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The Bubble Imperium

This time of year, here in London, one day has barely died before another is born. It is light until 10:30 at night. Then, it is light again at five in the morning. We have not had time to rest or collect our thoughts.

That is usually a plus. When you are in love, war, or a market mania the last thing you want to do is stop and think. You might decide to forget the whole thing. Why? Because they almost always lead to tears: heartbreak, death or insolvency, depending upon the affliction.

Today’s love affair is with the U.S. Imperium…the modern American empire had turned our hearts to mush. It must be infectious; now our brains, our money and our economy have turned to mush too. Today’s war is a dull, but expensive, fight against “terror” — whoever that is. And today’s market mania is in housing. All over the world, residential real estate is HOT! Hot. Hot. Hot. So hot they have to print the listing on asbestos. So hot the sidewalks melt. As hot as the core of the sun on a summer day. As hot as Hades without a shade tree. HOTTER than HOT. Hotter than a $25 pistol in a drug war. Red hot. White hot. Red, White, and Blue Hot.

We only mention it because everyone says so. Everyone says we have a real estate bubble. In fact, The Economist tells us it is the biggest bubble in history. The stock bubble of the late ’90s increased investors’ wealth, on paper, by an amount equal to 80% of GDP. The stock bubble of ’29 added an amount equal to 55% of GDP. But the last five years of the real estate bubble have added as to Americans’ wealth as an entire year’s output; that is, 100% of GDP.

Here, too, the syndrome is catching. Easy lending, easy spending policies in the U.S. have forced the whole world to keep up. Foreign central bankers must create more and more of their own money in order to sop up U.S. dollars — which are then relent to the United States. The result is a worldwide bubble in money and credit, reflecting in rising real estate prices almost everywhere. According to The Economist, this bubble has added $30 trillion worth of wealth in the last five years. This “wealth,” we caution readers in the words of the Economist, is “largely an illusion.”

And so the whole world is HOT, enjoying an once-in-a-lifetime shindig on borrowed money and borrowed time. In Australia and Britain, property prices seem to be softening already. American prices won’t be too far behind.

How do we know?

Longtime readers know that we have a deep appreciation for ignorance. Where others see enlightenment, we see rampant stupidity. Where others see geniuses, we see blockheads. Where others see the future clearly, we see only the murk of our own thoughts and desires. We have no idea what will happen, but when others bet that something extraordinary would become even more extraordinary, we are happy to take the other side of the wager. The mean would not exist if things did not regress towards it. The days get longer and longer until today; and then they get shorter. Gradually, the days’ length regresses to a mean of 12 hours of sunshine, 12 hours of darkness. The trend does not stop there. Then, the days continue to get shorter and shorter until December 21st, when once again, they regress to the mean.

Real estate will regress to the mean just like everything else, dear reader. Prices will either fall sharply. Or they will stop rising, and fall gently against inflation. One way or another, soon or late, the real price of property will go back to where it always has been. Yale economist Robert Shiller predicts a 25% drop in residential property prices. The Economist hints at a worldwide recession when the air goes out of the real estate market. Maybe they will both be right.

But how could we have a real bubble in real estate when so many people say so? Don’t worry, dear reader. This mania is a popular mania. And the average lumpen house buyer has no clue. He has heard that he is buying in a bubble. He’s happy to do so, because he has no idea what a bubble is. “Yes, there may be a pause,” he will tell you, “but property never goes down in price — not in America!”

• "No-money-down MANIA,” reads a headline in MONEY Magazine. The interesting thing in the story about the No-Money-Down gurus is the photo. The people attending are not a group of investors. They are fairly young people, lower-middle-class people by the looks of them. Our guess is that the concept of a “bubble” means nothing to them. We would also guess that they don’t have a lot of extra money to lose…and that they’ve bet their financial futures on the real estate bubble. This is very different from the punters who ran up tech stocks. They had to put up real money. But few mortgaged their houses to do it. When the bubble popped, they were poorer, but wiser.

What will happen to these people when the real estate bubble pops? They are already poor.

• How? When? We don’t know. But we regard the collapse of the housing bubble as a near-certainty. But it is like life itself; just because an end is inevitable doesn’t mean you are eager to see it come. People go about their business, buying and selling, as if it will never come. But it certainly will.

Another doomed phenomenon is the U.S. dollar. The American currency rose with the empire — from 1917 to 2002. But no paper money has ever endured. The dollar is now losing value faster than the Roman currency after Nero. That it will eventually be extinct is a safe bet. When it will happen is anyone’s guess. But gold is rising against the dollar and will, no doubt, continue to do so. Gold, food, houses, oil and other tangible things can only be brought into commerce at great expense in time and money. Paper dollars can be created at will. The relative abundance of the latter compared to the former makes the decline of the dollar inevitable.

And of course, the empire itself has a tomb waiting for it. As long as there are humans there will be human history. And what is human history but a record of the misadventures of the species? One empire is born; another dies. An empire is an extraordinary thing, like a market mania, a war or a love affair. All of them regress to the mean of ordinary life, where things are not HOT…HOT…HOT…but normal, common, usual…as cold, boring and peaceful as the grave.

• A reader, writing from Ireland:

“I write to you with the intention of passing on compliments and also with a genuine query regarding house prices in the Emerald Isle

“Due to a variety of travel and business adventures throughout my twenties I find myself at age 34 in the (slightly) unfortunate life circumstance of living with my parents.

“This is not entirely an unusual occurrence in Dublin. I have lots of friends my age engaging in similar living arrangements. Frankly, although I love my parents very much, I would much rather be living elsewhere (as would my long suffering parents).

“I pay a nominal rent and contribute to bills and am saving for a deposit to buy a house somewhere in Dublin. As you are most likely aware, local house prices have been steadily increasing and I reckon it will be easy enough for me to acquire an ‘agreement until death’ with a local lender secured against a habitable collection of bricks tethered with mortar.

“But my question is, ‘Should I bother?’

“I am trying to resist pressure to enter the housing market as it goes against my (minimal) better financial judgment breaking many property purchasing rules:

“1. Having a deposit greater than 30% of the asking price. (I possess considerably less than that at present. The parents have offered to help but I am uncomfortable with this kind offer.)

“2. Being able to afford repayments on a loan given a two to five percent increase in interest rates, I probably couldn’t.

“3. Entering a market where the price of the artifact is expensive. Every year I have put this off house prices have increased. But I have also experienced the benefits of purchasing property in a foreign land where there was a market ‘correction’ of over 20%. I know a drop in house prices is not (as is locally called) ‘impossible.’

“Should I move out, rent and save more slowly or should I stay, save and get a three-bedroom house, swapping cohabitation with my parents for cohabitation with tenants?

“Kind regards,Robert”

• Dear Robert,

We do not give personal advice, and if we did you’d be a fool to take it. But we have some thoughts.

First, we note that the house bubble has blown up prices in Dublin as much or more than anywhere else. Since that is the case, you could reasonably expect to get more house for your money later rather than sooner. House prices should revert to the mean. When they get to the mean, or below, you will make a better purchase.

Second, we caution that a house is not an investment. It is a consumer item. The time to buy a house is when you want one and can afford it, just as with any other consumer item. Will it be cheaper in the future? We guess it will, but we don’t like to run our personal lives on the basis of our guesses about the markets. Instead, we ask ourselves a specific question rather than a general one: do we want to pay that amount of money for that particular house? Or would we prefer to rent the one next door? That is, you might want to convert the whole issue from macroeconomics to a matter of personal, private interest. You cannot really know what the markets will do. So you have to ask yourself the questions without regard to your macro-economic guesses.

We have noticed, for example, that while we are perfectly happy to rent an apartment, our better half feels a strong desire to buy one. It is not an economic or investment question. It is simply a matter of personal taste. In our experience, women like to feel they have the family’s feet firmly on the ground — rooted in community affairs and mortgage payments. Men might prefer a more nomadic life. What can you do? You compromise. You divide decision-making. But here we give you some confidential advice, hombre al hombre: You tell your spouse that she will make some of the decisions and you will make others. Just make sure you make the important ones. That’s the way we have done it in our household. Our wife decides where we live, where the children go to school, where we go on vacations, what we do with our time, where we invest our money and how we spend it. But we make the important decisions, such as the family’s position on the European constitution and the revaluation of the yuan.

June 23, 2005

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century.

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