Dear Glenn, What's a Ponzi Scheme?

From today's Sydney Morning Herald, a quote from our Reserve Bank Governor, Glenn Stevens:

For a country of our size … and the population we have, it still strikes me a little bit hard to explain why the price of dwellings are at the upper end of what you see internationally.

Dear dear. How many times now have we heard the odd wise head pop up and ask why the same clowns who didn't see the global financial meltdown happen, such as central bank governors, are now being trusted for advice on where to go from here? There's no evidence any of them have changed any of the obviously useless intellectual equipment (theories, models) which left them totally blind to all of this only a year or so ago.

These bozos will now no doubt talk about boosting supply of housing to drive prices back below non-biblical levels. That's exactly what they said when the housing boom was underway as well, that the reason prices were exploding was because there was a lack of supply of housing, so everybody was busy auctioning up the prices on the existing houses in a desperate bid to get a home.

But it's bunkum. Supply and demand is one of the only concepts that has escaped the turgid world of modern economics and entered the public domain - it's probably the only concept that the average person who doesn't give a fig about economics understands. But it's a fairy tale. It works only in highly idealised situations, which means in almost no situations. There's hardly an area of life where you can't easily point out what utter rubbish it is. For example the self-serving drivel you hear from people on astronomical wages, that this is the 'market' at work, and there's such a short supply of utter geniuses such as themselves that the demand is huge, and therefore the price i.e. their wage, goes up astronomically as well. Teachers, anyone? There's been a worldwide shortage of teachers for many years, and yet their wages have decreased relative to the rest of the community.

The reason house prices went so nonsensically high and are still trying hard to stay there is that most housing markets are simple Ponzi schemes. Ponzi schemes are now in the press all the time, and Bernie Madoff's massive fraud is taken as a classic instance. But what he did is completely dwarfed by the Ponzi scheme that is the housing market.

In brief a Ponzi scheme works by promising investors large returns, and then paying these returns when they fall due using the money from new investors. In between nothing gets actually produced at all, the whole thing is reliant upon a continuing increase in the number of gullible investors.

What hasn't been widely noticed is that this is EXACTLY how the housing market works. House prices aren't based on any sort of objective valuation of the value of a property, they're based entirely upon what the next person is prepared to pay. The reason house prices went beserk in the past decade or so is that credit was so cheap, which allowed new buyers to afford bigger and bigger loans, which they used to turn this Ponzi buying into a complete frenzy. Everyone could see massive capital gains to be had for doing almost nothing, which is just like any gold rush or other gambling frenzy.

It's just speculation. Now let's apply the traditional economic 'theory' (I hesitate to dignify it with a serious term) of supply and demand. Would flooding the market with new houses slash the prices? Perhaps if so many houses were built that they outnumbered potential buyers. But even then those who buy real estate as an investment could continue to buy and sell properties for profit. It's immaterial how many houses are out there, because people can gamble/speculate on prices no matter how many there are. Look at poker machines, you would think the enormous growth in numbers of these in recent years (a huge increase in 'supply') would have dramatically weakened the demand for them. Nothing of the sort has happened, in fact demand has actually increased with the increased supply.

That's how gambling always works.

[I'm so close to putting the final touches on my alternative theory of 3D. I'll get to that soon, and I also have to finish off that stuff on the idea of the everyday.]

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