We’re concentrating on the May issue of Australian Small-Cap Investigator for most of this week, but we should still find time to lob a few grenades at mainstream thinking.

So, before Shae takes up the slack, a couple of quick things that took our fancy…

I said yesterday it might be worth waiting for the Aussie dollar to strengthen a little and the gold price to fall. Good luck with that. It’s piled on another few bucks overnight, trading above AUD$1,400.

And the GOLD exchange traded fund (the one your editor owns a few shares in) is trading above $139 per share.

But as the stock market continues to head south – as we feared it might, but hoped it wouldn’t – we think back to the warnings we offered over a year ago about the stock market rally and economic recovery being an illusion.

A government and central bank created illusion. But more on that another day.

Anyway, up in Sydney yesterday Luci Ellis, Head of Financial Stability at the Reserve Bank of Australia (RBA) spoke at an Australian Financial Review sponsored conference on housing. But for a start we’d like to grade her ‘F’ for the job she’s doing on overseeing financial stability considering how quickly the value of the Australian dollar continues to devalue thanks to inflation.

But best of all we liked this comment in her closing “Final Thoughts”:

“Recent data suggest that we do not have a credit-fuelled speculative boom on our hands. It would not be desirable for the current situation to turn into one.”

We have this image of Ms. Ellis standing in front of a large bubble that she’s tried to cover with an overcoat, insisting to passersby that there’s nothing to see.

But what “recent data” would Ms. Ellis be referring to?

I mean, it couldn’t be the data from the Australian Bureau of Statistics (ABS), the chart of which Ms. Ellis used to open her presentation:

Because pardon us for commenting, that’s got bubble written all over it. Well, our version has anyway:

And obviously she hasn’t noticed the numbers contained on the RBA website which provide an insight into the, erm, non-existence of the “credit-fuelled boom”:

Those numbers are in millions. We pointed out last week that residential borrowing had increased 50% in the last two-and-a-bit years.

Clearly that’s not a “credit-fuelled boom.”

But then Ms. Ellis would naturally deny the existence of a credit boom considering it’s her employers that have caused it. You know the rules, gotta tow the company line.

We do like how she used the following chart, which unwittingly should help to dispel the myth that rising population growth is necessarily linked to house price growth:

Prof. Steve Keen pointed out in an article for Business Spectator last week that if population growth running faster than new dwelling growth leads to rising house prices, why didn’t house prices fall between 1955 and 2004 when dwelling growth exceeded population growth?

The simple answer is that the real driver of house prices is easy credit. Plain and simple.

And when that stops – which it hasn’t yet remember… POP!

Finally, before we hand over to Shae, a quick note on a wonderfully dumb comment from Emperor Ken Henry:

“Projects which are earnings super normal profits will continue to earn super normal profits.”

Ha, ha… We’ve had “normal profits”, then “super profits”, and now “super normal profits.”

What’s next? “Super normal extra spicy profits”? “Vindaloo profits”? “My God, What a Profit”?

Not that a coercive sector servant has any idea what a profit is anyway, but that’s another thing.

As our Slipstream Trader Murray Dawes pointed out, the idea of companies making big profits is that it draws new entrants into the market, so that they too can get a slice of this so-called “super profit” action.

But if governments decide to take a big slice of those big profits, guess what, where’s the incentive for new entrants to enter the market, provide competition, and therefore drive those profits down?

By taxing the super profits, or super normal profits, it actually kills several birds with one stone. It punishes the incumbent for making a profit, it reduces their enthusiasm to produce extra, knowing that it will face a higher tax burden, it makes it less attractive for new entrants to come into the market, and finally it puts a handbrake on supply, potentially causing prices to rise.

Anyway, we’ve blathered on enough this morning, over to Shae to wrap things up…

Cheers,
Kris.

And if you’re one of the many Money Morning readers who’s glad we’ve stopped banging the housing drum then all I’ve got to say is, “Sorry, we’ll have a non property article for you tomorrow.”

Since we last stuck the boot into property a couple of weeks ago there have been more ridiculous headlines from the property spruikers than we could eat.

We had intended on keeping a record of them, but we figured it was a waste of time as it’s basically the same story being recycled every day:

“Sydney property prices set to double” – News.com.au

“Up to half of Sydney homeowners are set to become property millionaires, with house prices predicted to double in the next decade” the article claims.

Ah, we remember the good old days when striving to be a millionaire meant something. And when being a millionaire was based on net wealth rather than phony wealth.

You still see stories from time to time, the amazement when some old hermit pops their clogs and newspapers announce the deceased had been sitting on $5 million in cash which has been left to the local dog’s home. And the annoyed family wishing they’d paid more attention to stinky old grandpa.

But the future will be different. In the future there will be the same stunned amazement, except when the apparently wealthy old codger kicks the bucket eager relatives will find out the “millionaire” uncle hasn’t been lording it on a pile of cash.

Instead, they’ll find out he’s being chewing away at a $5 million equity finance redraw reverse mortgage facility. There goes the inheritance. His only legacy is for the family to scramble over who has first dibs on his underwear drawer!

“It’s equity mate!”

Anyway, we left you yesterday with this comment:

“[W]e quite often hear from readers who tell us that the best position to be in right now is to have oodles and oodles of debt. That the last thing you want to be is a net saver. At face value, there’s something to be said for that argument. However, as we’ll point out tomorrow, it’s not quite that simple.”

The argument goes that you take out as big a loan as possible, and over the course of ten, twenty or thirty years, hyper inflation, or even just normal inflation will help you pay off the debt.

As we said, there’s something to be said for the argument. We’ve heard a number of contrarian US commentators offer much the same advice to US home owners – more on that in a moment.

The problem is that it isn’t quite that simple. In the US, you’d be mad not to follow the advice. Especially when buyers can lock in a 30-year fixed rate for 4.875% for properties in Florida.

And if the loan is non-recourse then it’s even better.

With a rate as good as that, and with property prices already having slumped, buying property in the US should be a doddle. And thanks to inflation nipping at your heals, soon enough buyers will be left paying peanuts.

That all sounds pretty good right? Not quite, but again, more on that later.

In Australia, the case for leveraging up as much as you can isn’t as sound. For a start, prices are still sky high. Even the spruikers acknowledge there hasn’t been an Australian housing price crash so there’s no need to dwell any further on that point today.

Second, your fixed rate choices aren’t quite as good. Commonwealth Bank has a 15-year fixed rate mortgage charging 8.44% interest. With variable rates two percentage points lower, few home buyers would be prepared to pay the extra.

Not when the mainstream commentators have convinced the masses about there being a new “normal” rate of interest. Trouble is, it’s not “normal” at all. It’s completely abnormal. Almost grotesque in fact.

But anyway, the real problem with befriending inflation or even hyper inflation is three fold. First, you’ve got to have a fixed rate loan, ideally for the term of the loan.

But then there’s the second problem. In order for you to really “benefit”, the period of hyper inflation needs to kick in while your loan is still outstanding, the earlier the better. Plain old normal inflation just won’t cut it.

Even if you accept that housing is a hedge against inflation – which we don’t – then over the course of your home loan you’re still paying twice the cost of the property when you factor in the interest.

In other words, you need the value of the property to double just to break even.

The third problem with embracing hyper inflation is that all your other costs of living go up. Even if you managed to score a gain by locking in a fixed rate mortgage.

Can you imagine your weekly groceries bill going up from $200 to $5,000? Or your monthly electricity bill climbing from $90 to $850? Or even taking the train to work costing you $3,000 for the weekly fare rather than $80?

I know that may sound like crazy talk, but those are the sort of numbers you’ll be looking at if hyper inflation did take hold. Hopefully it won’t come to that. But can you see what I mean about the madness of wishing for inflation or hyper inflation?

But let’s set aside the pie-in-the-sky stuff. The stuff that hopefully won’t happen.

You see, there is another possible outcome. And that is the possibility the house you’re leveraging yourself up to the eyeballs in, the asset that you’re paying twice as much as the market price for, may not give you the kind of returns you’ve been promised.

Let me just repeat that one point first. When you buy a house with a mortgage, you’re paying twice the market value. That point, never mentioned by property spruikers shouldn’t be forgotten.

So, what if Sydney house prices don’t double by 2020? What if Melbourne house prices don’t rise by 10% per annum? What if the population of Australia doesn’t reach 50 gazillion by 2050?

And what if there isn’t an undersupply of housing?

We’re just asking. I mean those are all the arguments put forward by the spruikers to claim that house prices will always rise.

But as we look at those scenarios we’re trying to pinpoint which one of those inputs is iron-clad guaranteed to happen.

Let’s take the old favourite about there being an undersupply of housing. We’ve chosen that one simply because we could easily find the numbers to counteract the argument.

The numbers bandied around recently have been extraordinarily, erm, unscientific. Not that we’re making any claims to being the Sir Isaac Newton of property forecasting of course.

But anyhoo, we decided to run a few numbers…

According to the Australian Bureau of Statistics (ABS), the population of Victoria increased by 113,900 for the year until the end of June 2009.

Then if we look at the number of ‘dwelling units commenced‘ during the same period we’ll see that 41,900 dwellings began construction during that time. Even if we slide the commencements back a few months to take into account a nine month lag between commencements and completions, we can see the number is broadly the same – 42,451.

If we take an average of those two numbers, that works out as around 2.7 people per dwelling constructed. Which isn’t far off the ABS estimated household size of 2.6 people per household.

And then, during the same time, according to the numbers from the Victorian Valuer General, there were 96,426 sales of houses, units, apartments and vacant house blocks.

Now, not all of those house, unit and apartment sales would have just been churning between existing Victorian residents. There would be people leaving the state, entering the state, selling investment properties, buying investment properties, building one of those 40,000 new homes, and even – R.I.P – some deceased estates.

What we’re saying is, we’re still yet to see any evidence of a “chronic” undersupply of housing. What we can see is a rabid and irrational belief that house prices always go up.

To our way of thinking it’s not a chronic housing shortage that’s pushing prices up, it’s the availability of easy credit and no comprehension of risk by buyers of taking out a recourse loan – although perhaps the golden years of easy credit could be coming to an end, we’ll see.

So, as I say, imagine that all the things the property spruikers claim to be true aren’t true. What will happen then? Well, is it possible we’ll experience what the Yanks are going through with their housing bubble and crash?

This morning we jumped on to www.realtor.com to take a look at what a few thousand dollars will buy you in Michigan.

A three storey, four bedroom, two bathroom home in Detroit selling for… USD$89,900.

Don’t get us wrong, we know nothing about the area. But looking at the pictures of the property we can well imagine it coming straight from a scene in a 1980s daytime movie – dad, mom, two bratty kids with freckles, and a station wagon with wood down the side.

But the point to note on this property is that it’s a “short sale.” What does that mean? As we found out today, a short sale means that the house is on the market for a price below the outstanding mortgage against the property.

It also means that the sellers aren’t in foreclosure, so the bank isn’t forcing them to sell. But clearly the seller has a good reason to sell the home. And they aren’t the only ones either. Take a look at any number of the properties on the website and there’s a whole bunch of foreclosures or ’short sales.’

And don’t forget, the owner obviously has a non-recourse mortgage. So the bank will want to make sure the property is sold for as much as possible, because there’s no recourse to the seller if the sale price is less than the outstanding mortgage.

But by the same token, the bank isn’t going to push too hard. Because if the owners just want to get out they can just stop paying the mortgage, go into foreclosure and walk away, then the bank could be left selling the property for peanuts.

Such as has happened with this four bedroom, two bathroom, two storey home going for… USD$499.

And no, it’s not a misprint, it’s a “HUD Home” sale. That’s means it’s a Housing Urban Development Home. In other words, it’s a property that’s been foreclosed on by a bank and where the US government is trying to encourage buyers to pay rock bottom prices – before the neighbourhood is ghettoised.

If you think that’s a one-off, what about this four bedroom, one bathroom home going under the hammer for… USD$1,200.

Look, we’ve picked an extreme example using the rust belt city of Detroit. But guess what, property buyers in Detroit would have been told house prices always go up too. We’re only guessing, but we doubt if that property that’s going for USD$89,900 was originally bought for just USD$100,000.

Our bet is the current owners probably paid at least double that amount. The bank is on the verge of losing half of its “investment.”

So, we’ll ask again, could this happen here? To the same extent we’d have to say possibly not. Or rather, it won’t happen under the same circumstances due to the different liabilities for borrowers.

Simply for the fact that the non-recourse nature of mortgages in the US makes it more attractive for home owners to just walk away. Why pay thousands of dollars on a mortgage when you can walk away and rent for a few years, or even save up for a few months and buy a house for cash? Maybe buying from someone else who’s been foreclosed on!

But while the US housing market and non-recourse lending has been looked down upon by mainstream Australia, the fact is, wouldn’t you like to have a non-recourse loan?

Wouldn’t you like to have a loan where there was no risk of you losing all of your worldly possessions apart from your overpriced house?

The fact is, non-recourse loans are great for buyers. If you fall behind with your repayments or you just can’t be bothered to pay then you let the bank foreclose. They can’t grab a single extra penny from you.

Contrast that to borrowing here where loans are recourse to the borrower. Imagine the carnage if property prices fell by even just 20%, let alone the 95% some of these Detroit homes have fallen by.

Borrowers going into foreclosure would not only be thrown out on the street by the bank but they’d get a notice telling them to hand over the rest of their belongings to make up the shortfall.

From a savers perspective, when you compare the two, Aussie savers get a better deal. I mean, from the savers’ viewpoint, assuming there was no middleman (the bank), would you lend money to someone with the terms that they didn’t have to repay the loan if they didn’t want to?

That’s effectively what non-recourse lending is. A saver would be mad to lend money in those circumstances. But for the borrower it’s great.

The downside in Australia is that lending is recourse. If you can’t pay, tough luck, the banks will do all they can to grab the money back.

If household debt levels were low and property prices weren’t obscenely high then you’d rightly say recourse lending had done its job by making people more aware of the risks of borrowing.

But that’s the trouble isn’t it. Recourse lending should make borrowers more wary about what could happen if things go wrong. But who cares about that when you’re told house prices always go up, that there’s a chronic housing shortage and that the Australian population will be 60 bogzillion in 2050.

There is no doubt at all, that the concept of risk in the Australian property market is completely and utterly absent. Market signals that should indicate to borrowers the level of risk have been manipulated to such an extent that what is high risk now has the appearance of low risk.

And that’s the core of the problem. Strip away all the opinions, statistics and indices and you’re left with the simple and unarguable fact that the perceived risk of housing has been eliminated from the market…

Just at the time when it’s at its highest risk – it’s all upside and no downside apparently.

Cheers,
Kris.

“Consider a man and a woman each with a productivity of $10 per hour, and suppose, because of discrimination or whatever, that the man is paid $10 per hour and the woman is paid $8 per hour. It is as if the woman had a little sign on her forehead saying, ‘Hire me and earn an extra $2 an hour.’ This makes her a desirable employee even for a sexist boss. But when an equal-pay law stipulates that she must be paid the same as the man, the employer can indulge his discriminatory tendencies and not hire her at all, at no cost to himself.”

This example is applied to a comparison of male labour versus female labour. As was our article yesterday.

But in reality, it’s not even a Male v Female thing.

Because just take the same example and switch in ’skilled worker’ in place of ‘man’ and ‘unskilled worker’ in place of ‘woman’ – not that we’re saying all female employees are unskilled of course! – and the same principle applies.

Or interchange ‘experienced’ in place of ‘man’ and ‘inexperienced’ in place of ‘woman.’ Or any other example where wages are artificially manipulated by government decree.

You can use the same comparison to relate it to the minimum wage. In effect, pay equalisation is just another form of creating a minimum wage. It makes it illegal for an employer to employ someone for a lower wage than someone else.

And like the minimum wage, one consequence is that it creates unemployment.

Anyway, we just thought we’d drop that in. You can still leave comments on this article by going to the Money Morning website.

Back to today. We notice that even the mainstream commentary over at Business Spectator is starting to get a bit antsy with all this ‘economic recovery’ thing.

Two articles yesterday, one from Karen Maley and the other from Robert Gottliebsen clearly warn – as we have – that things aren’t as rosy as they seem.

Right now we’d say, hats off to these two mainstream commentators for saying it. However it’s too late, much too late for it to have any impact.

As the saying goes, the die is cast. The bubble has expanded. It’s like when you blow up a balloon. No-one likes having the thing pop right in their face, but there’s still the temptation to try and make it a little bigger, and that’s what’s happening with the Australian economy now.

The only problem is that in mainstream economics they either don’t believe that bubbles exist, or they believe they are caused by something else, or that even if bubbles do exist then they think they’re smart enough to manage them.

I mean, they’ll look at the last eighteen months and conclude they know the recipe for curing bubbles. So that even if another one is brewing, don’t worry about it, they’ve ‘fixed’ it before, they can do it again.

Look at all the economic data that’s been paraded before your eyes. As you know, we’ve been critical of the way the ANZ Job ad numbers have been reported.

Well, finally you could say the February job ads do look more impressive than some of the previous numbers. In February, ANZ Bank reports a total of 158,611 jobs advertised compared with just 109,177 in January.

You’d expect a pick-up in February, but still, it’s a 45% increase over the previous month. Although, compared to the same time last year, when the economy was on the verge of recession, job ads are still down by 3,723.

And remember, we’re using the original numbers, not the seasonally adjusted or trend numbers.

And then look at the other stats: “Australian economy continues to grow: ABS.”

According to the Australian Bureau of Statistics (ABS):

“Latest ABS figures show that GDP, in seasonally adjusted volume terms, grew 0.9% in the December quarter 2009, after growing 0.3% in the September quarter.”

The Australian economy continues to grow, grow, grow. That provides even more evidence to the mainstream that Australia has figured out how to perfectly direct and manipulate an economy to avoid collapse.

Although, the next paragraph from the ABS statement gave the real game away:

“Growth in the expenditure measure of GDP was driven by a 3.5% increase in private investment , a 10.2% increase in public investment and a 0.7% increase in household expenditure. Offsetting these increases was a fall in net exports. The fall in net exports was due to imports (up 7.7%) growing faster than exports (up 1.7%).”

Actually, we’ll rephrase that. We’re not sure it’s really given the game away as everyone knows public spending – or public ‘investment’ as the public sector drones prefer to call it – is going mental: money spent to ‘create’ jobs, then more money spent to ’save’ jobs, then another bunch of cash to compensate for jobs lost.

The madness never ends.

But that brings us back to the point we made above. While it’s good that some in the mainstream press are starting to whiff a bit of trouble, it’s all rather too late.

The time for warning about the nonsense idea that you can borrow to get yourself out of debt was a subject for twelve months or two years ago.

Yet at the time the mainstream press was too excited about making sure their elected representatives ‘did something.’ At the depths of the market meltdown, it wasn’t the time to ‘play politics’ or get bogged down in ‘economic theory.’ It was the time to ’save jobs’ and help those families who seemed to be constantly ’sat around the kitchen table.’

But the biggest problem right now is the sense of false security – or false sense of security, whichever you prefer.

We’ve noticed quite a bit of excitement about all the increased profits Australia’s robust and excellently run companies have made in 2009. Today’s Australian Financial Review (AFR) trumpets, “Earnings return, are shares next”, “Property turns the corner” and “How banks came out in front.”

According to the AFR, 80% of Australia’s companies reported profits in-line with expectations. It goes on, “Profits for industrial companies rose 3.8 per cent from a year earlier.”

But the AFR does point out, “Cost-cutting was an important driver of profits in the half. Some big companies reported falling revenue but were able to increase profits by reducing their spending on wages, property and technology.”

That’s something we noticed last week. This is what we wrote to Australian Wealth Gameplan subscribers last Friday:

“Last week we conducted a simple exercise. We looked at the company results for that week as reported in the Australian Financial Review (AFR). It printed the earnings results for 131 companies – large and small. As you’ll have read in the mainstream press, a lot of companies produced bumper profit results, such as Flight Centre [ASX: FLT]. What the mainstream press didn’t report was the less than exciting news on the revenue figures. Of the 131 companies detailed, just over half (66 of them) reported lower sales revenues than the previous corresponding half-year or full-year.”

It wasn’t just ’some big companies’ that reported falling revenue, it was half of those companies that reported during that one-week period.

What does that tell you? Well, as the AFR reports, many companies have slashed costs in order to beef up the bottom line. So the first question is whether they can keep doing that?

The other question is whether they can increase sales by as much as the market is now pricing in? Our guess is that will be much harder to achieve. And much of that is down to the sense of false security and the misplaced belief that the bright economists and central bankers have engineered Australia’s escape from the global meltdown.

The economy is growing, companies are hiring again, miners are mining stuff, credit is booming, and everything appears to be ticking along as though nothing has happened.

And as for that old subprime stuff, well surely that’s all fixed up, and no-one will make that mistake again. Trouble is, it’s often forgotten that subprime wasn’t the cause of the problem, it was the effect. The cause of the problem was excess credit and government interference.

Excessive credit simply manifested itself as subprime loans. Subprime borrowers were the means by which politicians could parade themselves as helping the poor, and by which bankers and young gun traders could earn themselves a bucket load of cash.

Therefore, solving the subprime problem will do no more than shift the excesses of credit elsewhere.

We’ve seen that before. Look at Enron. The trading guys at Enron weren’t specialists in electricity trading. They were young kid traders sat in front of six computer screens who just had to click ‘buy’ or ’sell’.

As soon as Enron collapsed they went off looking for other things to ‘buy’ and ’sell’. Many of them probably ended up trading credit default swaps and other such derivatives. Financial instruments that they were just as ignorant of as the electricity market.

Solving the global meltdown by blaming it all on subprime and removing that risk is like taking the keys from a youngster who’s been driving a sports car too fast, and instead handing him the keys to a 3000cc motorbike.

There will still be carnage it’s just that it will look different.

As much as the mainstream commentators may claim that lessons have been learned and that Australia didn’t have a subprime culture, it all misses the point. The old habits of excessive borrowing are still unchanged, and in fact are likely to get worse.

So the message is, if you’re looking for the next big economic meltdown to come from the US subprime housing market, odds are you’re looking in the wrong place. So where will it come from?

We’ll look at that another day. But our guess remains that you need to look north. Because China is brewing up quite nicely right now.

Cheers.
Kris.

Inflation, if mixed with deflation is fine. Prices rise, then prices fall.

But inflation by itself, well, that isn’t good at all. If you look at the chart below, you can see perfectly how the value of money has been devalued almost without break for the last fifty years:

According to the Reserve Bank of Australia (RBA) numbers on Money Aggregates, the M3 money supply has increased from the equivalent of $6.7 billion in 1959 to $1.19 trillion by the end of 2009.

In other words, the value of money over the last fifty years has fallen by 99.4%. To put it another way, the equivalent of a dollar held in 1959 is almost worthless if still held today.

Now, I know it’s not likely that you’ll have kept the same currency unit in your pocket or your bank account for fifty years, but the point is, thanks to inflation your wealth is being eroded on a daily basis.

Even if we look at a shorter time period, 1990 to 2009, you can see the M3 money supply has increased from $207 billion to $1.19 trillion:

That’s a depreciation of your dollar by 82.5%. And that’s just within the last thirty years.

The reason I bring this up is to try and settle an argument we’ve scoffed at but which the property spruikers are convinced is true. That is that property is a hedge against inflation.

That if you buy a property today it will rise in line with the prices of everything else and therefore your debt will be paid off easier because of inflation and you’ll be left with a higher priced house.

Our argument has been, “Where’s the proof that inflation and property prices are directly correlated?” And furthermore, we constantly warn anyone not to believe that inflation is your friend. By itself, inflation is always your enemy.

So far, the spruikers haven’t come up with anything to back their argument. So, our only course of action is to try and refute our own argument. We’re happy to try, it keeps us on our toes.

Below is a chart we knocked together using data from the Australian Bureau of Statistics (ABS) and the Reserve Bank of Australia (RBA). It compares the index values of ‘8 Capital City House Prices’, the Consumer Price Index (CPI), and the M3 money supply:

Now, before I go into too much detail, a quick note on the dates.

You’ll see it only runs from 1986 to 2005. Just to make it clear, we haven’t cherry-picked that timeframe for any particular reason. The only reason we’ve done that is the ABS changed the index calculation for house prices in 2005 and we didn’t want to mess around with trying to marry up the two sets of numbers.

Anyway, the dates aren’t as important as the comparison of the data sets over the same timeframe.

As you’ll note, using a logarithmic scale, the green and blue lines move almost in tandem.

In index number terms, the 8 Capital City House Prices index has risen from 61.3 in June 1986 to 251.9 in June 2005. That’s a 310.9% increase.

Over the same period, the M3 money supply increased from $125 billion to $678.5 billion. An increase of 442.8% in the money supply, or a decrease of 81.5% in the value of your money.

In percentage terms that’s a pretty big gap, but on the chart, well, it’s hard to see any difference. But, as we’ve pointed out before, you can’t just put two different data sets on a chart and claim there is or isn’t a correlation.

But in this instance, whether there is a correlation or not is irrelevant. We don’t need to prove or disprove it, we can simply look at the data and draw a simple conclusion. And that is, between 1986 and 2005 the M3 money supply increased by a greater amount than the value of the 8 Capital City House Prices index.

Therefore, we can say that during that period, house prices did not provide a complete or perfect hedge against inflation.

The divergence is more obvious if we use a linear scale:

The interesting point to note is by how much the official CPI number understates the impact of the devaluation of your money.

If you just take the 8 Capital City House Prices index and compare it to the CPI then you’d be left with the false impression that property is an inflation buster.

Whereas the truth is that the CPI number masks the real story. And that is the value of the dollar has fallen to such an extent that even the so-called housing boom has failed to maintain the value of your dollars.

In fact we can go even further than that and say that between 1986 and 2004, the real price of property would have dropped as the value of your dollar fell faster than the price of homes rose.

Look, we’re sure the property spruikers won’t like that, and they’ll set their Phasers from stun to kill, but those numbers speak for themselves.

If you accept the fact that creating more money has a devaluing effect on the money already in circulation, then you must also accept that you need to take the real rate of inflation into account when valuing an asset after a specific time period.

In this case the value of the 8 Capital City House Prices index has failed to keep pace with the increase in the money supply – M3.

Of course, articles such as this one from Peter Boehm over at Yahoo! Finance prefer to use the CPI when he claims, “Combine this with a return to stable economic conditions and relatively low and stable interest rates and you have the necessary ingredients for home prices to increase well ahead of inflation.”

He’s referring to the growth rates required to make the median house prices in Sydney, Melbourne and Brisbane $1 million by 2019:

The trouble is, by 2019, if the increase in the money supply is anything like it’s been over the last ten years, then the 117.8% increase for Brisbane will have been dwarfed by the 184% increase in the money supply:

Simply put, the increase in property prices won’t have kept pace with inflation.

We’ve heard plenty about “Property Millionaires”, yet the reality is that they don’t exist in the way the spruikers would have you believe.

What they should really be called are “Property Debt Millionaires.” $1.1 million of assets and $1 million of liabilities. Waiting for the so-called ‘equity’ in the home to increase and then withdrawing more cash to take out more debt.

Isn’t there a saying about ‘credit’ being the only difference between the hobo on the street and the majority of home owners?

So, when the spruikers talk about the median house price reaching $1 million in 2019, just remember a couple of things…

First, a million dollars in 2019 won’t be worth what a million dollars is today or ten years ago.

And secondly, if you look at the chart below:

If owner-occupied housing loans increase at the same rate as they have over the last ten years, then even though the median house price very well could be $1 million by 2019, odds are the median mortgage won’t be far behind.

The upshot is, by these numbers you can argue property prices have already fallen. But that’s only the half of it. So far, the insidious effects of inflation have meant borrowers are suffering a silent ‘debt-death’.

The realisation and the pain will be more obvious when borrowers experience an actual fall in the price of housing in dollar terms. Contrary to mainstream belief about Australia missing the housing crash, the facts are it’s likely to happen sooner than we all think.

Cheers.
Kris.

If you missed it, in an interview with the ABC Barnaby Joyce said:

“We’re going into hock to our eyeballs to people overseas. And you’ve got to ask the question how far in debt do you want to go? We are getting to a point where we can’t repay it.”

ABC reporter, Stephen Long’s response? Well, here it is:

“The polite way to describe that comment – nonsense. It’s not true, plain and simple. The credit ratings agencies don’t always get it right; the global financial crisis showed that. But they’ve got a lot of experience in rating sovereign debt.”

And then the little reporters scurry off to interview the usual suspects: Standard & Poor’s, Fitch Ratings, and Citigroup.

Hmmm, the ABC relies on two ratings agencies that rated subprime mortgage debt as triple-A, and an economist from a bank that was partially nationalised by the US government.

Not surprisingly they give the Australian government coffers the stamp of approval.

You can click here to read the transcript, but the gist of it is blah, blah, blah… Australia did better than everyone else, etc…

According to Citigroup economist Josh Williamson, asked whether Joyce’s comments were irresponsible he answered, “Absolutely.”

So, is Joyce’s comment nonsense? Well, it is in the sense that governments have one advantage that no one else has. And that is the ability to print extra money to pay off debts.

As we’ve mentioned before, if you crank up the Canon inkjet printer and run off a few thousand $50 notes, you’ll find yourself in the Slammer before you know it.

The fact is, most governments are too sneaky and dishonest to openly default on debt. Their first response is always to inflate the money supply to devalue the currency. That way, while the debt is repaid it’s done with a devalued currency.

But that’s the disappointing part about the mainstream media’s response to Joyce’s claims. It doesn’t take much effort to look beyond his statement to see there’s at least an ounce of truth in what he’s saying – not that he’s the first to say it of course.

And the other disappointing point is Josh Williamson’s comment that “We have an excellent debt to GDP position.” Because that’s only true of the government debt.

The household debt to GDP position, and income to household debt position is nowhere near as good. In fact it’s terrible.

And worse is that unlike government’s, households can’t simply print out extra $20 notes to pay off their debt. So the real problem isn’t the possibility of the government defaulting on debt, it’s the scale of the household debt default when that happens.

Of course, we frequently hear the argument that inflation is the friend of debtors. That over time the amount of debt reduces when adjusted for inflation.

We have to say, that’s one of the biggest furphies going around. Along with the idea that a house is a hedge against inflation.

As we’ve written before, in all cases inflation is bad for you and your wealth. Inflation is never good. At the extreme, ask Weimar Republic Germans, or Zimbabweans, or even look at your own position.

Has inflation really helped you out over the last twenty years? Didn’t think so.

The simple reason is that inflation forces you to work harder.

Let’s be honest. No one wants to work. We work because we have to. But imagine how much better it would be if there was no inflation. Or if there were periods of deflation to counteract the inflation.

Inflation devalues the dollar in your pocket which means you have to keep working harder and longer. Your ability to devote more time to leisure lessens the more inflation eats away at your income and your savings.

I mean, if your dollars weren’t devalued and prices didn’t rise then your savings would really grow, and without much effort either. Whereas now, as an investor you have to run just to stand still.

Look at the risks you need to take as an investor. Even a 10% or 12% annual return from taking big risks on the share market probably isn’t enough to beat inflation. And I mean the real cost of living increases not the phony numbers the Australian Bureau of Statistics (ABS) come up with.

And as for the idea that a house is a hedge against inflation, well, that’s more twaddle. It’s no such thing. In fact, in an inflationary environment houses become nothing more than a ‘White Elephant.’

If you want to know the origin of that phrase, just head over to the Lazy Researcher’s Handbook.

You see, inflation appears to help by showing a correlation with rising house values. Yet there’s no evidence that there’s a causal relationship.

Just on that point, we’ve seen plenty of people say, “Look at the chart, inflation has gone up over the last thirty years, so have house prices, therefore housing is a hedge against inflation.”

Not so fast. You can’t take two data sets, compare then and then just announce a correlation.

If it was that easy then you could compare house prices to a chart of your editor’s age over the last thirty years. You could conclude because both have risen that your editor is a hedge against inflation!

What utter nonsense.

Inflation inflicts greater harm on the homeowner due to higher maintenance costs.

Fuel bills go up, electricity bills go up, replacing furniture, fixtures and fittings all go up. And generally just keeping the home in good nick incurs higher and higher costs. The cost of moving goes up, the cost of downsizing to a smaller home goes up, and so on.

You only have to look the popularity of reverse mortgages. Old timers borrowing money in their old age because they’ve spent so much on maintaining their home for the last thirty-odd years. And because high taxes have robbed them of the chance to save, they’ve got no other choice than to put themselves into hock just to cover the weekly shopping.

Or another example. The relish with which a twenty or thirty year old home is advertised as a “renovate or detonate” property. How is that either an investment, or a hedge against inflation?

It isn’t.

That’s house price inflation for you.

Then at the extreme look at the number of Victorian stately homes in the UK that are falling apart. Lords of the manor having to rent out their 500 year-old ancestral home to bucks parties and corporate dinners because they can’t afford to repair the leaky roof.

Or if they’re really strapped for cash they have to flog it to National Trust and then live out their days in the Gatehouse because they can’t afford the heating bills or maintenance costs.

And they can’t sell them to private owners, because no one else is foolish enough to lumber themselves with such a White Elephant.

As I say, that’s the extreme, but the reality is, housing isn’t a hedge against inflation.

In fact if you compare it to something else which is claimed to be a hedge against inflation – Gold – they have nothing in common.

Gold is divisible, a house isn’t – you can’t sell it brick by brick and get the same proportional return.

Gold is transportable, a house isn’t – unless it’s some crappy weatherboard home no one wants and you’re prepared to pay for transport costs. Or, unless your home is a caravan! But then of course, according to Saul Eslake and his crew at the National Housing Supply Council, if you live in a caravan you’re homeless anyway, so that doesn’t count.

Gold is durable, a house isn’t – see the examples above.

Gold can be hidden from the government if they try to confiscate it like the US government did in the 1930s. Try hiding a house! Good luck with that one.

Plenty of people will tell you Gold isn’t a hedge against inflation anyway, that it’s a hedge against political instability. We’re prepared to consider that argument. But we’ll also say that if Gold isn’t a hedge against inflation, then housing most certainly isn’t either.

The fact is, while Barnaby Joyce may not be 100% correct, he isn’t 100% incorrect either. Record high household debt levels have indebted the Australian population.

So even though the odds of the Australian government ‘honestly’ defaulting on its debt obligations are near to zero, the odds of Australian households being forced to default under the pressure of the White Elephant of housing is better than evens.

Cheers.
Kris.

That it’s not fair to compare the return of a leveraged investment property with an unleveraged dividend paying stock.

Of course that’s nonsense. Of course it’s fair. As we pointed out in yesterday’s article, the over-riding sales pitch for property investors is the benefit of negative gearing. That you should borrow as much as you can in order to be able to get the biggest tax advantage.

The property spruikers can’t have it both ways. When was the last time you heard a property spruiker tell you that you should only ever pay cash for a property? Hmm, thought so!

Anyway, on to today…

At roughly the same time as you receive today’s Money Morning, the Australian Bureau of Statistics (ABS) will release the latest quarterly consumer price index (CPI) figure.

You can almost guarantee that whatever the outcome, the mainstream commentators and economists will paint it as positive news for the Australian economy.

If the CPI is lower than expected then that’ll be good news as it ‘proves’ that stimulus spending hasn’t ignited inflation. And if it’s higher than expected it will ‘prove’ how resilient the Australian economy and consumers have been.

Then there will be the follow-on analysis as to what this means to the Reserve Bank of Australia’s (RBA) interest rate decision next week.

But if the analysis of the “top macroeconomist” from Access Economics, Chris Richardson is anything to go by, prepare to be bamboozled and baffled.

In a wonderful piece of illogical thought, according to today’s News Ltd article, families will be able to make savings on their mortgage repayments this year thanks to rising interest rates.

Has some clever way of fiddling the books that would be worthy of a “Cut your mortgage in half” story on Today Tonight been discovered?

Erm, not quite.

Money Morning reader Adrian brought our attention to the story from News Ltd this morning:

“Mortgage respite in sight for homeowners”

At first glance you could be forgiven for thinking Mr. Richardson is predicting that interest rates will fall, or at the very least remain unchanged this year.

But look, we’ll give him the benefit of the doubt. Either he’s one of Australia’s most inept economists or John Rolfe at The Daily Telegraph is one of Australia’s most inept journalists.

Or maybe it’s both, who knows.

According to the article, “Futures markets predict the Reserve [RBA] will raise official interest rates by 1 per cent this year, beginning with a 25 basis point increase in February or March.”

We won’t argue with that statement, the Futures markets are indicating that as a strong possibility.

But have no fear, because this is where the “savings” come in.

Despite the prediction that the RBA will increase rates by 1%, Mr. Richardson believes the banks will only pass on 0.7% of the increase to borrowers.

Should they do so then “homeowners repaying a $300,000 mortgage would save more than $60 a month.”

Of course the “saving” only comes after they’ve seen their mortgage repayment increase by over $120 a month. But as the paper points out, “That would be great news for new homeowners such as Strathmore Meurer and Sarah Emms. The St George customers, who bought a Petersham house, have already been hit by repayment increases of $300 a month.”

Oops! So ‘lucky’ Strathmore and Sarah can look forward to possibly an extra $120 a month on top of the $300 increase by the end of this year. And that’s providing Mr. Richardson is right and the banks don’t follow the RBAs rate increases.

But at least it may not be an extra $180 a month. The $60 difference is the saving apparently.

But wait, the “savings” are expected to continue into 2011 as Mr. Richardson claims, “We are probably looking at 30 basis points in 2010 and another 30 or 40 points in 2011.”

So if we take the current outlook from the Futures market on the direction of interest rates, it’s building in the likelihood of rates reaching 5.1% by June 2011:

Click to enlarge

So giving Richardson another benefit of the doubt he’s predicting that borrowers will only be burdened by an interest rate rise of 0.75% over the next eighteen months…

The rest will be savings!

We’ll believe that when we see it.

Look, we’ve no idea where interest rates will end up. All we do know is that it will be higher than 3.75%. But the mistake the mainstream is making is the idea that RBA interest rates at 5% is the ‘normal’ level for interest rates.

That by increasing the cash rate to that level is just returning them to a neutral point in the interest rate cycle.

Unfortunately, as the example of Strathmore and Sarah shows, that’s not true. “Normal” for them was when the cash rate was 3%. Just as “normal” was 7.25% for new borrowers in March 2008.

When interest rates move back to 5% and the mortgage rate increases to 8% or 9%, it will be very abnormal for those that have borrowed at all-time low rates.

In fact, you can guarantee those borrowers won’t be cheering the “savings” they’re making just because the mortgage rate is at 9% instead of 9.5%. Far from it.

But it’s the whole idea that an increased cost is being repackaged by the mainstream media as a saving. Of course, it’s not that different from the shopping bargain hunter who’s ecstatic at getting something for half price even though they’ve bought something they wouldn’t normally have purchased.

There’s no saving at all, just an increased cost.

Today’s CPI number will likely produce a similar reaction. A lower figure than expected will have the commentators all of a lather that the inflation genie hasn’t been let out of the bottle, ignoring the fact that the cost of living has still risen.

Whereas a higher than expected number will get the cheerleaders excited about the prospect of a further interest rate rise and all the lovely “savings” borrowers can make in the coming months.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

On Monday, the S&P/ASX 200 was down 70 points in the first 15 minutes of trading. After the initial drop, the index closed the day down by only 32 points to 4,717.90.

The Australian Bureau of Statistics will release the Consumer Price Index (CPI) for December. These figures are the last set of figures the RBA is waiting on for when they meet next Tuesday.

The Dow Jones Industrial Average was down on Tuesday, closing at 10,194.29, lower by only 2 points.

The Fed’s two day Open Market Committee began yesterday, however many are expecting rates to remain unchanged as Ben Bernanke is yet to be confirmed as chairman for a second term. Read more here.

In the UK, the FTSE was up by 16 points, ending the day at 5,276.85. Surprisingly, it was the Pharmaceutical companies that pushed the Footsie higher, with most averaging a again of 1.5% for the trading session.

The Nikkei was down by 1.78%, closing at 10,325.28.

The price of spot gold in Australian dollars is trading at $1,222.37 while in US Dollars it is trading at $1,098.18. The price of silver in Aussie dollars is $18.68 and in US Dollars it is $16.78.

The Aussie dollar versus the US dollar is trading at USD$0.8985, and against the Japanese Yen JPY80.57.

Crude Oil closed at USD$74.71

For the biggest movers on the market yesterday click here…

Sell Australian Dollar and buy Japanese Yen – tick

Put options on Westfield Group – [screech!]

According to Richard F on the Money Morning blog, he has a much better idea than the Westfield trade:

“How about shorting RP Data – (ASX: RPX).”

Now that would be just spiteful wouldn’t it! It’s a thought though. They are super leveraged to the housing market. When that falls over you wouldn’t think there would be too many punters coughing up for their research.

Although let’s be fair about it. An even better trade would have been to have bought RP Data stock last year when it was trading for less than 10 cents per share:

Now it’s trading at just below 50 cents. We can only hope Mr. Joye and his mates took the opportunity to tuck in at what was clearly a bargain price.

The only problem with short selling RP Data is the lack of liquidity. If you look at the one-month chart below you can see it rarely trades:

You’d need bravery the size of basketballs to risk getting yourself in on a short position there. With such low liquidity it wouldn’t take much for someone to push the share price higher and suddenly you’d find yourself in a margin call and having to sell your house to cover the losses!

So, as a short selling proposition, I’d stay clear of RP Data.

Why not buy Japanese stocks?

There are a couple of other alternatives, but before I get on to those, a quick note on the Sell AUD, Buy JPY contrarian trade.

First, you can read Slipstream Trader editor Murray Dawes’ take on the Aussie dollar in the companion article.

But buying the Yen is potentially just the first step. Rather than paying to hold Yen – because you’re forfeiting interest payments on Aussie dollars – you could go one step further and follow the advice of The Daily Reckoning’s Bill Bonner.

Bill thinks the trade not just for 2010 but for the entire next decade is to buy Japanese stocks. Aside from the obvious – Sony, Toyota, Honda – your editor couldn’t tell you a single thing about which Japanese stocks to buy.

But if you like the idea – and again, this isn’t advice, just information – the easiest and probably lowest cost approach is to buy the iShares MSCI Japan exchange traded fund. It trades on the ASX with the ticker IJP.

You can buy and sell it just as you do any other share traded on the market. I’m not saying you should go for it but… ah, why not, I like the Japan trade idea. Look at the chart below to see the twelve month performance:

If you go for it, just be careful when placing orders as it’s also reasonably illiquid – yesterday less than five thousand shares changed hands.

Anyway, back to the bearish property strategy…

Other suggestions have been that Westfield isn’t a great idea due to its exposure to the US and UK markets. Something more local would be a better bet.

We had another look at all the commercial property trusts and not surprisingly the best time to short sell them would have been eighteen months ago. Many of them are still in the red by 80% or 90%.

Short selling them now is certainly possible, but there’s probably better options.

Commercial property trusts still well down

Something like the SPDR S&P/ASX 200 Listed Property Fund [ASX: SLF]. As the name suggests it’s a listed fund made up of a number of individual trusts which are also listed on the ASX.

In fact, we had recommended it as a buy to Australian Small Cap Investigator subscribers earlier last year as a way to get exposure to the potential bounce in the property sector. That happened to some degree, however we only picked up just over a 20% gain before advising subscribers to cash out in November.

But the most obvious idea is one we overlooked. If you’re bearish on Australian residential property then surely you’d look to sell the company with the biggest exposure to it.

It’s a proverbial no brainer.

And with the share price of the company in question back to pre-crash levels, thinking about doing something soon isn’t such a bad idea. Here’s the chart:

It’s Commonwealth Bank of Australia [ASX: CBA] of course.

Go for the biggest when selling short

As the company proudly admits, it’s the safest of the four major banks because it has the largest exposure to Australian residential mortgages [gulp!].

Of course, short selling something just because it’s high isn’t always the best strategy. Especially if the price goes even higher. So for this one I’m happy to defer to our resident Slipstream Trader and technical analyst Murray Dawes.

I asked him this morning what he thought of the idea. The upshot is that it’s not a trade Murray would make right now, and it’s not a trade he’d recommend to Slipstream Trader members just yet.

However, he does think there’s an opportunity for a quick swipe at it on the short side, providing you’ve got your stop order placed close behind in case it swings the other way.

But in terms of a Contrarian Investment Idea for 2010, getting in to a short position on CBA looks premature. We’re not thinking of short term trading ideas, we’re thinking about longer term progressive downward movements in the share price.

Plus you want to protect yourself against potential losses as well.

One way to do that is with what the guys at City Index call a ‘guaranteed stop loss’ order. I won’t give you all the details here because I don’t have the space. All I will say is that it’s a good way of knowing exactly what your maximum loss will be before you make the trade.

That’s got to be worth something.

It’s certainly a good idea if you want to trade on the short side but are worried about getting ‘caught short’ and losing a bunch of cash.

Anyway, I think that pretty much settles our 3 Contrarian Investment Ideas for 2010:

• Buy gold
• Sell Aussie dollar, and buy Japanese yen
• Short sell CBA – but not just yet!

But as I wrote earlier in the week, if you’ve got any other ideas or you think our contrarian ideas are rubbish, feel free to make comments when on the Money Morning website when this article is posted later today.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

The S&P/ASX 200 was down yesterday to 4,868.10, lower by 31 points. The positive lead in from the US has seen the index open up nearly 20 points higher this morning.

The Australian Bureau of Statistics will release their figures on the labour market today, and these will include the unemployment rate.

The Dow Jones Industrial Average closed at a 15 month yesterday. The Dow ended the day at 10,680.77, up by 53 points. However Bruce Bittles, a chief investment strategist at Robert W. Baird, is worried that expectations are a too high and the market is “suffering from a little too much optimism”. Read more about the US market here.

Overnight in the UK, the FTSE dropped 0.46% to close at 5,473.48.

The Nikkei closed at 10,735.03, lower by 1.32%

Gold continues to dominate the news this week after another short rally last night. Spot gold gained about USD $9 overnight, based on speculation that the Fed will keep rates at these unnatural lows for an extended period.

The price of spot gold in Australian dollars is trading at $1,232.66 while in US Dollars it is trading at $1,138.11. The price of silver in Aussie dollars is $20.18 and in US Dollars it is $18.63.

The Aussie dollar versus the US dollar is trading at USD$0.9236, and against the Japanese Yen JPY84.37

Crude Oil closed at USD$79.67

For the biggest movers on the market yesterday click here…