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Housing Bubble and Everything Bubble in One Simple Picture

To understand the magnitude of the housing bubbles simply compare the index of wages to the index of prices.

How Did We Get Here?

That's easy.

Average Wages vs CPI

Note the correct CPU comparison for this chart is CPI-W not CPI-U, not that it matters much.

No matter what official CPI one uses, the chart is a joke. Why? The CPI only reflects rent, not actual housing prices.

The Fed made this mistake during the housing bubble and they made it again from 2011 to present.

More bubbles will burts and that is very deflationary. By chasing its tail, the Fed creates the very conditions it seeks to prevent.

Price Deflation Not a Problem

For years, the Fed desperately sought more inflation. However, a BIS Study on the Historical Costs of Deflation shows routine price deflation is not a problem.

According to the BIS, “Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.”

Meanwhile, people keep faith in the Phillips' Curve. It's pathetic.

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Mike "Mish" Shedlock

One other factor drives homes higher, it the govt subsidy to homeowners, i.e. tax break on interest. This gives the illusion that you are getting a break but in reality it has helped drive prices up. Its really a gift to the builders.

I think I read Robert Shiller from Yale say something like for the past 150 yrs house prices have risen at about the rate of inflation. And he said that prices were currently 35% above that. So that means a 35% correction if there is a reversion to the mean.

There is no question historic low rates are the only thing that has allowed home prices to outpace incomes by so much. Thus keeping the payment down, which is what matters to home owners. Also, the last 5 years or so has seen a ton of foreign Chinese buying. That likely has a something to do with prices so high on the coasts.

After three-plus decades of credit inflation that flowed (mostly) into asset prices, discussing inflation/deflation is difficult.

Since the bond market lows in 1981, every dollar borrowed (by anyone, especially Uncle Sam) and spent performed an amazing feat: At least two dollars of "wealth" were created, the first as a dollar spent cascading (at monetary velocity) through the "GDP-producing" economy while a second dollar, the IOU, was counted as an asset in the bond market. This magic-money-machine continued as long as collective trust in the veracity of those IOU's (which are nothing but promises of future cash flows) remained high.

Are we not awash in fantasy-level promises of future cash flow? This blog details some of the pension excesses, unpayable under any fantastic assumption (IL's 3% COLA in perpetuity is an exercise in innumeracy, for example, when looking at pensions.)

Back in 1981 the existing amount of debt was a puddle in comparison to today's Bond Ocean. While the bond bull market drove debt service lower, people flooded more debt into that ocean, but when rates hit zero, there was nowhere to go but up. The capital gains on debt as rates fell were applied to a pond of IOU's. Now that it's an ocean of them, the promised collapse in capital value as rates rise is a mathematical axiom, a veritable Mount Vesuvius now smoking and rumbling. It all rests on nothing but mass psychology, of mass trust (pathological trust, that is.) The amount of debt extant is an abstraction far beyond the minds of men to grasp. There is no limit to the amount of an intangible asset that can be floated into a bull market; the law of supply and demand simply does not apply. The amount of debt (and its yield) is nothing more than a fad or a fashion...herd-level cognition that has nothing to do with reason or logic, and for which industrial-scale rationalizations arose.

I submit this is the economic/financial side of the Leftist coin. Leftism is for all practical purposes a theology of wish-fulfillment, the notion that political systems can fine-tune every aspect of life to eliminate all that is deemed undesirable. It is pure, unadulterated belief in unreality, of a world without limits, a world of unlimited resources. All that matters is the fad of the day. That this collective mindset has been rallying since the Protestant Reformation hides just how odd is the entire project. I think the last 50 years are the "blow off top" of this entire long-lived fashion in groupthink. Debt could grow to orbital levels, genetics don't dictate any aspect of human condition, Chinese labor could make everything Americans want, while Americans pawn their entire nation to buy the trinkets, even as American jobs moved from making final goods from natural resources to pushing intangible "assets" from one electronic account to another. And several industries (most notably the economics profession) arose to "'es-splain" why all this makes perfect sense.

Is this incorrect?

After 37 years of compound credit inflation, most of which provided the mass-minded rationalization for sky-high asset prices, I suggest a much larger decline is likely.

The precursors of an unprecedented market collapse are:

  1. a huge buildup in credit (esp. non-self-liquidating debt.)
  2. recent history that taught Pavlov's Investors that markets always come roaring back, so only fools capitulate.

Market lows occur amidst capitulation. Now that people have been taught, twice in the last 17 years, that a 50% drawdown is nothing but a massive buying opportunity, are we at a point where stocks (and houses) could fall 50%, rally 50%, fall 50%, rally 50%, over and over, and people would not capitulate, in fact they'd pour in more capital each time the market began one of those rallies?

I think all asset markets are vulnerable to -95% catastrophe.

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