What really makes a bubble? Are bursting bubbles inflationary or deflationary? What lessons can we learn from history? In this article Justice Litle addresses these issues. ~editor
By Justice Litle, Editorial Director, Taipan Publishing Group
A burst housing bubble is a harbinger of deflation, not inflation, due to massive debts incurred and massive savings lost.
To really get your head around the inflation debate, it helps to understand the late great housing bubble. To that end, this description seems as informative as they come:
The smell of Boom was everywhere. It caught even those who were not particularly attracted by it. A former president of Freddie Mac, William Popejoy, arrived to head up a large savings and loan, American Savings. He had moved from the suburbs of Washington, D.C., “and we bought a four-bedroom house in Benedict Canyon for a hundred and sixty-five thousand dollars. We’d get over six hundred thousand for it now, in just five years.” If you could do that, without trying, what could you do if you were trying, if you were refinancing the first house and buying a second? “I own ten million dollars’ worth of houses,” said a thirty-year old actor… Money everywhere. The California dinner parties were all full of talk of overnight fortunes.
Yep. That captures the essence of the housing bubble all right. Home values zooming from $165K to $600K in “just five years”… goofball 30-year-olds buying millions of dollars’ worth of properties… dinner party talk of overnight wealth…
Here’s the catch though. The paragraph I just cited isn’t describing the housing bubble of the mid-2000s. It’s describing the housing bubble of the late 1970s.
The excerpt is from a book called Paper Money by “Adam Smith,” aka George J.W. Goodman. That book was published in 1981.
If you read carefully you’ll have noticed something eye-opening. The housing prices in the 1970s bubble sound just like modern ones. William Popejoy paid $165K for his house in the Paper Money example. Just six or seven years ago that counted as high-end for a house (and still does in many areas of the country). I personally know a few young couples who bought for circa $130K-$160K in northern Nevada (circa 2003).
Here are a few more tidbits from the 1970s housing bubble, as recorded from real estate brokers quoted in Paper Money:
- Century City condos were listing at $425,000 and selling for $250,000 higher.
- Beverly Hills “fixer uppers” went for $595,000.
- Santa Monica “tear downs” — where you basically buy the lot — went for $950,000.
And again, those prices are not modern day — even though they could be. They are from the disco era. Back then, too, there were the same exact arguments about why home prices could never go down… why California was a special market… why built-in demographic trends guaranteed perpetually rising home values for as far as the eye could see… on and on ad nauseam.
Take a deep breath and repeat after me: The game does not change. The game does not change. The game does not change…
(If you’re interested in more of my and fellow editor Adam Lass’s financial market predictions and investment commentary, sign up for Taipan Daily.)
The Unbelievable Maestro
It turns out that colossal idiot, Alan Greenspan, was making his mark back then too.
In the 1970s, Alan Greenspan — future Chairman of the Federal Reserve — was serving on President Ford’s Council of Economic Advisers. And true to Greenie form, “The Maestro” was arguing that maybe the housing bubble wasn’t so bad, because consumers were saving by way of their housing payments. Everything was fine, you see, because when John and Jane Homebuyer spent $3,500 per month on a mortgage, those payments were good as retirement gold. The house was the 401(k).
Talk about déjà vu all over again. In the 2000s we heard the exact same ridiculous argument from unthinking permabulls: The dumb notion that grossly inflated housing prices actually represented a meaningful store of consumer savings, and somehow canceled out alarming spending trends in other areas.
Supposedly it didn’t matter that American consumers were emptying their bank accounts and socking away jack squat for a rainy day, because, miracle of miracles, home prices were going to rise forever and all that capital appreciation would bail them out.
And Alan Greenspan, that unbelievable genius, was making this same argument THIRTY YEARS AGO. And though he saw how things turned out the first time, Greenspan made the SAME ARGUMENT AGAIN — as the Fed Chairman who pumped up the second great housing bubble — 25 years or so down the road.
The mind boggles. It really, really does.
Our Bubble Has Burst
And once again this begs the question: How can we expect a repeat of the 1970s any time soon, when the key drivers of the 1970s have already played out?
They had an insane housing bubble. So did we. They had crude oil prices going through the roof. So did we (oil at $135 a barrel in 2008).
But now? We’re on the backside of the slope.
That ’82 number, in the 11% range, was not too far above the headline unemployment of today. Except in ’82, the unemployment peak came after Paul Volcker “broke the back of inflation” with sky-high interest rates. It came after a devastating anti-inflationary recession.
So if we already have unemployment on par with the levels Paul Volcker created jacking interest rates up into the teens, what does that tell you?
It tells you we’re in a world of hurt, that’s what. Our speculative bubble has already gone bust, and trillions of dollars in homeowner wealth went bust along with it — leaving a crushing mountain of debt behind. Food stamp participation is through the roof. And as The New York Times reports, the new trend to watch is families in homeless shelters:
For millions who have lost jobs or faced eviction in the economic downturn, homelessness is perhaps the darkest fear of all… from 2007 through 2009, the number of families in homeless shelters — households with at least one adult and one minor child — leapt to 170,000 from 131,000, according to the Department of Housing and Urban Development.
With long-term unemployment ballooning, those numbers could easily climb this year…
This is an environment in which the average homeowner — the average American — is more likely than not to be frightened out of their wits. We are not going to see baby boomers rush out and speculate again any time soon. We are going to see them throw nickels around like manhole covers.
And as we have said loudly and repeatedly in these pages, such an environment — a pushing-on-a-string deflationary environment — is very constructive for gold and gold stocks. Which is probably why GLD and GDX busted through their respective price ceilings like tissue paper this week.
Article brought to you by Taipan Publishing Group. www.taipanpublishinggroup.com.
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