The price of a real estate in gold

The Daily Reckoning has a chart showing that nominal gains in housing since 1913 has been in the neighborhood of 4.4% per annum.  Take the following example:

5561 Keith Ave Oakland, CA  1913- $5,750; 2011 ; $843,500.  = 14,595%

But what happens if we price the house in gold which was $18.93 per ounce in 1913 and $1435 today ?

5561 Keith Ave Oakland, CA  1913-303 oz gold ; 2011-587 oz gold = 93%

That’s on the high end of the scale.  Suppose we took another house on the low end:

28 Sanford St. Trenton NJ  1913-$3,600 ; 2011 $200,500 = 5469%

28 Sanford St. Trenton NJ  1913-190 oz gold ; 2011-140 oz gold = -26%

The nominal gain in the 28 Sanford house over 100 years was 5469%, but the real gain as measured in gold is -26%.  This is a remarkable consideration.  In my view, what it really means is that those investment advisors (e.g., James Altucher) who say that buying a house to live in is not an “investment” have been absolutely correct.  It is likely a relatively good store of value, as compared to the dollar, but even that really depends on the location of the house.  If a house is bought in a thriving industrial metropolis but ends up in a ghost town like Detroit, real estate is a very bad investment indeed, in the long run.

I would contend finally that home owners often win in this game because they have access to a low interest debt product, a mortgage.  The interest paid, the maintenance on the house, insurance and property tax, the main expenses of the house, are roughly equivalent to or less than what one would pay in rent.  The significant advantage of borrowing a large sum today and paying it off over the course of time is that the dollars borrowed are worth more than the dollars paid, because inflation, which has been more common than deflation over the last 100 years, benefits debtors.

But real estate as an investment gives the impression of phenomenal gains; but as measured in gold, these gains are far less dramatic.  However, in some cases, owning a home may protect the investor from robbery via inflation.

Just for fun, I’ll do the same with my house:

Price paid in 1997 = CDN $200,000 ; 2011 – CDN$400,000 = 100%

Price paid in 1997 = 404 oz gold; 2011 = 287 oz gold = -29%

I conclude that my house has had phenomenal nominal gains in the last 14 years, but no serious real gains in that same period.

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Why I think QE will create inflation and why it is qualitatively different than credit expansion

Meredith Whitney has come down hard on the municipal bonds and she is getting a lot of heat from others, including David Rosenberg.  But even if she is wrong, bonds of all sorts are bad investments because the US dollar is going to hell in a hand basket.  But what about shrinking credit which causes deflation?  I am no economist but here is why I think QE causes inflation while credit expansion is less inflationary:

Inflation is caused by too much money supply chasing too few goods.  Money supply can be created through credit expansion or through QE.  Credit expansion results in the creation of goods and services such as building of houses and manufactured goods, for every time a business borrows, its creates more real wealth in the form of its products.  Every time a home owner buys a house with a mortgage, the demand for new housing goes up and it results in larger supply of homes, i.e., more goods.  Thus, though credit expansion can obviously create bubbles, it also results in the increase of goods and services.

QE, quantitative easing, or the monetization of debt results in a disproportionate demand for goods and service without the creation thereof.  This is because the US federal debt is being monetized, and the US government in turn gives the money to government workers, pensioners, social security, welfare, food stamps, etc.  I.e. to people who increase demand without increasing the quantity of goods and services.  This increased demand, too many dollars chasing to few goods, devalues the dollar.

And this is why I think that QE leads to inflation and why it is much worse than credit expansion.

Is debt sin?

I stumbled upon an interesting article today called, “Debt is Sin“.  The author, Bob Mallory writes:

The fact is, everyone knows that debt is wrong, and no one refers to it as if it’s a good thing. Yet the further we seem to wade into financial bondage in America, the more our Christian financial counselors and pastors falter when it comes to the Word of God.

Let’s cut to the chase: Debt is a sin. It’s a sign of a covetous heart, and not trusting that our Heavenly Father will provide us with everything we need. Since American Christians worship an insufficient savior, they turn to credit to purchase the things they want. The Scriptures are consistently negative when discussing financial debt for believers. It’s never neutral or positive, as many financial counselors will tell you.

He lists a set of scripture verses as proof texts:

Exodus 22:25-27; Deuteronomy 15:6; Deuteronomy 28:12; Deuteronomy 28:43-45; Leviticus 25:35-38; Nehemiah 5:1-5; Psalm 15:5; Psalm 37:21; Proverbs 6:1-5; Proverbs 11:5; Proverbs 12:9; Proverbs 22:7/1 Corinthians 7:23; Ezekiel 22:12; Matthew 5:42; Matthew 6:24; Luke 6:34-36; Luke 16:13; Romans 13:8; 1 Timothy 6:6-10; 2 Timothy 3:1-5.

Now first of all, many of these texts warn against covetousness and the love of money (e.g., 1 Tim 6.6-10; 2 Tim 3.1-5; Matt 5:42; Matt 6:24), but not against debt.  Others, to be sure, counsel the Christian to avoid debt (Rom 13.8), explaining that debt puts the person into virtual slavery to the creditor (Proverbs 22), and naturally, it was a blessing that Israel was to be a creditor nation, not a debtor nation, unless it sinned against the Lord, in which case they would become a debtor nation (cf. Deuteronomy).  Proverbs 6.1-5 actually counsels against providing security for someone else’s debt.  Finally, in Israel, it was against the Torah to charge another Israelite at interest.  But do these passage all say that debt is sin, no matter what kind of debt it is?

First, I would suggest that this way of thinking is basically a “fundamentalist” approach to the Scripture (see this post) in that it attempts to create a new law for Christians; that if the Christian followed that law, he would be on the path of blessedness.  It may be true that this path of avoiding every form of debt could be blessed.  Certainly in our current recession, had you avoided debt, you could be far ahead of those who were leveraged to the hilt, such as stock holders who received margin calls in 2008 and 2009; or Lehmans and Bear Sterns, which were highly leveraged investment firms.  Such advice might have seemed prescient for such people.  However, I approach the Bible differently.  The Bible contains wisdom and advice, which is bound to a particular context.  The crucial task of hermeneutics is to determine the principles taught by the Scriptures and to attempt to apply them in new cultural contexts today (see Klein, Bloomberg and Hubbard, Introduction to Biblical Interpretation, chapt. 11) through the help of the Holy Spirit and the accumulated wisdom of the church through the ages.  Thus, the categorical use of biblical advice as the new Torah is not a good way to apply the Bible today.

Contemporary financial advisers correctly distinguish between good debt (cf. this post) and bad debt. The effect of bad debt is that the debtor becomes a slave to debt payments.  The effect of good debt is the opposite.  It leads to profit and wealth.  I would agree that wisdom teaches us that bad debt should be avoided, and it is a sin if it is accompanied by greed and a lack of self-control.  A poor person who borrows in order to survive is probably to be pitied rather than called a sinner; the Bible often defends such people and condemns those creditors who exploit the poor.  However, people who accumulate credit card debt to buy consumer goods because they can’t defer gratification have a problem, not too dissimilar from alcoholism.  It is a spiritual problem related to a religion of consumerism.

But there is also good debt.  Good debt is money borrowed to make a gain or profit.  An example would be the borrowing of money to purchase a high yield stock.  As long as the interest rate is lower than the yield and the stock maintains its value or experiences a capital gain, the debt creates a profit for the debtor.  Another example would be the purchase of a house to live in or to rent out;  as long as the mortgage holder saves on rent, builds up equity through the repayment of the principle and capital gains, this is good debt.  Another example would be the line of credit that a business has in order to fill orders.  Without the line, they would not be able to make sales without first taking a large percentage of the cost from the buyer, which is actually a form of borrowing from the buyer instead of the bank.  This is not always convenient. So businesses will often borrow money from the bank in order that they do not have to charge their customer in advance.  Businesses also have what is called “net-30” or “net-90” etc.  This means that they extend credit to their customers of 30-90 days; the customer in turn has borrowed because they don’t have to pay for it up front–they can then in turn sell the item to their clients and pay their supplier only after they themselves receive payment.  Without these different kinds of debt, businesses today would come to a virtual standstill.  Our current economic system puts creditors with capital together with businesses and people who need it–banks serve as the go-between between these two parties, and everyone is supposed to make a profit from such transactions.  The question then is:  Would the Bible forbid categorically such transactions?  Is it so clear that good debt is sin?  I don’t think so.  My wife’s company which was started by my father-in-law about 45 years ago has debts;  it provides jobs to 25+ employees.  Now if we decided that it was sin to take on debt, undoubtedly we would have to close the business, and all those employees would lose their jobs.  I think it is better to use debt wisely and to continue to provide good jobs with benefits to these hard working men and women.  [Note it would be eventually possible to use retained earnings instead of bank credit to make these transactions–but Canadian tax law makes it very expensive to retain earnings in a company of this size].

But is there biblical support for my position?  Let’s consider the parable of the talents in Matt 25.14-30, which is the “canon within the canon” of this blog.  Jesus teaches that a man going away on a journey lends his capital to three of his servants, with the ostensible purpose that upon his return, he will receive a rate of return on his deposit.  These three servants receive 5, 2 and 1 talent respectively.  This is an  enormous amount of capital:  a talent is 6000 denarii, and a denarius is probably about 2-4 days wages at minimum wage in ancient Palestine.  So the man who received 5 talents had enough capital to pay 60,000-120,000 people minimum wage for one day; this would certainly be enough to start a business of some kind.  The servant with five talents received the equivalent of well over half a million US dollars.  The first two servants were entrepreneurs who were able to double their master’s money during that period. They would receive their reward for their diligence and their willingness to risk.  The one who received one talent was afraid of his master and of risking the capital, and so he buried the talent which equals about US $87,000-174,000 (considering $7.25 per hour as minimum wage). Imagine the master’s wrath!  He lent the wicked servant an incredible sum and the man buried it.  So the master says that he should at very least have given it to money lenders so that if he himself wasn’t going to risk it, they would at least find a suitable placement for the funds, and pay him interest on the money.  Jesus called this man wicked, and he received his reward (to be cast in outer darkness).  So Jesus teaches us that the wise risk of capital is not a sin; the sin here is the failure to put at risk the capital that has been lent.

This parable is amazing on so many levels.  But at very least we must acknowledge that Jesus commends those who are not afraid to take risks.  But he does not even tacitly condemn creditor/debtor relations in this parable.  He acknowledges them as facts of life and uses them to illustrate our relationship to the Kingdom of God.  We are debtors before God, because it is He who has made us his regents and lent to us his capital to see what we will make of it, and we need to use what we have from Him profitably so that on the day of reckoning our master will commend us as good and righteous investors.

I would like to conclude by making the following points:

(1) The New Testament is not the new Torah.  Its principles need to be applied to new contexts with judicious wisdom and with the guidance of the Holy Spirit.

(2) We need to distinguish between good debt and bad debt.

(3) Jesus does not condemn the wise use of good debt, but rather, told a parable in which standard business practices illustrate our indebtedness to God.

(4) In our culture, not all debt that leads to profit making is a sign of greed, for it can be vehicle for creating wealth (which is a blessing) and providing jobs.

(5) The wise servant is the one who can thrive in the circumstances in which he finds himself.  Thus, we must ask, given the current economic environment, culture,  and tax structures, how can we Christians learn to thrive and create wealth?