Wednesday, 16 May 2012

What Isaac Newton Knew About House Prices …That the IMF Should


‘Actioni contrariam semper et æqualem esse reactionem: sive corporum duorum actiones in se mutuo semper esse æquales et in partes contrarias dirigi.’
          – Law Three, Principia Mathematica Philosophiae Naturalis,
Sir Isaac Newton

Or to non-Latin speakers (including your editor)…

‘To every action there is always opposed an equal reaction: or the actions of two bodies upon each other are always equal, and in the parts directed to contrary.’

Apparently, this is a new idea to the guys and gals at the International Monetary Fund (IMF). But thanks to ‘three decades’ of research, the boffins at the IMF have finally found out what Sir Isaac Newton knew 325 years ago.

That is, every action creates an opposite and equal reaction.

It’s Newton’s Third Law.

OK. Newton’s third law doesn’t directly relate to house prices. And strictly speaking, he’s not saying that what goes up must come down.

Even so, you can easily apply the words from the Third Law to asset price action. And we strongly suggest you pay close attention to them.

Because the latest IMF report (World Economic Growth 2012: Growth Resuming, Dangers Remain) reveals the central bankers’ plan to ignore the laws of maths and physics. Instead, they’ve got their own ideas on how things should work.

Only this time, they assure you, things will be different…

We were stunned when we read this statement buried on page 89 of the latest IMF report:

‘Based on an analysis of advanced economies over the past three decades, we find that housing busts and recessions preceded by larger run-ups in household debt tend to be more severe and protracted.’


They’ve only just figured that out?

It’s taken them ‘three decades’?

Oy vey.

But that statement was nothing. We read on…

‘Based on case studies, we find that government policies can help prevent prolonged contractions in economic activity by addressing the problem of excessive household debt. In particular, bold household debt restructuring programs such as those implemented in the United States in the 1930s and in Iceland today can significantly reduce debt repayment burdens and the number of household defaults and foreclosures. Such policies can therefore help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.’

Bottom line: it’s not the job of the State and the central banks to prevent asset bubbles. It’s the job of the State and central banks to inflate asset bubbles and then make sure they don’t burst.


By implementing ‘bold household debt restructuring programs…’

You understand that’s shorthand. It means using private savings and taxpayer dollars to bail out those who get over their head in debt.

Of course, as we see it, the State and central banks cause the asset bubbles in the first place. So it’s no wonder there isn’t a peep from the IMF about government and central bank intervention causing price bubbles.

No, in their view the market causes all the problems and so the government must intervene.

Bubbles are good…busts are bad. That’s why they’re so keen to keep the ‘good’ stuff and get rid of the ‘bad’ stuff. Trouble is they ignore the fact that too much of the ‘good’ stuff causes the ‘bad’ stuff.

But the IMF commentary is more than just about house prices. It gives you a sneak peek inside the maniacal mind of central planners.

The Market is Sending Warning Signals

All around you, the market is screaming out. It’s sending warnings left, right and centre that something isn’t right. The message?

That the market needs a natural purge of all that’s bad…bad banks…bad economies…bad governments…bad central banks…

The whole darn lot needs a dose of economic Metamucil so world economies and the free market can start from scratch.

But that won’t happen anytime soon, because, as the IMF notes, it has a different take on things:

‘We also highlight the policy implications. In particular, we explain the circumstances under which government intervention can improve on a purely market-driven outcome.’

This morning Bloomberg News reports:

‘Spain said it would take over Bankia (BKIA) SA and may inject public funds into the banking group with the most Spanish real estate as the government prepares the fourth attempt to overhaul the financial system.’

According to the report, Spain will use 4.5 billion euros of taxpayer dollars to buy a 45% stake in Bankia.

And as the chart below shows, Spain’s biggest bank, Banco Santander, S.A. has fallen 64.2% since reaching a post-bust high in 2009:

Spain's biggest bank, Banco Santander, S.A. has fallen 64.2% since reaching a post-bust high in 2009Click here to enlarge
Source: Google Finance

Meanwhile, in the U.S., JP Morgan Chase & Co. [NYSE: JPM] announced a USD$2 billion loss due to… ‘synthetic credit securities…’

The banks will never learn as long as they know there’s a government and central bank to provide the ultimate backstop.

And finally, Bloomberg News reports the following comments from U.S. Federal Reserve chairman, Dr. Ben S. Bernanke:

‘If no action were to be taken by the fiscal authorities, the size of the fiscal cliff is [so large that there's] absolutely no chance that the Federal Reserve would have any ability whatsoever to offset that effect on the economy.’

In other words – you got it – the government must spend more so the economy keeps growing. And as a result, they delay the necessary bust yet again.

We’re not a fan of former U.K. PM, Margaret Thatcher, but she got one thing right: ‘You can’t buck the market.’

It’s just a shame to see so much taxpayer money wasted in order to refute her—or rather, to save the bacon of politicians, bankers and other vested interests.


This post originally appeared at Money Morning Australia on 11 May 2012


  1. Here's an article that point to QE causing JP Morgan's $2B loss.

    Basically, they sensibly hedged their hedge, then QE happen and reversed the market trend causing them to double down and get into real trouble.

  2. I do hope Kris has a brother called Simon.

  3. So what if they lost $2.5B. Does that not mean that other parties gained that amount?

  4. @Greg: No, not every investment is a zero-sum game. Foreign exchange is one of the few that is. But most investments that go south represent an absolute loss of value to everyone--and particularly to investors.

  5. Would you care to show your workings on that conclusion PC?

  6. @TWR: I don't pretend to know the details of the JP Morgan stuff up, so I won't comment on that.

    But if you take resources worth, say, $30 million and put them into a project that buyers decide is only worth $15 million--let's say it's a large housing project in Orewa or Tauranga or Queenstown--then if the developer goes bust before it's finished you're left with a money loss, an unfinished project worth bugger all, and resources that could have been used elsewhere poured instead into something of lesser value than when you started.

    (And even it were finished as planned, in taking resources from higher value to lower value it still represents an overall economic loss to everyone.)

    In microcosm, that's what happened in the crash. People paid money for things which they quickly discovered weren't worth what they paid for them. That's a dead loss for them, and for everyone else.

    (And because so many of these projects were financed largely by money created out of thin air, when the projects crashed so did the money supply. But that's another story.)

    Now it's true that someone can now pick up that losing project for a song and carry on and complete it--if by the time it's completed there is still demand for it at that or any price.

    But no-one has gained what the developer lost. We've all lost out.

    Investing, for the most part, is not a zero sum game.

  7. I guess gregster's point is that those hypothetical $30m of resources "went in" to something. So maybe they bought Gib board or solid gold taps, or something, but the vendors of those items have the money, rather than the investors. The market value of the finished product may be less than the cost of the resources used to produce it, but the money hasn't disappeared into thin air.

    The JPM issue may be different of course as that doesn't relate to bricks and mortar, and I don't know the ins and outs of that either.

  8. So what if they lost $2.5B. Does that not mean that other parties gained that amount?

    Yes, in this case that is quite correct.

    The money went to other banks and traders, and it's not difficult to lose such amounts. They simply did not have a good risk manager.

  9. @PC Yes, OK, I know what you mean in those cases. I'm no expert.

    Wall Street Journal: "this was not a loss to the taxpayers of America. This was a loss to shareholders and owners of JP Morgan and that's the way America works Some people experienced a loss in this case because of a bad decision. By the way, there was someone who made a gain. The $2 billion JP Morgan lost someone else gained."



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