One of the reasons that everyone seems to act so surprised at the “economic meltdown” is because we measure everything in U.S. Dollars while paying little attention to the value of the dollar itself. The dollar is a floating currency. The amount of dollars in circulation can dramatically increase or decrease in any given period of time as seen fit by the central bank, the Fed. An increase in the money supply will push prices up, while a decrease in the money supply pushes prices downward. Therefore, an asset’s true value can remain constant while it’s dollar denominated value can fluctuate – and vice versa.
Looking at statistics or charts denominated in U.S. Dollars can be very deceiving, and if that’s what you’ve been doing, then you were blindsided by the recent collapse of various markets and institutions. If during the past decade you were looking at real prices (as measured in grams of gold) it would have been quite apparent that housing prices were experiencing erratic growth that was likely unsustainable. Gold has been the real currency used by humans since the dawn of time, and even after Nixon took us off the gold standard in 1971, all markets continue to follow logical boundaries of movement as priced in gold.
The good news is that we can now look at this type of data to more comfortably estimate where the bottom is. Warren Buffett commonly perpetuated the addage attributed to Baron Rothschild: “Buy when there’s blood in the streets.” This means that you should be buying (greedy) when most everyone else is selling (fearful) and be selling (fearful) when most everyone else is buying (greedy).
That said, the charts over at www.pricedingold.com show the Case-Shiller Home Price Index as returned to 1997 levels (top). The chart for U.S. Median Home Prices (below), however, tells a less clear story:
To me, this all translates to a crystal ball that says housing is near its bottom, but median home prices may fall a bit more. This would support investment into inexpensive housing. Keen real estate investors will be diverging from trendy lofts and luxury homes in order to focus on where the real money will be found – affordable housing. Many American families will be financially destroyed by the acts of Wall Street and our central banking system. They will need to start over. At the very least, many American families will start living within their means… which they will find to be much more modest than previously thought.
The housing prices that should remain strong will be those at the lower end of the spectrum. In today’s chaotic marketplace, buying an $80k home for a 50% discount should be a solid bargain. On the other hand, buying U.S. real estate for cash flow may be a confusing (often losing) game in years to come because I suspect rent raises will be unlikely to follow inflation beyond 15%.
All in all, my perspective for wealth preservation in the next few years can be summarized in a few points:
- Anything that is bought and sold in U.S. dollars shouldn’t be held for the long term due to monetary instability.
- Demand for affordable housing will continue to grow while demand for luxury housing will continue to shrink.
- If you can find a bargain (at least 50% under fair market value) on an affordable-priced home, buy it because you should feel confident that its market value is fairly solid. Buy it if you feel like you can liquidate it for its market value in one year or less.
- Stay away from cash flow real estate if it is bought, sold, and rented in U.S. Dollars or any currency pegged to the U.S. Dollar.
- Stay away from investing in mortgage notes or trust deeds whose return is paid in U.S. Dollars.
Once you start checking your assumptions against prices in gold, you gain an understandable, logical, and predictable viewpoint.
### Update ###
The five guidelines above are for a person who is interested in growing wealth. If wealth growth is not high in your priorities, long term ownership of affordable-priced U.S. real estate should still provide a good hedge against inflation. This means you will likely experience double digit price appreciation, although this will be accompanied by double digit costs of living increases. That can be an effective means of wealth preservation.