patrick.net

Frank, You said the economics material that I gave the link for all seems to be Keynesian…

The link contains about 60 textbooks covering a wide on a wide variety of topics in economics ranging from introductory economics to econometric techniques – something for everyone. Certainly the Keynesian view is included, but it is not the case that all of the materials are Keynesian.

Speaking of Keynesians, I had the opportunity to meet John Kenneth Galbraith (in Vermont) many years ago. That was a treat for me since his work was in vogue during my training. However, I was then and continue to be more inclined toward the monetarist school.

As for the names you mention, Milton Friedman was my hero when I was a young economics student. Of course, I have read from the works of many other great economists. I continue to read the views and work of many contemporary economists on a regular basis as part of my effort to stay sharp, and to make better investment decisions.

I believe not.

Further on Shiller… Using the GDP deflator for inflation the plateau disappears and we have a long secular rise in prices over the last 40 years, with peak periods coinciding with the actual market cycle peaks. No tricks or interpretations. Just straight government data.

I believe Shiller used the CPI. This index overstated inflation during most of the plateau years, and many claim that it has understated it in recent years. This would make the price adjustments in the older years greater causing a flattening of the data, while making the price increases in the recent years seem steeper. So, the Shiller plateau and the recent severe surge are likely the result of data problems in the inflation adjustment. This effect goes away when the GDP deflator is used for the inflation adjustment.

I suspect that the details of this graph has not been examined in the way I have done it (using an alternative). Apeer is likely to ask "Did Shiller use a reasonable standard?" and conclude that he did. Is it the best (most accurate choice? No. Would that be obvious to academics? Probably not.

Over the long run the errors are modest and do not seem to be a big deal in the big picture. However, a few points per year are a big deal when compared to a flat line.

The general principles of his research and book remain worthy even if this particular graph is flawed.

I suspect that the details of this graph has not been examined in the way I have done it (using an alternative). Apeer is likely to ask “Did Shiller use a reasonable standard?” and conclude that he did. Is it the best (most accurate choice? No. Would that be obvious to academics? Probably not.

Hmmm... not quite yet ready to casually dismiss the painstaking research of such a respected academic (with no personal axe to grind) as Shiller. Especially when it's so consistent with so much other data indicating a sharp spike in RE prices relative to other indexes (incomes, rents, consumer prices, etc.) over the past several years.

Yes, I agree that the much manipulated CPI has understated true inflation at least for the past 10 years or so (as use of hedonics and substitution became commonplace at the BLS). Eliminating such statistical gimmickry and substituting a bullshit-corrected CPI would shrink that sharp spike somewhat, but even so, it would still exist and still be quite large.

So, the Shiller plateau and the recent severe surge are likely the result of data problems in the inflation adjustment. This effect goes away when the GDP deflator is used for the inflation adjustment.

Zephyr, what makes you so sure that your GDP deflator is a better measure of RE prices relative to Shiller's CPI data?

What makes you so sure that you can eliminate the historical/data errors that you claim plagues Shiller's results with your method? If the raw economic RE data from the periods prior to the mid-1960's is nonexistent to spotty, then how would the GDP deflator provide more accurate results with the same (supposedly) unreliable data?

Garbage in, garbage out, right?

Have you plotted your RE graph using the GDP deflator in place of the CPI? If so, would you be willing to share the results with us?

Fair enough. I was trained in history, not economics, and using a flawed quantitative analysis like that would get you into trouble around a history department.

flak,

Don't be too quick to dismiss Shiller's analysis. While I respect Zephyr's considerable experience and breadth of knowledge, he is not all-knowing or infallible.

He may or may not be correct on the GDP deflator being a better historical yardstick for guaging RE prices. Ditto for Shiller's data and methodology. I'm not saying he isn't, I'm just taking the old Scottish approach and declaring it "not proven".

But when I read Shiller’s book, I thought he had avoided that problem, using something more sophisticated than that straight correction. I don’t own a copy of the book, but someone here must, and perhaps could enlighten us.

I'm going to have to call in "lazy" on this as well. My wife bought me the book as a birthday gift a while back, but I haven't read most of it yet. I think you're right about him using something better than straight CPI correction, though.

One thing that makes me think his historical data is more accurate than Zephyr suggests is that he relies heavily on RESALE data --as in tracking the same houses as they are resold throughout the years. His reasoning is that this gives you a more accurate picture of asset inflation by comparing apples to apples. In other words, it's not comparing an 1890 Victorian to a 2005 McMansion --it's tracking the actual sale price of the SAME house over the timeline.

ScottC,

I don't think the other bloggers were attacking you personally, or accusing all Realtors everywhere of being stupid and dishonest. They were mainly responding to your rather sweeping statement about "full disclosure":

"Real estate is a legal transaction that requires full disclosure. So honesty is the only policy. "

Perhaps you meant to say, "honesty SHOULD BE the only policy", or, "honesty is the only policy for me and my close associates". I think you can see the distinction here. Clearly there are plenty of Realtors (especially here in Cali) for whom dishonesty and distortion are a way of life.

As far as making a successful career in RE, I'm sure that it normally involves a great deal of hard work, diligence and intelligence. Which is why you'll probably still be in the business 10 years later, while most of the newly-minted CA agents will not be. A temporary across the board lowering of employee standards/qualifications in a mania-related field is a quite common phenomenon, and is not restricted to RE (as IT workers will attest).

Everyone's job looks easy to other people.

"No tricks or interpretations. Just straight government data."

This is a joke right? :-)

"I’m wondering how many of you have ever had to sit down and write a check for $10,000 and mail it to the IRS"

Yes, for us employees, about 1/3-1/2 gets taken out of every pay check. How lucky are we?! ;-)

Zephyr, for a different perspective on deflation, read my post Nov 22, 5:55pm in this thread.

Nov. 22 (Bloomberg) -- Inflation outside of food and energy will probably accelerate next year, prompting the Federal Reserve to raise rates another three-quarters of a percentage point, according to a survey by the National Association for Business Economics.

Not everything is as rosy as some would have you believe...

http://www.usatoday.com/money/economy/2005-11-22-wages-1a-cover-usat_x.htm

From a Cincinnati rag...

"Greater Cincinnati/Northern Kentucky and most housing markets across the country are safe from a feared investment bubble, according to the top forecaster for the National Association of Home Builders."

Oh gee a "top forecaster"! I guess we're all wrong then, huh?

Oh gee a “top forecaster”! I guess we’re all wrong then, huh?

A nameless top forecaster?

I'm waiting for troll brothers to start advertising....buy one McMansion, get one free. :)

.........but then again, it's probably still not worth it.

"A nameless top forecaster?"

Yes, but it is "...according to THE top forecaster", so there can only be one ;-).

Based on listings from realtor.com for NYC tri-state area, number of homes for sale on average have been increasing >100% annualized over the past several weeks. Some areas such as Paramus, NJ are close to 200%. Not what I would expect during fall/winter and with holidays right around the corner.

You californians might want to read the piglet book...especially those in sacromento http://tinyurl.com/bn8j8

Alot of good information on this site as far as taxpayer protection
http://www.cagw.org/site/PageServer

“Second, the re graph is purposely linear and not log-normal or you could see that current returns are far from unprecedented.”

This would certainly make the exponential increases look less dizzying, wouldn’t it?

Self-serving statistics, Lesson #47: If you don't like what the graph is showing you, arbitrarily change the scale and/or data until it does. If that doesn't work, try discrediting the graph-maker.

Problem solved!

"Yes, we’ve all heard the story before – if prices are falling, consumers stop buying because they expect the prices to be lower if they wait, blah, blah, blah. This is nonsense. We all know that the latest electronic gadget will be cheaper next month, we all know that this season’s must have outfit will be 50% off in the Spring, we all know that Christmas gifts for the kids will be cheaper in January. Still, many of us are compelled to buy the costlier product precisely because we want it NOW!"

"All these under-consumption theorists should be required to spend several weekends with their five-year old nieces and nephews at Toys-r-Us to teach them a little about the effort involved in deferring instant gratification."

LOL - well put, Frank!

As a compulsive saver and value shopper, I totally agree with you that deflation would be better for us and probably better for the economy in the long run, by quickly wringing out excesses, favoring saving over consumption, etc.

Here's the problem: The Fed/government doesn't share that view, nor do the powerful corporate & banking interests who wish to see the lucrative debt cycle continue. In fact, the Fed has made deflation Enemy #1.

Say hello to "Helicopter" Ben :-( ....

Deflation is great for the consumer until he loses his job and has no money to take advantage of the lower prices.

While deflation makes everything cheaper in nominal terms, the real costs do not decline by the mere strengthening of the currency. If deflation is very small (under 1%) it can be tolerated without much adverse effect on the economy. However, meaningful deflation creates an environment where investors are better off holding their cash idle - rather than investing it to receive fewer dollars later. Job growth and output growth then grind to a halt, and this puts further downward pressure on prices. Prices will decline faster than wages, and profit margins disappear, leading to layoffs and shutting of production to escape the cost squeeze, and to conserve cash. Economic decline continues as the deflationary spiral accelerates, and people hoard cash rather than invest in growth.

Periods of mild deflation can be somewhat prosperous, but not as prosperous as they would have been without deflation. The second half of the 1800s was such a period. It did have many years of economic difficulty, but also had prosperity with mild deflation. Technology lowers real costs and this enable virtuous deflation. However, deflation reduces the benefit of investing, and eliminates the imperative to keep the money working. This negative effect overpowers the system and undermines the economy.

Going back to the Shiller graph discussion… I don’t like log-normal scales. I prefer linear graphs. They are more intuitive. Log-normal graphs flatten everything, but the problem is that it is already too flat for the years prior to 1990. It’s a data issue – not the scale.

"Here’s the problem: The Fed/government doesn’t share that view..."

As you imply, inflation is their meal ticket. I was just pointing out the popular misconceptions about deflation. And boy, are they popular! It's amazing how well their propaganda machine has worked over the decades.

If you are saying that it will never happen, you are in good company. Still, I wonder about Japan. ;-)

HARM, On some of your earlier points:

The GDP deflator is a more stable and broader measure of the monetary phenomena of inflation. The CPI is intended to measure the impact on consumers only. Because it only includes consumer goods it is not really a true measure of the general price level.

As for the old years, the data is sparse and I agree that using a better deflator is of little significance. As you said, garbage in, garbage out.

There are pockets of good data out there for the old years for selected localities, but not on a consistent basis with each other, and privately held or proprietary. In other words, not generally available.

Thirty years ago I conducted a study of real estate prices using some pretty good data spanning the 50 years from 1920 through 1970. It was actual same home type data by year, by neighborhood, for about 40 distinct neighborhoods in a major SMA. This home price data was very proprietary to its source, but they allowed me to use a derivative of the data (indexed values, not the raw prices). This was actually just as useful because I was measuring the changes over time and differences between neighborhoods. In addition, I already knew the latest data points, so I was able to calculate all of the actual values anyway.

I was exploring and measuring the determinants of value and the determinants of changes in value. I was testing various common ideas and seeking new ones. I had lots of data. I also had several economics students assisting me in running hundreds of regression scenarios with all manner of data combinations that we could think of and obtain (incomes, interest rates, distance to employment, etc).

The purpose of the study was to evaluate the market realities for the benefit of improving residential investment strategy. After finishing the study I decided that I did not want to share what I had learned with anyone. Selfish, for sure - but I saw a competitive advantage that would be worth more to me than any recognition that could come from publishing the results. What I learned has helped me tremendously as an investor.

And I am not interested in selling books. When you sell books you don’t have to be right – you just have to sound right. You must be persuasive. As an investor being persuasive is not important, I have to actually be right.

If you are saying that it will never happen, you are in good company. Still, I wonder about Japan.

Not saying it can't happen, frank, just that ol' Ben & Co. will do everything in their power to prevent to try to stop it. How successful they will be remains to be seen.

deflation is no worse than inflation..........if we do have severe inflation, the ones who will get squeezed the most will be those who overleveraged themselves with debt. Companies will not pay their workers more, they are already cutting costs by outsourcing.... Inflation will only cause more people to default on credit........deflation on the other hand will put more money in the pockets of those who are indebted, not that they'll be smart enough to pay off their debts, but may give them a chance......either way, the outcome will not be pretty........but if you ask me, I have to say that deflation would be a better outcome.......let everything else deflate along with house prices.

What will happen to the homes of people who are foreclosed on? The same thing that happens to the homes of people who die. Someone else buys it. And death is more prevalent than foreclosure.

Allah, A brief study of economic history would show you that deflation is far worse than inflation. Even if you do not understand the theory, you should be able to see the difference in the results.

What will happen to the homes of people who are foreclosed on? The same thing that happens to the homes of people who die. Someone else buys it.

Someone else does buy it, but usually for a much cheaper price.

Allah, A brief study of economic history would show you that deflation is far worse than inflation.

You cannot always use history as a guide....during the great depression, things were alot different than they are today. I am not an economist, but I do know that it would take higher income to support high inflation and the companies in this great country of ours will not pay the price for american workers. Sure....deflation is not good for companies, but do you think inflation is? If people cannot afford to support themselves, they will have to find another job and/or move to a community that has cheaper living expenses. Also, people will cut back on spending and that can't be too good for companies either.

Thirty years ago I conducted a study of real estate prices using some pretty good data spanning the 50 years from 1920 through 1970. It was actual same home type data by year, by neighborhood, for about 40 distinct neighborhoods in a major SMA. This home price data was very proprietary to its source, but they allowed me to use a derivative of the data (indexed values, not the raw prices).

...The purpose of the study was to evaluate the market realities for the benefit of improving residential investment strategy. After finishing the study I decided that I did not want to share what I had learned with anyone. Selfish, for sure - but I saw a competitive advantage that would be worth more to me than any recognition that could come from publishing the results.

Zephyr,

As far as the GDP being a better/broader measure of inflation, you may or may not be correct, although some believe it overrelies on substitution and thereby understates the impact of real price hikes on the consumer.

I certainly understand not wanting to reveal valuable proprietary research you're currently using. But without knowing what it reveals, it's hard to debate you over it's merits relative to Shiller's methods & data.

How about this: if you were to re-plot Shiller's RE price graph using the GDP deflator as an index, and substituting your own price data, what would be the approximate result?

Zephyr writes:

“Deflation is great for the consumer until he loses his job and has no money to take advantage of the lower prices.”

Deflation, to the extent that it is a corrective process, will temporarily bring higher unemployment rates as factors shift from mal-investments to more efficient allocation of resources (e.g. who needs all those Real estate agents!). The new jobs created will be more permanent because they are not the result of some inflation-induced bubble.

“While deflation makes everything cheaper in nominal terms, the real costs do not decline by the mere strengthening of the currency.”

Real costs do not decline by the mere strengthening of the currency, but because of the more efficient allocation of resources (i.e. more efficient production) - something that under a price targeting, inflationist economy has historically been proved impossible to achieve (repeatedly).

“…deflation creates an environment where investors are better off holding their cash idle”

I think I sufficiently covered this in my prior post. Let us just agree to disagree, then :-).

“…deflation reduces the benefit of investing, and eliminates the imperative to keep the money working”

Huh? You are assuming that there are no good investments in a deflationary period? That is not historically supported, and seems counter-intuitive. An economy that is good for both consumers and businesses, after all, has to be a good place to invest.

"But it strikes me that even the most stupid sheeple will look at the fact that that shiny new car or toy ( like the bike ) keeps getting cheaper then it’s best to wait"

It depends on individual circumstances, but if this were a general rule then I would never own a computer, iPod, Palm pilot, digital camera, TV, bike, or one of a dozen other toys that become continuously cheaper over time.

Necessity is only one factor. I think you grossly underestimate the desire to consume now as opposed to later. We all want to enjoy the fruits of our labors at some point. It is ridiculous to think that in a deflationary environment, everyone will take their money to the grave with them ;-).

The value of looking at price data such as the Shiller graph is to show how the real price has changed over time. It would be better to look at the total cost of ownership rather than the price. However, that is not as easily portrayed. Working with price data we can take the analysis to a more refined level than mere price. Mere price ignores changes in the average house. How much house do you get for your money?

Over the last 50 years the average home has increased in size dramatically. This size growth is an important factor in considering housing price changes over time. In addition, homes built or remodeled today include a much higher level of luxury finishes and features. It is hard to calculate the value of these upgrades with confidence. However, we can calculate the cost per square foot to see how housing costs have changed over time on an apples to apples basis relative to size.

I have done a rough calculation of the inflation-adjusted median home price per square foot. I used the U.S.A. median prices, median home sizes and the GDP deflator for the last 40 years. I have stated the values as an index where 1965 equals 100%. Here is the result:

1965 100%
1970 135%
1975 118%
1980 134%
1985 131%
1990 157%
1995 127%
2000 152%
2005 197%

Housing prices per square foot have roughly doubled. It is interesting to note that inflation-adjusted household incomes have also roughly doubled since 1965. Interest rates were rising or high during the 1970s and 1980s suppressing price appreciation, and the declining and more favorable interest rate environment of the last 20 years has accelerated housing prices. Interest rates today are comparable to what they were in 1965. The net effect of the additional considerations is that housing is more affordable today than it has been during most of the last 40 years. Not surprisingly the percentage of households that own the home they live in is now at an all-time high.

The net effect of the additional considerations is that housing is more affordable today than it has been during most of the last 40 years. Not surprisingly the percentage of households that own the home they live in is now at an all-time high.

Housing is not more affordable...........the only reason it seems that way is because of the looseness in credit standards and the crazy types of mortgages that are available. If we didn't have these two elements, it would be no more affordable than it was back then....and there would not be a bubble.

the percentage of households that own the home they live in is now at an all-time high.

...another thing,.......the percentage of ownership statistic is totally flawed. Someone who took out a 0% down, IO ARM cannot reasonably be called a homeowner........and I know when this crash plays out, the percentage of homeowners(as they like to call it) will drop lower than it was before the boom due to cash out refi's and spending on investment properties.

R. Patrick, You are spot on with your comment that deflation would cause some deferral of purchases. They would not fully stop. That is not possible, but it is a well established fact that consumers react to expectations about future prices. When prices are expected to rise significantly consumers rush to purchase if they can. This is in fact one of the symptoms and a contributing cause of bubbles. They (we) also tend to wait on some purchases when we expect prices to fall. Many on this board are in fact advocating that very behavior regarding home purchases.

It is certainly true that not all purchases can be deferred or accelerated. But for those that can be consumers do respond to expectations of future price changes.

You are right that even the most stupid sheeple will see the benefit of this strategy and act on it to some extent.