A few weeks ago, I spoke about asset bubbles. One of the things that puzzled me was how asset prices can run ahead of inflation. So, I have done some digging and come up with at least a partial explanation behind this strange phenomenon of property prices consistently outperforming inflation and average earnings. It’s not as simple as you might think and even today, I will focus on one dimension, which is mainly around the growth of the money supply ahead of consumer spending and consumer prices. So, if you are ready for a little historical, statistical analysis, then buckle up, maybe grab a notepad and listen carefully as we uncover some unseen truths behind asset price inflation.
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Resources mentioned
UK Inflation data from the Office of National Statistics & Consumer Price Indices since 1960 & A really cool site that simply has really cool data!
UK Average Earnings Data
FTSE 100 & All-Share Index Performance
The Money Supply definitions
Interest Rate history through The Bank of England statistics archive
The best infographic on the World's Money Supply I can find!
Life After The State - Audiobook by Dominic Frisby
Save Time, Save Money & Make Profit in your property deals with the Property Deal Tips service from The Property Voice
Link to the Podcast feedback survey
Today’s must do’s
Understand that asset prices are largely being driven by inflationary measures that are NOT tracked by official inflationary indices! Asset prices are being swollen by the growth in the money supply. So, monitor the true money supply to get a picture of how asset prices could change over time...and how bubbles can form potentially. Then, get yourself some of these assets if you want to avoid being left behind! Assets of course include property, but extend to stocks and shares, precious metals, bonds and other fixed interest deposits, and alternative assets such as art & collectables...and perhaps a little bit of Crypto-currency to hedge against a total collapse of the financial system as we know it...Remember, income feeds you for a day, assets can feed you for a lifetime 😉
Don’t forget to check out the new Property Deal Tips service to help ensure you have great return on investment properties in your portfolio.
Subscribe to and review the show in iTunes…and while you are at it please help us to spread the word by telling all your friends too!
Property Investor Toolkit – here is the book link on amazon.co.uk & amazon.com
Get talking!
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Start a conversation on Twitter with us @PropertyVoiceUK on our Facebook page or connect on Linked In if you like
Transcription of the show
Hello and welcome to another episode of The Property Voice podcast. My name is Richard Brown and, as always, it’s a pleasure to have you join me on the show again today.
A few weeks ago, I spoke about asset bubbles. One of the things that puzzled me was how asset prices can run ahead of inflation. So, I have done some digging and come up with at least a partial explanation behind this strange phenomenon of property prices consistently outperforming inflation and average earnings. It’s not as simple as you might think and even today, I will focus on one dimension, which is mainly around the growth of the money supply ahead of consumer spending and consumer prices. So, if you are ready for a little historical, statistical analysis, then buckle up, maybe grab a notepad and listen carefully as we uncover some unseen truths behind asset price inflation.
Right, now on with the show.
Property Chatter
My day today
- Snagging check on a property renovation
- Discussing a project, I am looking to buy and arranging a viewing on another
- The rest of the day was spent researching for today’s podcast just for you!
Different Measures of Inflation
- Retail Price Index (RPI)
- First calculated in early 20th Century to measure the effect on workers of price changes during the First World War
- It has been rebased at least 3 times since its implementation
- Deemed not fit to be an official national statistic in 2013
- The latest measure of RPI is 4.0% as of October 2017.
- Consumer Price Index (CPI)
- Tracked since 1996 (effectively also rebasing)
- Since 2013 was the official measure used by the Government
- Includes a ‘basket’ of 700 goods and services spanning 12 categories, namely: food & beverages, alcohol & tobacco, clothing & footwear, housing & household services, furniture & household goods, health, transport, communication, recreation & culture, education, restaurants & hotels and miscellaneous goods and services
- Note the following:
- Housing excludes owner occupier costs, the costs of buying property and council tax but does include rents and housing maintenance and service costs
- Health excludes the most national health service expenditure besides things like prescription and dental charges
- Transport & communications excludes government spending on infrastructure projects
- Recreation & culture, excludes government grants
- Education excludes publicly funded education
- Other services do include some housing related costs, such as mortgage fees, legal fees and such like but excludes the cost of financial assets like stocks and shares
- The latest measure of CPI is 3.0% as of October 2017.
- Consumer Price Index including owner occupier’s Housing costs (CPIH)
- It’s basically CPI including a notional allowance for the cost of renting your own home…so not mortgage payments or the cost of buying a house, just the notional rent it could occupy.
- So, given the fact that CPI already includes rent payments, does it make any difference? Probably not much!
- It is not an official measure but has been recommended to become one by some, see here: http://www.independent.co.uk/news/business/analysis-and-features/cpih-inflation-measure-level-what-is-it-why-care-uk-statistics-authority-economy-currency-a7869171.html
- The latest measure of CPIH is 2.8% as of October 2017.
- Wage Inflation
- The Office of National Statistics complies data on average weekly earnings: regular pay, total pay and bonus pay
- The last measure in September 2017 was 2.2%
- House Price Indices:
- House Price Index - The UK House Price Index (HPI) is a joint production by HM Land Registry, Land and Property Services Northern Ireland, Office for National Statistics and Registers of Scotland. Land Registry, and their equivalent in Scotland and Northern Ireland, figures offer a record of all sold prices - arguably the most meaningful, but it's 4-6 weeks old by the time you've read about it. It includes all lenders, cash sales and auction sales as well as repossessions. Introduced in June 2016 and includes all residential properties purchased at market value. It now succeeds the HM Land Registry House Price Index. Keep in mind that it takes time for sales to be reported, so the data is released based on around 40% of the data being available and is later revised based on all data once this is available. Latest measure available is 5.4% for September 2017. This is probably the best index of actual sales data over short-to-medium timescales.
- Nationwide & Halifax House Price Index - are based on the value of mortgages they approve and therefore on property that is for sale right now. Both of these roughly account for 20 per cent and 8 per cent respectively of the 75 per cent of sales that are mortgage financed. It does not include cash sales. Nationwide has the advantage of dating back to 1952 (Halifax from 1983) and so provides the best long-term insight into house price growth, which has averaged around 8% a year over the 55+ years that it has been in operation. Although, it only relates to its own mortgaged properties and so is limited to a small subset of the total market. The Halifax Index showed a 5.4% rise in the year to October 2017, whereas the Nationwide Index was at 2.5%.
- Rightmove House Price Index – compiled by Rightmove based on asking prices (not sold prices) from its own listings since 2013. focuses on property on property for sale right now. The latest index figure is 1.4% for October 2017.
- Zoopla - lists every UK home (27m) and estimates values calculated using a proprietary algorithm that analyses millions of data points relating to property sales and home characteristics in local geographic areas. The latest measure is 3.6% in November 2017.
- The Royal Institution of Chartered Surveyors (RICS) - speaks to its members (estate agents and valuers) every month to see whether they are seeing house prices rise or fall, then turns this into a percentage. It records changes in market sentiment rather than actual house prices.
- Hometrack's house price index - similar to RICS and is based on contributors' opinions on the achievable selling price for each of four standard property types in every postcode district, so the prices are hypothetical rather than based on sales.
The Money Supply
Different measures of money supply. M0, also called 'narrow money', normally include coins and notes in circulation and other money equivalents that are easily convertible into cash.
Another one of these measures is M4, otherwise known as a "broad money aggregate" or 'broad money supply', as it is based on the most inclusive methods of calculating a country's money supply, it results in the broadest estimate. The general rule is to include the totality of assets that households and businesses use to make payments and to hold as short-term investments.
Comparing some of the different indices over the past 30 years
Official Inflation Figures
Remember, this largely tracks consumer spending cost increases.
CPI – 2.6% average since 1989
RPI – 3.4% average since 1987
Average Earnings
This tracks our average income growth from employment activities.
The ONS average earnings figure – 4.1% average over the past 30 years
Money Supply Data
These are the official measures of how much money is in circulation in the economy.
M0 Money Supply (narrow money supply) – 5.8% average growth since 1987
M4 Money Supply (wide money supply) – 7.6% average growth since 1987
UK House Price Growth
Nationwide House Price Index – 6.2% average since 1987
Land Registry House Price Index – 6.7% average since 1987
Stock Market Growth
UK All-Share Index – 6.4% average since 1987
Interest Rates
Bank Base Rate – 5.1% average since 1987
Some Global Money & Asset Stats
This puts things into perspective, in terms of how the World’s money is spent.
Bank Notes & Coins in Circulation - $7.6Tn
World’s Above Ground Gold Reserves - $7.7Tn
Global Stock Market Capitalisation - $73Tn
Global Money Supply – Narrow Money (M0) $36.8Tn
Global Money Supply – Broad Money (M4) $90.4Tn
Note only 8% of Global Money Supply is in physical cash
Global Debt (governments, corporations & households) - $215Tn or 325% of Global GDP. 33% of Global Debt was added in the last decade alone.
Global Residential Real Estate - $162Tn or 75% of Total Global Real Estate
The Global Derivative Market – Ranges between $544Tn and $1.2Quadtrillion! Examples of derivatives – credit default swaps and collateralised debt obligations…infamous from the Global Financial Crisis
Oh and Bitcoin is worth around $138Bn
So, what’s my point?
- Official inflation figures only measure around 10% of what we actually spend our money on
- Earnings are only one way in which we generate cash to spend…as we have seen already, banks and governments create money that also gets spent in the economy…mostly on the 90% of things we don’t track price growth on.
- Currencies have come off the gold standard, meaning Governments can print money without having any physical asset, such as gold, to back up the ‘I promise to repay the bearer on demand’. This has led to large-scale printing of money to fund government budget deficit spending, wars and infrastructure debt.
- Banks are now allowed to practice what is called Fractional Reserve Banking, which means they can create money at many times that taken in as deposits. It is perhaps surprising to hear that a bank in the UK does not need to hold any cash at all to cover its liabilities! However, thanks to banking regulations such as Basel II, banks are now at least required to hold 15% of their liabilities in Tier 1 Capital, which includes retained earnings and shareholder funds. As I have said before, this is like having an 85% LTV mortgage, but mostly secured on a range of assets far less secure than purely property. This means banks now create huge sums of money in the form of debt lent to customers and between one another and much of that debt gets spent on assets, including property.
- So, governments print money that gets spent on its own activities such as schools, hospitals, pensions and other items not captured by any measure of inflationary price tracking. They also print money and buy back their own government debt, which of course pumps more money into the economy, usually for banks to lend money but at the same time tends to increase asset prices, especially bond prices, whilst reducing returns, although that’s not always the case.
- Investors also use their money to buy assets in the form or stocks, shares, property and so on…all of which fall outside of the official measures of inflation.
- Investors can further leverage their purchasing power by using bank borrowing, much of which is secured against assets and in particular property or real estate.
- This all helps to explain to a large extent why house prices have outpaced official inflation measures. In summary this is down to:
- Official inflation measures excluding large elements of housing costs from the items it tracks, in particular house prices.
- Banks and governments can print money, 90% of which gets spent on items not tracked by inflation.
- We don’t merely spend what we earn in income, we also spend what we create through the multiplier effect of government and bank increases in the money supply...including debt.
- Significant elements of this additional money supply gets spent on assets, including property
- Is it all fair? Probably not! Those that can print money, create money deposits or borrow money can spend this on their own agendas, which includes asset purchases for many. These asset purchases are typically, bonds, precious metals, stocks and shares, property, art & collectables, alternative assets and as you have seen quite a lot of derivatives.
What can we do about it?
- Complain and campaign for change...for what good?
- If you can’t beat them, then join them and 'game the system'!
- Caution: best be sensible as asset prices do tend to boom and bust as we have spoken about in previous weeks, so spread your money around a little across different asset types or classes.
- Remember that income brings a lifestyle, whilst it exists, whereas assets bring long-term wealth regardless of your capacity to generate an income from your own labour. So, make sure you get on the asset train as early as you possibly can!
There we have it then. This has been a subject that has been on my mind for a while now and I wanted to share some data to back up some of the thoughts I was having. I have provided some links to many of my data sources in the show notes. However, if you want an overview of the subject, I can recommend that you read the audio book: Life After The State by Dominic Frisby. I could not find it in written format on Amazon, however.
I have to say that I studied Economics at A-level and as a part of a University degree. However, I was certainly not aware of many of these economic realities back then. Mind you QE and Fractional Reserve Banking did not exist back then either, so I am not being too hard on myself 😉
I hope that some of today’s rather more statistical and technical musing has helped to explain at least in part why house prices have tended to outperform official measures of inflation. Now, what you do with that knowledge is up to you!
Before I leave you today, a quick recap on some of the deals that we shared with our Property Deal Tips subscribers in the past week.
For example:
- We found a BTL in Swindon within ½ of the station. It has an 8.6% gross yield, £253 per month net cashflow and a 10% return on cash investment along with a nice equity boost of around £10,000 by acquiring the freehold.
- Or if you prefer undertaking a project, we located a 4-bed semi in Braintree, Essex in need of a refurbishment. Buy using cash or bridging finance and enjoy a 10% or up to £28,000 return on your investment for 6-9 months’ time in the project.
Where can you find projects like this for just £97 a year I hear you ask?
Head over to the new Property Deal Tips page and just sign up: https://www.thepropertyvoice.net/propertydealtips/ I would love to see you join us!
I do plan to increase the subscription level once I reach a certain subscriber count, so if you want to lock in the introductory rate of £97 a year or £9.97 a month…best not delay any longer! You can also help to support the cost of running The Property Voice in the process, so if you value the content that I am putting out, you can say thank you by subscribing as well 😊
Ok, that’s me done for now, you can of course email me podcast@thepropertyvoice.net if you want to talk about anything from today’s show or more generally in property investing. Also, the show notes will be over at the website www.thepropertyvoice.net
But for now, all I want to say is thank you very much for listening once again this week and until next time on The Property Voice Podcast…it’s ciao ciao.