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Minyan Mailbag - Money Supply and Real Estate



Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Prof. Succo,

Just doin some work after a great GIANTS GAME! If real estate prices have peaked (which I believe) and the economy has a big deficit, dependant on foreign buying of treasuries, possible stagflation, etc. (views which I agree with you) then is a scenario looming of declining real estate. prices and declining stock mkt? What confuses me is that if real estate. peaks (which I believe as no one I know talks much about the mkt but how much their house is worth and how they are looking for the next strip mall) then shouldn't that money find the mkt?

But the other side of me thinks that the avg. consumer is living off of debt, refis, has cost increasing, property taxes, health care, etc. and they will just reign in the spending and the money does not find the mkt but their savings accounts. People feel wealthier when the biggest asset keeps going up and they spend more and take more money out of their home. Just was curious if you can discuss the relationship of real estate with spending and the stock mkt and your thoughts. I feel that I should just buy puts on a bunch of stocks that I believe will get smacked and take my kids on my first vacation in 2 years! Just trying to game it like everyone else.Your site is the best and feel like the discussions every day make things a little more clearer in a difficult time.

Minyan Scott


The ultimate question is asked in between the lines of this query: how does an expanding money supply drive relative asset prices?

First a little background. Let's go back to 1971 to the virtual end of the Bretton Woods accord, the end of linking money supply to the stock of gold. Economic pundits will tell you that this watershed event was the result of tremendous political will to end an archaic system of money. But remember, history is written by the winners, and in this case, the winners (at least until now) have been "monetists". I think in reality the reason the U.S. and eventually the rest of the world went off the "gold standard" was the result of a lack of political will to do the right thing.

The U.S. was trying to finance the Vietnam war when, at the time, almost all of our debt was internal. We lacked the political will to do the right thing, maintain fiscal and monetary discipline. Instead of raising taxes (which for an unpopular war would have been almost unthinkable), we began printing money to finance the war. This created a problem because as U.S. dollars wound up in the hands of foreigners through trade, they had the right to exchange those dollars for a certain amount of gold. In other words, any country that wanted to print money and consequently increase their external debt through trade deficits had to follow a path of discipline: they were constrained from irresponsible monetary and fiscal policy through the relationship between currency (fiat money) and gold (a finite "real" money).

So as the U.S. printed dollars we began to see foreigners exchange those dollars for our gold. We were in serious jeopardy of depleting all of our gold. The end of Bretton Woods ended our obligation to exchange dollars for gold and we were free to print whatever we wanted. Of course this created a surge in inflation as the dollar was effectively de-valued and rates rose at the same time. Stagflation was what we inherited from our foray into a "fiat" currency system. Not until Volker painfully invoked fiscal and monetary discipline nearly a decade later did our country heal from this episode. We clearly did not learn our lesson as we are now embarking down that road once again, unfortunately at a much higher speed this time.

Monetary discipline means constraining the money supply and growing the economy through an increase in the velocity of money. This occurs over time when an economy "outperforms" others through productivity. We have chosen the opposite path. Some may argue vehemently that we have very high productively; I would say that is highly questionable. It also ignores the level of productivity we would have had had we maintained more economic discipline over the years.

So let's go back to the question. What an expanding money supply over time does is (on the margin) makes income worth less (as there is more currency out there of which income is derived) and makes nominal asset prices higher (more currency chasing finite assets). The wealthy, who own assets, love this and the middle class hate this because they depend on the value of their income to live. Why do you think the "wealth" between the wealthy and the middle class has been widening? I have said this before: the reason the middle class accepts this situation is that they are "allowed" to borrow future income to make their standard of living today palatable.

The bottom line is this. Real estate prices on a nominal basis, as well as stock prices, can continue to rise to new heights as the Fed continues to print money. They will continue to print money until the world says NO! We won't know when that is, but it will be signaled first by asset prices. They will suddenly begin to go down in the face of higher money supply. This is why the Fed cannot let people think that there is any inflation: bond prices would drop first and drag stock prices down with them. This is why the Fed cannot let gold prices rise dramatically: it would indirectly signal a collapse in the value of "fiat" money. Did you know that the notional amount of gold derivatives over the past 18 months has skyrocketed? Did you know that the normal issuers of derivatives that supplies the "short" side of the market are gold miners but that they have actually been covering these short positions? This means that someone else is providing more "short" derivative positions into the market. My guess is that the only "someone" that could be is a financial entity.

Or stock prices could signal this process first (although I lean to bond prices); stocks after all are "pretty smart too" in the long run.

If bonds don't drop significantly when (if) real estate prices top out, then stocks could go higher as this "slosh" or money finds a home: the "fiat" money has to go somewhere. A significant drop in bond prices would signal a "sea change" in our foreign bond holders as to how much of our currency they want to hold. This drop in bond prices would absorb the extraneous supply of money going into nominal asset prices. Bulls main thesis is that there is no end in sight for the willingness of foreigners to re-cycle their dollar holdings back into U.S. securities. They argue that there simply is no place else for them to go.

They may be right, although I don't think so: as debt continues to mount in the U.S. marginal debt holders will demand a higher risk premium. The only thing I can do is to I urge people to monitor the dollar yen rate for a signal that "the sea is changing".

If the dollar yen breaks 100 keep your eyes glued to U.S. treasury bond prices.

No positions in stocks mentioned.

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