it makes sense that they would. Housing is the number one consumer item. Consumers buy as much housing as they can afford – but not more. What happened in the 10 years – 1997-2007 – was an aberration, an unnatural freak caused by a rare conjunction of various absurdities. The dollar-based financial system…the collapse of the dotcoms…9/11…Asian export-mad economies…Alan Greenspan – all conspired to bring about a huge run-up in housing prices and consumer debt.

The two circumstances – like Butch Cassidy and the Sundance Kid – worked together. One kept his firearm on the bank manager, while the other cleaned out the vault. Consumers were able to borrow vast amounts, because their major collateral – their houses – was rising in value. And with the extra credit, they were able to buy more houses!

But the two desperadoes met their end, it is said, like Che Guevara, gunned down by the federales of Bolivia. And once they were dead, they were dead forever.

So too, our guess is that the bubble in housing and lending is over. If not forever, at least for a long time. Credit or interest rate cycles tend to last a long time – about as long as an investor’s career. High- grade yields reached a peak in 1920 and then retreated until after WWII. Then, they rose again…for the next 35 years. Since 1981, they’ve gone down…at least for 22 years…maybe longer. One generation is convinced that interest rates always go up. The next is sure they always go down. One thinks credit gets easier and easier. The next knows it will never be able to borrow another dime – and doesn’t want to. One generation forgets what the generation before it just learned. That’s the credit cycle.

But what did U.S. consumers learn during the last great credit cycle? What are they learning now?

One of the surest ways to make money in the last 10 years was to buy a house. The baby-boomers, especially, saw home ownership as equivalent to saving for retirement. Houses always went up in price; everyone knew that. If you had enough houses you didn’t need any money in the bank. A popular retirement planning technique was to buy a second house at the beach in your ’40s or ’50s. And then, when you were ready to retire, you could sell the main house.

But this is where the Next Big Trend comes in. The baby boomers are suddenly realizing that houses are not the same as savings. And they’re suddenly facing up to the idea of financing their retirements in a world of declining house prices…and rising costs.

“Home energy prices are expected to soar,” reports the New York Times.

What will they do? First, they will be forced to go back to saving. They won’t like it. But they will have no choice. They need money for their retirements. And the only way they can get it is by reducing their spending and saving more.

We know what you’re thinking, dear reader. You’re thinking – “it’s about time!” We’re thinking the same thing. Americans desperately need savings…capital…resources.

But we’re thinking something else too – that the U.S. economy of the last 20 years was built on excess consumer spending. Savings rates went from around 9% of GDP down to zero. Now, if they go in the opposite direction – and they must, in our opinion – the drop in consumer spending will cause the worst recession since the ’30s. We’re not just saying that to be provocative. We can add two and two. Subtract 9% from an economy that is growing at, maybe, 2%. Do that over a period of 10 years (the boomers don’t have to save just one year…they have to save every year). Of course, it isn’t quite that simple. When money is saved it doesn’t disappear. Some of it is re-invested in the real economy, leading to more jobs…more output…and growth. But it takes time to convert a consumer economy into a more balanced economy. And it takes time to pay off debts…and write-off mistakes. In the meantime, you have an economy walking backwards for a long time. And probably tripping over something along the way.

But wait. Will the Bernanke Fed allow it? Will the Obama administration permit a serious, multi-year recession? How will they try to prevent it? What will happen when they do?

Ah…we’re glad we don’t have time to answer those questions today. Stay tuned for tomorrow…

*** Japan says it is in recession. China says it is trying to avoid a slowdown, by loosening credit restrictions. The United States is probably already in a recession; its central bank is giving away money to try to get out of it. So is the U.S. government. Britain is falling into recession too; the IMF warned Britain not to cut rates to try to save itself. Europe must not be far behind…with the lowest consumer confidence numbers in memory.

The whole world is slowing down.

But commodity prices, while retreating, are still up for the year. Copper is 14% ahead of last year. Gold is up 5%. Aluminum is 23% more expensive.

Tanker rates are falling; tanker captains have been told to go more slowly to save fuel. And the oil producers are selling oil forward in order to lock in today’s prices. The industry seems to have little faith in today’s prices – even though oil has come down about 15% from the peak.

*** Another farcical chapter in the history of the War on Terror seemed to come to a close this week. It turned out that the ‘terrorist’ responsible for practically shutting down the U.S. postal system – closing mail rooms across the nation, and frightening old ladies to the point that they were afraid to open letters from their grandchildren – was most likely working for the U.S. government. Bruce Ivins cost the nation millions, maybe billions of dollars, when he sent the anthrax spores through the U.S. mail. But at least he had the good grace to save the country the few bucks it would have spent putting him on trial. After threatening to kill his co-workers and adversaries, he decided it was time to exit the stage.

*** Tomorrow too – more on the Zimbabwe with Oil, Venezuela…

Bill Bonner
for Markets and Money

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.

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