Tuesday, August 31, 2021

Home prices and the M2 surge

The latest Case-Shiller statistics for June (which is actually the average of April, May, and June prices) show that national home prices rose almost 20% from the prior year. This is by far the most dramatic increase in home prices ever recorded. Could it be a coincidence that the M2 money supply rose by 28% over this same period, also an all-time record? If we want to understand the burst of inflation that has occurred over the past year or so, we need look no further than the money supply. For prices to rise significantly across a range of assets and markets, there must be a corresponding and significant rise in the money supply.

With the Fed assuring us that there will be no reduction in its balance sheet and no meaningful increase in short-term interest rates through the end of next year, the US economy is going to be awash in extra money for a long time. The recent burst in inflation is therefore highly unlikely to prove temporary or transient.

This is huge and very unwelcome news.

Chart #1

Chart #1 shows the nominal and real index of national home prices, as calculated by the S&P CoreLogic Case-Shiller methodology, which is widely considered to be the gold standard for home price trends. Prices are now at all-time highs, both nominally and in inflation-adjusted terms. Prices are on track for blowing away the sky-high prices we last saw in 2005-2006, which in turn were temporarily goosed by crazed lending practices.

Chart #2

Chart #2 shows the year over year change in this index, about 18%. It's a safe bet that we'll see prices continue to rise for at least the next several months. 30-yr fixed rate mortgages are going for about 3% these days, which is only modestly higher than the all-time low of 2.85% which was set in February of this year. Those same rates averaged about 6% in 2006, by the way. 

Chart #3

Chart #3 documents the virtual explosion in the M2 money supply that began in March of last year. The M2 money supply is now (as of the end of July) about $3.7 trillion above its long-term trend line. That extra $3.7 trillion can be found almost entirely in retail bank checking and deposit accounts, all of which are readily convertible into spendable cash. We have never before seen anything like this in the monetary history of the US. We have seen things like this in Argentina, however, where soaring inflation has always been preceded and accompanied by huge growth in the money supply.

Milton Friedman must be rolling over in his grave these days.


Dave Daline said...

Hi Scott, thanks for the update. What does this make you want to do with your money?

Tim H said...

Short the 10 year.

skydude said...

The inflation we have recently seen has been driven by declines in productivity and output. Productivity determines the value of a nations currency, not the quantity of the currency. Covid idled productive resources and enhanced unemployment benefits lowered incentives to work, both of which led to lower levels of productivity. That is a large reason for inflation.

Real estate prices have risen because of supply and demand, the former being relatively subdued since the great recession and the latter having increased.

Milton Friedman's axiom that inflation is everywhere and always a monetary phenomenon is incorrect.

Scott Grannis said...

Skydude: You are a brave man to challenge Milton Friedman.

What to do with my money? I’ve answered that question quite a few times in prior posts, but to be brief:

Avoid holding cash money. Don’t be afraid to owe money, which is equivalent to shorting money. Owing money at a long-term fixed rate (e.g., mortgages) is especially attractive. Avoid all short-term financial instruments. Avoid government bonds and most high quality corporate debt. Owning stocks is appealing, since they afford a degree of inflation protection and they represent productive assets. Owning real estate is also appealing, although with prices approaching nosebleed territory I would avoid bidding wars, especially in the residential sector.

skydude said...

I have refinanced my houses and other peoples homes recently at rates around 2.25%, even for cash out options. Long term that seems unbeatable and to offload debt at a long term rate of 2.25& is a no-brainer.

Benjamin Cole said...

Well, you know what I am going to say.

I applaud Scott Grannis for highlighting a huge national problem, about 1000 times more important than Afghanistan.

Expensive housing.

The real culprit is property zoning and other government regulations and restrictions on property rights.

Yes, the Fed is exacerbating the problem temporarily. But the same problem has cropped up all through much of urbanizing world, the Hong Kong, to Seoul, to Canada, Great Britain, Australia and the US.

China has some problems in some cities, but less so, and Japan even less. The CCP masters say they will build 1 million more housing units in Shanghai to cut down costs. That almost makes communism look appealing.

The Fed is trapped in some ways. The US banking system is heavily exposed to real estate. As John Cochrane points out, the US banking system leverages up and borrows short to lend long. What could go wrong?

So the Fed cannot let real estate prices go down, or the US banking system collapses too. See 2008.

Also, the very large US trade deficits means there is a lot of global capital looking for a home in the US, and that is driving up US asset prices, including housing.

Is there a Hyman Minsky moment in the works?

I hope not.

Ausgarry said...

Agree with Benjamin, the banking system can’t afford a correction collapse in real estate and nor can the government (at least here in Aus): lest unhappy house owners turn into unhappy voters.

Benjamin Cole said...
This comment has been removed by the author.
Encinitas Undercover said...

It's not only the banking sector that's heavily exposed to real estate. It's the whole economy. The wealth effect of high asset prices is crucial for consumer sentiment, and the consumer is the biggest part of the economy.

The Fed is creating enormous generational and racial wealth inequality, all to prop up consumer spending.

The Smoky Mountain Hiker said...


If I can follow up on your comment above. What about TIPS? Your comment about gov't bonds and short term instruments has me a little concerned that I put my money in the wrong place. I recently sold a fully-owned house and took out a loan to buy another - specifically to take advantage of the low interest rates and the threat of higher inflation. I divided the receipts between a REIT index and 2 TIPS funds (VAIPX VTAPX). So far the TIPS aren't doing too bad vs my mortgage rate. Should I find a new garage instead?


John said...
This comment has been removed by the author.
Scott Grannis said...

Re: what about TIPS? TIPS are expensive these days, since real yields are at very low levels (10-y real yields are -1.05% today). TIPS are a good buy only if inflation continues to rise and the economy turns out to be very weak. In other words, TIPS investors are paying high prices since they worry a lot about rising inflation and weak growth. TIPS are also expensive because investors are looking for safe havens, and TIPS are government guaranteed and somewhat inflation-protected.

If the Fed raises rates by more than the market currently expects, the real yield on TIPS is likely to rise (the Fed can only tighten policy by raising real interest rates). That would hurt the price of TIPS, even though their nominal coupon would rise with rising inflation.