Australian property good investment??Part 1: how money printing distort the property market

April 20th, 2007

Share |

At this point in time, rental vacancies rate in Australia are at record lows (see Rental vacancies lowest on record). One finance commentator commented that it is so low that it should be considered a ?rental crisis.? He believes that this can only mean one thing?rents and property price are going to increase. As such, some investors are returning to the property market.

For us, we have some reservations on the merits of property as investment. Granted, you may not lose money if you invest in property today, but we doubt it is the best place for wealth. Furthermore, property investments are not as risk free as some may assume, as we said before in Those who have knowledge don?t predict. Those who predict, don?t have knowledge:

To give you an example, we recently heard this assumption, which was manifested in the form of an advice: ?Don?t worry about investing in property. They will never go down in value in the long run.? Try telling that to the Japanese in the early 1990s when their property bubble crashed?those who bought and held out at the top had to wait for decades to recoup their loss.

We will start on a series on the topic of: Are Australian property good investment? Today, we will examine the origins of this rental crisis. Only with a proper understand of it can we then evaluate the merits of property as investments in this current investment climate.

First, what caused the existence of a property bubble (especially in Sydney) in the first place? For the answer to this question, we suggest that you read our earlier article, The Bubble Economy. In short, the property bubble is the result of monetary inflation (aka ?printing? of money) and not due to a sudden and disproportionate increase in ?demand? for housing. To fully understand what monetary inflation is, we recommend that you read this article, Cause of inflation: Shanghai bubble case study. The property bubble in Shanghai is even far worse than Sydney?it defies all rudiments of proportion, common sense and prudence.

Next, how did monetary inflation distorts the property market? As we said before in Wasteful investment not the cause of housing un-affordability,

When money was too cheap [that is a manifestation of monetary inflation], it artificially induced a boom in demand for housing. Builders, upon seeing the rise in price as a result of the artificial boom, rushed to construct more homes than what was really required by the underlying demand. As a result, wasteful investments were made by the housing industry.

How does this work? First, let us examine the concept of inflation from our previous article, Cause of inflation: Shanghai bubble case study:

Consider the case of a fixed money supply. Whenever people increase their demand for some goods and services, money will be allocated toward other goods. Thus, the prices of some goods will increase?i.e., more money will be spent on them?while the prices of other goods will fall?i.e., less money will be spent on them.

Let?s say you are a builder and you see that house prices have been increasing rapidly. What would be your conclusion? You will surely conclude that there is an increase in demand for houses. If the money supply is fixed, then it means that this increase in demand for houses imply a decrease in demand for some other things in the economy. Therefore, the price of a good is a signal to producers that there?s a shortage or glut of that good. In a free market economy, this will divert resources from the production of things in glut to the things in shortage. Now, what happens if the money supply is not fixed i.e. money is printed and fed into the economy? As we discussed before in How to secretly rob the people with monetary inflation?, this implies that there is more money chasing the same amount of goods. The extra newly printed money has to go somewhere and in this case, goes to house price. A question to ask: Are there any changes in the economy that necessitate such an exaggerated increase in demand for houses beyond its fundamentals?

As you can see by now, easy money (i.e. monetary inflation aka ?printing? of money) distort the price signals in the economy and misallocate resources in the economy that would not have happened in a truly free market economy.

However, some may say that the current building bust is due to factors like land scarcity, lagging infrastructure and so on. For their argument, we have a counter-argument. Their argument further validate the Austrian School?s concept of mal-investments (see our article, The first step in an economic slowdown?mal-investment in capital). Capital (which is an Austrian concept that has different meaning) has structure. Ludwig von Mises, said it nicely:

It is customary to describe the boom as overinvestment. However, additional investment is only possible to the extent that there is an additional supply of capital goods available. As, apart from forced saving, the boom itself does not result in a restriction but rather in an increase in consumption, it does not procure more capital goods for new investment. The essence of the credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment. The entrepreneurs employ the available supply of r + p1 + p2 as if they were in a position to employ a supply of r + p1 + p2 + p3 + p4. They embark upon an expansion of investment on a scale for which the capital goods available do not suffice. Their projects are unrealizable on account of the insufficient supply of capital goods. They must fail sooner or later. The unavoidable end of the credit expansion makes the faults committed visible.

The additional investments by builders into building houses can only be completed if you have complementary capital (e.g. land, infrastructure, equipment, labour, etc) already invested. Because monetary inflation distorts the price signals to the builders, they engage in an investment boom that will be doomed to failure because these complementary capitals did not suffice. For example, as you can see, land gets more and more expensive. Infrastructures are non-existent. There are labour shortages. If the price signals to builders were not distorted in the first place, then those booms of building activity would not have gone so fast as to outstrip the shortage of complementary capital.

In the next article of this series, we will examine how this distortion leads to this current rental crisis. Keep in tune!