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Rocky Mountain High Real Estate Prices

Dan McReavy - 30/05/2015 12:31 CDT

Denver, Colorado, United States

According to the May 30th Zillow Home Value Index, US home prices are still 8.9% below their all-time peak reached in 2007.  Aside from a few markets like the New York metropolitan region (banking money), Washington D.C. metropolitan region (government money) and technology-infused areas of the Pacific Northwest, including, San Francisco and Seattle, real estate prices are still at or below their 2007 peak.

The Denver area is catching a strong real estate bid because the market was never over-built leading up to the 2007 market peak, the area's dominant government employment base (non-cyclical and more stable) and an influx of Californians looking for a lifestyle comparable to Northern California.  I have bookmarked and watched several high-end listings of very nice homes/properties in the market and these properties still haven't sold with listing times in excess of 365 days.  The real estate market boom seems to be in homes that qualify for conforming mortgages.  With mortgage interest rates near historical lows, the people who haven't bought homes are now piling in, but people need to consider the relationship between US Treasury bonds and mortgage interest rates that are a premium over the US Treasury's borrowing costs.

US bonds will continue to be the go-to savings asset for banks, corporations and the super-wealthy until:

      * If not resolved, the European Union fractures and the market for European Union bonds is fully-discounted to reflect the situation.
  * The renminbi is added to the IMF's SDR basket to qualify Chinese sovereign bonds as international reserve assets.

The (accounting) value stored in US treasury securities can only be eliminated by:

    * Repayment (currency printing) - we've inflated borrowing and haven't printed currency.
      * Increasing outstanding credit increases the demand for currency - the debt is serviced with currency.
      * Increasing the supply of money increases the demand for savings instruments - stocks and bonds.
    * Default and write-off - the total (accounting) value decreases which requires the total market's price level to decrease in tandem.
      * Market indexes are like the water level in a cup and the price of all financial instruments are like the drops of water that fill the bucket.

As long as the (accounting) value (outstanding credit) exists, the debate is only about where the value is flowing to at any given time.  This is the nature of bond (the credit entry) and stock (the debit entry) prices moving inverse to each other.  The post-2008 federal spending binge by all governments around world has resulted in a bubble of both sides of the US financial system's accounting ledger because people and institutions outside of the US have been moving money back to the US financial system to minimize exposure to their own failed domestic political and financial systems.  Since the US financial system has enjoyed bullish markets on both sides of the ledger and the (accounting) value hasn't been reduced (elimination) and, instead, it has been multiplied three-times since 1999, the big money has started moving their (accounting) value into other (physical) value stores.  This is what caused the first boom in precious metal prices post-1999.  This is also what drove the final boom in real estate prices from 2000-2007 as people sought more tangible vehicles for saving and investing.

The 2009-2015 bounce in real estate prices is just a part of the final topping process for the real estate bull market that started back in the 1940s when the post-World War II financial system was established.  The post-World War II financial system has failed twice. The first failure was in 1971 when Richard Nixon, on the advice of the US Treasury and the nation's largest banks, announced the closing of the Federal Reserve's Gold Window which ended international conversion of US dollars into physical gold.  This initial failure of the post-World War II financial system was really a soft-failure, or default, because there was no creditor liquidation to extinguish financial insolvency.  Instead, the US dollar continued to enjoy its position as the dominant international medium of exchange with all currencies floating in value in real-time against each other.  The US dollar's international trade acceptance and deep market for investment options has created a self-reinforcing dominance against all other currencies.

The second failure of the post-World War II financial system came in 2008 when the hoarding US financial securities caused mortgage securities to become over-priced relative to the real estate that they secured.  The outcome was a multi-trillion dollar hole in the international financial system and an exhaustive list of federal bailouts to support the continuation of international and domestic economic activity.

The problem that the international financial order is confronted by today is that income determines a borrower's ability to borrow and repay an obligation.  Since April 2000, the US civilian labor force participation rate has declined and it has rapidly declined since its December 2006 peak.  Measuring the jobs added to the economy is an inadequate measure of economic health without comparing it to changes in the total population.  The ratio of civilians employed to the total population is still down 8.3 percent since the April 2000 high.  Not only do fewer people have jobs in comparison to the country's population, but the real income of most people is 8.7 percent lower than it was at the data-points 1999 high.  Together, this all adds up to a reduced ability for the economy to borrow and repay.

Economists and politicians love to talk about GDP growth, but GDP growth is an inadequate measure when one person buying a new Range Rover ($83,495 MSRP) contributes more to GDP than five people buying a new Chevrolet Cruze ($16,170 MSRP).  It could be argued that an unemployed person doesn't even need a used Chevrolet Cruze if they don't have a job to get to each day, but what does this mean in the long-term for the financial and political stability of the world's, currently, most-stable country?  Society's wealthiest will continue to enjoy their wealth as long as they continue to spend it and spend it lavishly.  If society's wealthiest save too much they are at risk of unfavorable changes in the political winds as the economy's money doesn't circulate fast-enough or as diversely as it needs to in order to support the continuation of the post-World War II financial system.

Prospective home buyers should consider how higher taxes and higher interest rates could impact the future value of home prices.  Interest rates are near historical lows and states and municipalities do not enjoy the same borrowing capability as the federal government.

Caveat emptor.