The Brothers Austrian

A co-worker of mine recently put me on to a great op-ed that was in WSJ Monday morning by on Bubble economics by Steven Gjerstad and Nobel Laurelate Vernon Smith. The whole article is fantastic but I want to focus on one small part of it that really baffled me:

“In 1983, the Bureau of Labor Statistics began to use [for CPI] rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.

With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since “owners’ equivalent rent” is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.

With nominal interest rates around 6% and inflation around 6%, the real interest rate was near zero, so household borrowing took off. As measured by the Case-Shiller 10 city index, the accumulated inflation in home-ownership costs between January 1999 and June 2006 was 151%, but the CPI measured a mere 23% increase. As the Federal Reserve monitored inflation in the early part of this decade, home-price increases were no longer visible in the CPI, so the lax monetary policy continued. Even after the Fed began to slowly raise the fed-funds rate in May 2004, the average rate remained low and the bubble continued to inflate for two more years.”

So what does owners equivalent rent really mean according to the BLS?

“(The) BLS asks each homeowner for their estimate of the house’s implicit rent and what occupants would get for their rent (how many rooms, etc.) if the owner did rent their home.”

When the Bureau of Labor and Statistics do their surveying for shelter index portion of CPI they ask the following question (verbatim):

“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

Man I would love to get one of these calls.

If you ask someone about their home value, that is something they probably know about, but if you ask someone about their house’s implicit rental equivalent is, now that is a different story. Most people do not understand the economics of rental properties well enough to give such an opinion. Furthermore, how many people living in Mc-Mansions can even contemplate what their monthly rent would even be when they live in a neighborhood that may not even have on housing unit that charges on a monthly rent basis?

I think Gjerstad and Vernon know what Hazlitt knew decades ago: inflation numbers are blatantly cherry picked and scrubbed to make it seem like the COLA estimates are much lower then they really are.

Furthermore the BLS states that, “Because rents are not volatile, the CPI can use a longer interval between pricing observations than it uses for other consumer items.” I guess we will have take that statement about volatility at face value.

Click here for more information regarding the housing index and CPI

Wendall Wilkie Inflation, Real Estate, Uncategorized cpi, Hazlitt, housing bubble, Inflation

There are many, many, micro inputs that collectively have combined to culminate into this massive credit crisis. The creation of the Federal Reserve, coming off the gold standard, the invention of the credit card, the invention of asset backed bonds, subprime lending, etc etc etc. Who could have ever thought that all of these things would culminate into a crisis this big? Well Hazlitt knew the problem was on the horizon in the 1950’s and make no mistake, Hazlitt was woefully aware of how devastating inflationary policies could be.  Have we forgotten about what the fall of the German mark  ultimately lead to? The below statement actually strikes the fear of god into me!

“Like every other tax, inflation acts to determine the individual and business policies we are all forced to follow. It discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.”

-Henry Hazlitt (Economics in One Lesson)

· Discourage prudence and thrift- government encouraging spending ?

· Gambling and speculation -Flipping houses, LBO’s-?

· Desperate remedies-monetizing debt-?

I believe that the above statement by Hazlitt not only summarizes how we got into this “credit crisis” but also summarizes where we will end up. Monetizing debt is just the start of the desperate remedies. I fear that the impudence of the governments of the world will lead to further instability. Now, as brutal is this instability may end up being it is my job, I still look for future investing opportunities.  That’s why I have coined the GGO Investment Theory- Guns, Gold & Ordinance (perhaps we should substitute oil for ordinance?). That is not to say that I recommend running out and buying stocks, because I actually wholeheartedly believe that equity indexes will cough up another 40%–that’s right I said 40%–within a year. When the cough up comes, however, I will be ready to pick up some defense stocks on the cheap. As far as gold goes, well you better have some of that before that cough up comes, because otherwise you will be paying up to own the bullion.

Wendall Wilkie Gold, Inflation, Stock Market defense stocks, economics in one lesson, Gold, Hazlitt, Inflation, oil

“Often the masses are plundered and do not know it.”

Ah, yes, nary a week should go by without hearing from our good friend Frederic Bastiat.  The French economist, who died too early and too soon after his emergence as a economist.  Bastiat died at the age of 49, only six years after truly finding economics, as a theoretical study, at the age of 44 (thanks Wikipedia!). In that time Bastiat published some real economic gems.  This from his Selected Essays on Political Economy:

“But what relief can the landless find in the proclamation of the right to employment? In what respect will this new right increase the amount of food or the number of jobs available to the masses? Is not all capital employed in giving them work? Will it increase by passing through the public treasury? By taking it away through taxation, does not the state close at least as many sources of employment on one side as it opens on another?”

Fast forward to today and we face a similar, but different problem for the masses.  In all of their zeal to get reelected save the economy, the government spending trillions of dollars.  Some of these ’stimulus projects’ will help select portions of the masses, but in the end, the only real stimulus will be in the green ink industry.  What will the masses be left with?  At the very best significant inflation, at the very worst hyperinflation.  Inflation always falls upon the masses the hardest.  And thus, the masses are being plundered without even knowing about it.

Teacherman Government Spending, Inflation, Politics economist, employment, frederic bastiat, hyperinflation, Inflation, masses, political economy