'The US housing bubble will disappear'

That the US housing bubble will disappear someday is a certainty. That it will blow up catastrophically is a fair bet, warns The Daily Reckoning's Bill Bonner.

The total value of residential property in developed countries rose by more than $30 trillion, to $70 trillion, over the past five years – eclipsing the combined GDPs of those nations.

Consumer spending and residential construction have accounted for 90 percent of the total growth in the American GDP over the last four years, and more than 40 percent of all private-sector jobs created since 2001 have been in housing-related sectors, including construction and mortgage brokering.

America made some of its biggest gains this past year, with average prices of homes rising 12.5% in the year and prices in Florida, California, Nevada, Hawaii, Maryland and Washington, DC, rising more than 20 percent, while in Palm Beach County, Florida, it rose over 35%. Sales of existing homes in the US set a new high at 7.18 million in April.

Some foreign countries showed bigger gains than the US in the last year, with prices up by 23.6 percent in South Africa, 19 percent in Hong Kong and over 15 percent in Spain and France. But average house prices have actually fallen by 7% in Australia since 2003; Sydney's bubblicious prices have plunged by 16%. In Britain, sales have contracted by a third from last year and have also slowed down in Ireland, the Netherlands and New Zealand. In Britain and Australia, these declines followed what were only very modest interest rate increases.

23 percent of all American houses bought last year were for investment and in Miami, one speculation hot spot, 70% of condo buyers are investors/speculators.

Last year, 42 percent of America's first-time buyers – and 25 percent of all buyers – put no money down.

In California, 60 percent of all new mortgages this year are interest-only or negative-amortization.

House prices in relation to rent have hit all-time highs in the US, Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. In the US, the ratio is 35 percent above its 1975-2000 average. The price to rent ratio is a cardinal indicator of over valuation.

Nobody will ever grow broke borrowing at 3-5% to carry assets growing in value by 10-14% a year. It really doesn't matter how long you run that movie forward in time, the borrower never loses.

What happened at the inflection point in your graph is the Asia crisis. At that point, trading profits from Asia economies began to be parked in dollars or recycled to US portfolio investment, in preference to being invested in new capital in Asia itself. Emerging markets which had been galloping gave way to a preference for US as a destination for capital.

When the rest of the world starts bidding 6% real for capital, the US will have to generate its savings domestically. Since instead the rest of the world is saving while getting 0-1% real at home, half their capital comes here and we get to use it.

When the US next does have to generate its savings domestically, it willdo so just fine, because all the houses will still be here not there, and ours not theirs. Same with all the Toyotas etc. They have paper. Which they can redeem for US exports, or sit on for the rest of their lives, but has no other earthly use. And keeps oh about 5% of its value after a century.

It might be said that no sane group of men would accept monopoly money that does not hold its value at miniscule interest rates in return for their own real sweat savings and capital. Fine, so half the world is insane in our favor. We won't go broke from that, ever. If you take my counterfeiting and consider it cash, I'm not the one who will go broke that way.

Next ask yourself what supposed confluence of events is going to make the US Fed drive rates to the moon and leave them there despite a wrecked and crashing economy. It isn't going to happen. If capital earnings world wide can stand it, then sure real interest rates can go higher all over, and if other countries free their various frozen unfree markets they can compete with us in attractiveness for investment. But precisely those conditions ensure we can only face seriously higher rates if there are correspondingly seriously improved real opportunities.

You can't beggar someone by giving them real capital for empty promises.

Sorry, the article is just illiterate. Nothing is said makes the slightest real economic sense.

There is no interest rate spiral - long rates have remained stubbornly under 5% despite the Fed tightening short rates beyond that. It is possible that condition may pass, but its fundamental cause is the eagerness of the rest of the world to hold claims against dollars, even at meager returns and even with a dollar supply that rises relentlessly.

The reason for the deflation in Japan is their unwillingness to deregulate their capital markets. They embraced Keynesian nonsense about public works and their supposed multiplier effect on the real economy, nowhere in evidence. People will consume more only if the mix of goods offered is what they actually want. Since Japan rigs its capital market to send abundant capital at zero rates to large favored firms, the mix of goods actually on offer is not set by demand but by the past investment decisions of large favored firms. They are making what foreigners wanted 15 years ago, not what Japanese consumers want now. Ergo, prices remain soft.

But it is nonsense to say the nominal Japanese economy is contracting 5% a year. It is doing no such thing. Instead is has stagnated, with occasional patches of slight growth. If ever a proof were wanted that high rates of savings and net creditor status were not a foolproof recipe for economic growth and success, it is modern Japan. The missing ingrediant is freedom of entrepeneurs to unseat old businesses, take the assets those currently monopolize, and turn them to other more desired uses - as dictated by sovereign consumers.

By freezing its capital market, Japan leaves workers and real capital in the hands of large firms making yesterday's goods and goods wanted elsewhere, not those desired in Japan. Simultaneously, their huge export surplus and protection prevent any serious inroad of foreign business supplying the rich Japanese consumer - although the highest tier luxury goods have done OK there. Not being offered anything they actually want at attractive prices, Japanese consumers prefer to save. The government, beholden to the large firms frustrated by this, strives to get them to spend more on the same old same old, without success.

Japanese savers cannot bring about the needed shift themselves because takeovers are basically impossible in Japan. Past losses discourage real estate and stock speculation as well. So it all gets packed in the lowest risk assets, earning no return at all, and merely subsidizing anyone who can borrow in Yen. That was meant to be a subsidy to large Japanese firms. But in the age of futures markets, anyone on earth can borrow in Yen, with every bank as market maker and arb intermediary. (Just sell a Yen future).

The huge interest rate differential between dollars and yen is only an equilibrium position without net flows, if the yen appreciates by an amount every year, equal to that difference. In practice it does nothing of the kind. Meaning those who borrow in yen to lend in dollars make a killing - the US financial sector first and foremost.

You can't compete with a free economy with a closed one and pick your own fiscal and monetary policies - not with financial markets open and as flexible as they are today. If you try to anyway, the freer side just gets much of the earnings of your capital.

This is not sinister exploitation of friends. The US has continually urged Japan to free its markets and encourage its consumers, to transition to a more demand led and domestically focused economy, etc. Which would be great for them and healthy for us in the long run. They have not done it. As more and more of the US financial sector has come to understand that this is a stable decision on their part, they have had to pay more and more to us in effective subsidy to maintain the status quo.

The article imagines that somehow the returns on assets financed by easy money in the US, will plummet and thus make debt the winner and assets carried by it the loser. It can certainly happen in specific asset classes and has. But what imaginary relationship is supposed to make debt pay the highest returns as the money supply explodes? It can't happen. Central banks can drive the return on holding cash, as far into the negative as they like.

Of course they normally prefer not to, they want the currency they oversee to be an attractive asset etc. But if they see economic damage from excess returns to cash and debt, they can and they will drop those returns to zero. Unless every form of reasonable investment is forbidden, there will always be potential investments with positive returns, in any free economy. Freedom plus flexible money means deflation is not a credible problem. Only inflation can plague the set up.

And the inflation that causes house prices to collapse will not be invented this side of doomsday. Inflation is precisely why they rise. Real estate carry is in fact the market's main answer to easy money central banks world wide. The only thing that can stop that is a lender's "strike", not its own logic or success. The lenders in this case being foreign exporters sending great gobs of net capital to our shores every year, in return for paper.

When that goes away, so does the trade deficit. All the demand not met by foreign production (as no longer so willing to take dollars) goes to US production instead. All the prices held down by foreign competition rises instead. The dollar declines, which also adds to price pressure, upward. This is not a recipe for deflation, either.

If the US had no great asset position - like say Indonesia- loss of foreign capital might be disasterous. But of course this is not remotely the case. The US household sector has over $52 trillion in net worth, and all that capital will earn returns. If real IRs are higher, it will earn higher returns.

The US simply has the best investment climate in the world, among major developed countries at least. That is why corporate profits rise at double digits rates. It is why the financial sector reports earnings 30-40% above a year ago, despite the supposedly epic calamity of house prices no longer galloping. Nothing on the horizon is going to change that, short of nuclear attack.

Meanwhile it is also worth mentioning that a fair portion of the "foreign" capital financing our current deficits is foreign in name only. The carribean has larger investment positions in the US than even Japan. That is simply US money parked offshore, to avoid taxes or other regulation, etc. It amounts to several trillion by now. The Eurodollar market dwarfs even that.

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