Gold, Quantitative Easing, And Property Prices In Malaysia

I read this over the weekend:

Applying the brakes – made for the short term – can be dangerous
FOOD FOR THOUGHT
By DATUK ALAN TONG

...Recently there has been a proposal to raise the floor price of properties for foreigners from RM500,000 to RM1mil to curb or control the prices of houses from increasing too fast. This proposal is on top of the other “cooling off” measures such as the 70% housing loan policy for purchase of a third property, the increase of real property gains tax from 5% to 10% imposed on properties sold within two years of the sale and purchase agreement, and the new ruling on housing loan limits based on net income rather than gross.

There is no doubt that the introduced “cooling off” measures have reduced the buying spree of properties. However, the intended objective of these measures to control the price of properties has yet to be seen. Introducing measures without critically identifying the root cause of the increasing property prices may instead create situations that would not be beneficial to the industry as explained by the theory of Risk Homeostasis.

So, what determines rising prices?

We need to find the root cause of the issue in order to identify a long term solution. The basis for rising property prices now is largely due to the direct and indirect impacts of quantitative easing programmes i.e. the increase of money supply, carried out by governments around the world since the start of the global financial crisis…

…When there is too much money chasing too few goods, prices will increase but not necessarily value. In reality, we are facing a situation where there is too much money in the system, causing a decrease in the real value of money and pushing up prices of goods and services including construction materials.

For example, in early to mid 2000, a condominium in Mont'Kiara which was sold around RM500,000 would now cost us about RM800,000, equal to a 60% increase. But measured in a different “currency”, that condominium would have cost us 8kg to 10kg of gold in early to mid 2000 and today, only worth about 5kg of gold. This is a sharp decline of 38% to 50% and is an illustration of how prices are going up due to the drop of currency value because of worldwide inflation and pump-priming policies.

However, if the property prices are not allowed to rise, it is not possible for developers to build below costs when the construction costs are constantly rising. This will cause a shortage of supply which will further push up prices in five to 10 years time.

So, what happens if you base a “long-term solution” on the wrong root cause?

Both rounds of QE in the US and the UK has so far done little more than to replace the money destroyed by deleveraging households and corporations. In Europe, financial system support through asset purchases has been “sterilised”, essentially replacing private sector debt obligations with ECB debt obligations – the extra money created has gone back to the ECB and doesn’t circulate.

Also bear in mind that much of the money “printed” under QE by the Fed and the BOE are still on their balance sheets in the form of excess reserves – those funds aren’t being used to buy anything at all. At this point, somebody’s going to say “Ah-ha, but the more reserves banks have, the more they can lend!” But that’s a complete misunderstanding of the modern credit process, as banks don’t actually need reserves to make loans. In any case, endogenous money creation via credit growth is no better than it was pre-crisis, so there’s no excess cash being generated from that source either.

And comparing property prices to gold :rolleyes:

Here’s the natural log-transformed time series of gold prices since 2000 (USD per troy ounce; London morning fixing; average monthly prices; source: Bundesbank):

Natural log transformation changes a series from an exponential line to a largely straight one – the slope of the line is the percentage increase in the price. I’ve shaded the periods coinciding with the Federal Reserve’s QE1 and QE2 programs.

See any change in the rate of increase in the price of Gold during the period of QE? Neither do I. More interestingly, the price of gold fell at the start of each QE program, before eventually rebounding. So at bottom, QE isn’t the reason for gold prices going up – and by extension, for property prices to go up.

In fact, try almost any commodity against the gold price, and you’ll find that the same pattern as against property, for example “black gold” – you could get a barrel of WTI oil with 0.1 ounces of gold at the end of 2000, but the price now is about 0.07 ounces (an increase of around 30%).

That suggests that it’s not all about currencies losing their value over time through excess money creation (and inflation), but rather that the price of gold is fundamentally outrunning everything else.

Turning to the main point of the article, the author suggests that restricting credit for property might reduce property supply over the long term, creating conditions for an asset bubble. But credit is the primary source of new money creation in an economy – almost the very same thing he identifies as the “root cause” of property prices going up recently.

You can’t have it both ways.