|
Sydney is suffering a housing crisis. Housing has become so expensive to buy or rent that many families cannot afford independent housing. In Sydney and most other places in Australia an average family can no longer afford to buy an average house. In response to the crisis, many young adults have delayed moving out of their parents' homes, some younger buyers are pooling resources (eg two couples buy one house) and outright homelessness has increased with charities reporting record numbers of homeless people in Australia. In crisis there is opportunity and landlords have responded by raising Sydney rents to a high percentage of average earnings, and by creating an unprecedented number of illegal half-houses to rent to people desperate for even half a house to live in. Since Australia's population now exceeds 20 million, and we now have less than 100 acres of land per person, some people believe that this acute shortage of land is what has driven housing to unattainable prices for an average young family. I think the housing crisis is not caused by a shortage of land, but by a shortage of government permission to build houses. Government has simply given permission to build fewer houses than are needed to house all the families here. It's that simple. It is a monumental failure of government. This article is about more than just a planning problem in one city. It is about ignorance of markets and price, and the absurd things people believe about economics. I recommend the article to all readers with an interest in these things, particularly part 1. The housing crisis in Sydney is duplicated throughout the world where similar views and policies are found. Every Australian capital city is affected, as are parts of New Zealand, the United Kingdom and parts of the USA. I recommend this entire article to all readers who are concerned for poorer families struggling to pay for housing in these places. The article has been divided into two parts: Part 1 delivers the "Parable of the Frozen Oranges" and covers the meaning of price and the real meaning of Sydney house prices. Part 2 gives more details about the planning failures, the role of investors, moronic proposed solutions, and the underlying reasons for the planning and housing disaster in Sydney. Some solutions to these problems are also given. The Parable of the Frozen Oranges Once upon a time there was a school attended by 10 boys. The school was in a place called "Orange Land" where the great orange dream of all mothers was for their children to eat one orange per day. With this in mind, the boys' mums set up a school canteen, arranged an orange supply from a nearby farm, and sent their children to school with money to buy one orange and other food from the canteen daily. As happens so often in life, the children were given unequal amounts of canteen money each day. The 1st boy was given $1, boy2 was given $2 and so on, with the richest boy10 getting $10 per day. For a long time everything worked fine. Every day 10 oranges were delivered to the canteen and sold for $0.20 each. Each boy obediently bought one orange and spent the rest of his money on other things. The Natural Orange Squeeze Then one day there was a problem at the orange farm and only 9 oranges arrived from the farm. Fred and Frank ran the canteen, so to handle the shortage they adjusted the orange price to "market price" (via a Dutch auction process) and found that at a price of $2 the demand for oranges was exactly 9. (The boy with $1 missed out). A few days later only 8 oranges were delivered, so the market price became $3, $24 dollars of oranges were sold, and 2 boys missed out. Later when only 7 oranges were supplied, the market price became $4, $28 dollars of oranges were sold, and 3 boys missed out. During this orange shortage, some children complained that they could not afford to buy an orange anymore. But Fred's defence was "Supply and demand. The market sets the price, not me". The school headmaster overheard the grumbling about oranges and asked the canteen if everything was all right. "Yes sir" said Fred "our orange supply has increased from $2 per day up to $28 per day.” "Wow that's a strong orange market" said the headmaster "talk about healthy growth." That night the headmaster spoke to his neighbour, an economist, and bragged about the orange growth. "Wow" said the economist "An income of $10 per day can conservatively be capitalised at $40,000. The orange division of your canteen alone is worth at least $100,000." Contrived Orange Squeeze One day things at the farm got back to normal and the supply reverted to the normal 10 oranges. But Fred did not want to see a bad orange market with the price returning to $0.20, so he held back several oranges in the freezer. In fact he found that he could maximise profit if he sold exactly 6 oranges each day at a price of $5 to receive $30 (with 4 boys missing out daily). Now with Fred contriving to choke the supply of oranges the market price was set by a combination of Fred's restriction and the amount of money each boy could possibly afford to pay. Yet Fred's defence still was to parrot that "prices are set by the market" and the boys ignorantly nodded in agreement and did not blame Fred for their predicament. For the boys did not understand markets. Ignorant Meddling Still the boys complained and complained and eventually the headmaster decided to do something about the problem. The headmaster prided himself with his grasp of economics and knew well enough that a market was something to be worshipped, and never interfered with. He felt that he needed to solve this problem without being seen as to meddle with "the market". His greatest fear was that this canteen might be a "free market". He didn't know exactly what this was, but he knew all too well that the free market was an object of awe, and it was the greatest sin to even suggest a problem could arise from the use of this type of market. The headmaster took a deep breath and pressed on. He felt sure could solve this problem without spoiling the purity of this canteen market. The problem was obvious to him, and it wasn't a bad market. With 10 boys and 6 oranges, quite clearly there was a shortage of dollars. The 4 poorest boys simply did not have enough dollars to buy oranges. The market price of an orange was $5. Therefore any mother who sent her child to school with less than $5 was depriving her child of an orange. How could she expect her son to obtain $5 worth of orange for the lesser amount she supplied? The effrontery of some mothers! "Too few dollars. Mothers to blame. If I can devise a program to raise more dollars, all the boys will get oranges and I will get the credit." thought the headmaster to himself. The headmaster got out his calculator and punched in the figures. Since only 4 boys missed out at $5 per orange, no more than $20 per day would be needed to ensure every boy could buy an orange. To achieve this, he ran a fundraising day and collected many dollars. The next day he tried out his scheme and before lunch gave an extra $5 each to boy1, boy2, boy3 and boy4 taking their totals up to $6, $7, $8 and $9 respectively. The scheme worked as far as ensuring that boy3 and boy4 got an orange. But the headmaster was shocked and dismayed to see that the market price moved up to $7 causing boy5 and boy6 to now miss out for the first time. Not only had the scheme failed to get extra oranges into the hands of the boys, but it had interfered with the precious market by changing its price. Fred and Frank were delighted by the scheme and loved the resultant higher capitalised value of the canteen. They wanted the failed scheme to be given more funding, but the headmaster scrapped the scheme and gave up. Bad though it was for children to miss-out on food, interfering with a market was an even worse thing. This problem was obviously one he could not solve. "This problem needs someone even more expert in economics than I" said the headmaster to himself. A Deeper Freeze and Bigger Squeeze The canteen continued to hold back oranges and maximise profit for a long time until Frank noticed there were 2000 oranges in the freezer. "Hey Fred" he said "we've got an asset worth $10,000 here" (2000 of $5 each). "Let me run the canteen and see if I can boost our equity." To this end the next Monday Frank froze 5 oranges (instead of the usual 4) and sold the remaining 5 at market price of $6 each. The freezer now held 2005 $6 oranges for a value of $12030. On Tuesday Frank froze 6 oranges and sold the remaining 4 at market price of $7 each. The freezer now held 2011 $7 oranges for a value of $14077. On Wednesday Frank froze 7 oranges and sold the remaining 3. The freezer now held 2018 $8 oranges for a value of $16144. On Thursday the freezer held 2026 $9 oranges worth $18234, and on Friday the 2035 oranges were worth $20350 as the market price of a single orange hit $10. Frank noticed that his freezer value had increased by more than 10% per day for 5 days. At this historical rate of increase it would not be long before the freezer was worth a billion dollars! Who said there was no investment that always went up? Reality Bites Oranges Sadly, whilst the unrealised capital gain on the frozen oranges soared, the scarcity of oranges to eat was having a bad effect on the boys. Some children simply could not afford an orange. The other richer and more lucky children could afford to buy, but were left with much less money to buy other things which they reasonably wanted and in normal times could have "afforded". It was clearly unfair to all the boys. There was some debate amongst the boys over what was to blame for the high prices. Being boys they came up with all kinds of idiotic explanations ranging from illegal aliens taking oranges to taxes raising the price. One lone boy suggested that maybe they just needed more oranges. He was laughed off as an idiot. This dolt could not appreciate the complexities of economics. Clearly the orange problem was one of price, not quantity (thought the boys). The whole situation was very divisive to the boys. It created orange "haves" and orange "have-nots". Disagreements over the cause and solution added to the strife. The boys who could afford oranges felt themselves superior to those who could not and gave themselves credit. They blamed the poorer boys for not having enough money. They pointed out all the other food the poorer boys bought with their money. "If you did not buy all those things then you all could afford oranges" The richer boys chided. One boy suggested that they should be given a special "orange buyers grant" so they could all afford oranges. Some boys thought that taxes should be added to oranges to make them cheaper, other boys thought taking away taxes would do the trick! Other boys suggested that low interest rate loans were the solution to the problem, or that they should get more money from their parents as a kind of advance on their inheritance. Fred and Frank overheard the boys arguing and were delighted. As long as the cause was in dispute, the canteen could continue to deny fault and rake in large profits. Sadly, the boys' solutions were never going to work. All of their solutions focused on dollars, and how many more dollars were needed, or how to transfer dollars from one person to another. All these solutions were garbage, because the problem was actually a numerical shortage of oranges available for sale. It was a food shortage, not a funding shortage, that was the underlying cause. Any solution that did not increase the number of oranges was nonsense and could not possibly work. At this point word of the boys' predicament got through to the mothers. The mothers had heard talk of the capital value of the orange division of the canteen. They had heard stories of the huge value of its frozen orange stocks. These simple mothers who thought a canteen was a simple device to provide food to their children, were now told that it could make the entire school rich. Yet despite this excited talk, each day all they could see was their boys returning home with their money spent and no orange in their tummy. At its worst point, nearly all of the boys were being literally frozen out of orange ownership by the policies of the canteen. This was a situation that needed to be fixed. Mums Storm the Canteen The wise mums, who had created the canteen and ultimately controlled it, came to a realisation and stormed the canteen, demanding a change of policy. The headmaster replied that there was an orange boom in progress that was making the school very wealthy and we must not interfere with the market. "The canteen is now making many more dollars each day, the canteen is now worth so many more dollars, and think about how many dollars the freezer of the canteen is worth." said the headmaster. "We don't need no bloody more dollars" said the mothers "our children need more @#$% oranges". All the talk of dollars had obscured the simple physical reality that there was inadequate supply of oranges to the children. "If this canteen is not supplying the necessary number of oranges to our children then it must be replaced with one that will, regardless of who loses dollars or who doesn't get the dollars they were hoping for" stated the wise mothers. The mothers rectified the problem because they understood what the true purpose of the canteen should be. The purpose was to give a sufficient number of oranges to their children, not to take the maximum number of dollars from their children. This was the purpose, and achieving this purpose was the true value of the canteen to the school. The dumb men made the mistake of confusing the price signal which is "exchange value" of a market with the "use value" of the canteen. This is an extremely common mistake because the English language badly overloads the term "value". Many people who don't understand markets have come to believe that anything that gets more money from a market must be a good thing. This belief has merit in a competitive market situation, but is dangerously wrong when it involves a license to sell a naturally scarce resource. The real meaning of all the dollar values in this story can be easily seen: * If the farm sends 7 oranges instead of 10, then this action has done 3 oranges of damage to the children (compared to the normal situation). This physical damage is unavoidable, being caused by a physical shortage of oranges * If the canteen invokes market-based rationing and makes $28 in profit, then this is $28 of damage to the children, in addition to the 3 orange shortfall damage. In total, the 10 boys combined have now been hit by a shortage of 3 oranges (which they cannot eat) and the loss of $28 (which they must pay to the canteen). The $28 damage was not strictly necessary and was purely the result of applying market-rationing to a shortage situation. * If the canteen has a capitalised value of $100,000 then this represents $100,000 of similar damage to children over the lifetime of the canteen. The $100,000 figure is obtained by calculating a discounted present value. * The $20350 value of the frozen oranges and the projected billion dollar value were simply ridiculous. The $20350 value would require all 2035 oranges to be sold at $10 each. But the $10 per orange price only exists when a single orange is sold per day. Therefore the $20350 "value" is a computation based upon a theory of selling few (1) and many (2035) simultaneously. It is nonsense. The billion dollar projected value of the freezer is even more absurd. It is based upon a continuation of factors that cannot possibly continue. The fundamental problem with the canteen was that it had "lost the plot" and changed its focus off what oranges it could give to the boys onto what dollars it could take from them. If you assume that every market is good and pure and beyond reproach, and if you assume that anything that gets more dollars from a market is good, then you will draw some moronic conclusions, like the canteen men did. Once all the talk was about more dollars instead of more oranges, the plot was clearly lost. This is in fact a useful clue. If you ever find a problem where all the talk is about dollars and not about the underlying physical resources, then you can assume that people have lost the plot there too and don't know what they are talking about. Housing Crisis Similarities There are many similarities between the orange shortage in the parable and the housing shortage in Sydney:
To further see the similarities between the orange shortage and Sydney's housing shortage, I will rewrite the "reality bites oranges" section and change a few words (in italics). Does this describe the housing situation in Sydney, Australia, New Zealand and England? I think so. Reality Bites Housing Sadly, whilst the unrealised capital gain on every homeowner’s house soared, the scarcity of houses to live in was having a bad effect on the young families. Some children simply could not afford a house. The other richer and more lucky children could afford to buy, but were left with much less money to buy other things which they reasonably wanted and in normal times could have "afforded" (like having babies). It was clearly unfair to all the young families wanting to buy a home. There was some debate over what was to blame for the high prices. Being human they came up with all kinds of idiotic explanations ranging from illegal aliens taking houses to taxes raising the price. One lone boy suggested that maybe they just needed more houses. He was laughed off as an idiot. This dolt could not appreciate the complexities of economics. Clearly the housing problem was one of price, not quantity (thought everyone). The whole situation was very divisive to society. It created housing "haves" and "have-nots". Disagreements over the cause and solution added to the strife. Those who could afford houses felt themselves superior to those who could not and gave themselves credit. They blamed the poorer people for not having enough money. They pointed out all the other things like DVD's and IPODs and overseas trips the poorer people bought with their money. "If you did not buy all those things then you all could afford houses" The richer people chided. One boy suggested that they should be given a special "first home buyers grant" so they could all afford houses. Some boys thought that capital gains taxes should be added to houses to make them cheaper, other boys thought taking away stamp duty taxes would do the trick! Other boys suggested that low interest rate loans were the solution to the problem, or that they should get more money from their parents as a kind of advance on their inheritance. Politicians and their crony developers overheard the boys arguing and were delighted. As long as the cause was in dispute, they could continue to deny fault and rake in large profits. Sadly, the solutions were never going to work. All of their solutions focused on dollars, and how many more dollars were needed, or how to transfer dollars from one person to another. All these solutions were garbage, because the problem was actually a numerical shortage of houses available for sale. It was a housing shortage, not a funding shortage, that was the underlying cause. Any solution that did not increase the number of houses was nonsense and could not possibly work. At some point word of the next generation's predicament got through to some old voters who cared. The old voters had heard talk of the capital value of Sydney's housing stock. They had heard stories of the huge value of their own houses. These simple old folk who thought housing was a simple device to provide shelter to their children, were now told that it could make the entire society rich. Yet despite this excited talk, each day all they could see was their own children returning home from work with not enough money to buy housing and raise a family of their own. The Meaning of Unrealised Capital Gains Many people misunderstand unrealised capital gain. An unrealised capital gain on a house is the amount of dollars you guess it would sell for today, less the dollars you actually paid for it. We call the capital gain unrealised, because you haven't got it yet. The main problem is that many people are treating the gain as if they do already have it. These people think they are already rich, when they are not yet rich. That's the main mistake. In the parable, when Frank looked at unsold oranges in the freezer he saw big dollars. Now many Sydney homeowners see their unsold house as money in the bank. Frank had 2035 oranges that "could" sell for $10 each, and now many Sydney homes "could" sell for half a million dollars. Can they really? These unrealised capital gains appear to represent great wealth. Is it an illusion? What's the difference between unrealised gains and true wealth? The key is to know the "three missing links". An unrealised capital gain offers great promise, but three things must yet happen to make the homeowner actually rich: 1) They must lose the need to live in the house, and hence gain the ability to sell it 2) market prices must remain high in the interim 3) a buyer must come along and actually pay the market price These are three missing links. If any of these three does not happen then a homeowner will never convert an unrealised gain into real riches that give real benefit. Hidden Liability The first issue is a matter of a hidden liability. Imagine if I was to tell an Australian that the price of a transplant heart on the black market of Vulgaria has just gone up to $1 million. Very few Australians would feel richer as a result of this price change. Quite simply, people are smart enough to know that they cannot sell their own heart because they need to keep it inside their body in order to live. In accounting terms the need to keep a heart is a liability that cancels out the value of their own heart which is an asset. You possess an asset, but your need to keep it is a liability. Strangely, when it comes to houses, many people are not smart enough to make the very same connection. Many homeowners feel they are richer because their house could sell for a higher price, even though they need their house and therefore cannot sell it. If a Sydney house owner-occupier is not able to sell the house because he needs to work in Sydney or he wishes to live in Sydney, then this person has gained nothing from higher house prices while his position remains unchanged. Although the house is an asset which now has a higher price, the person's need to live in Sydney is a liability that has risen just as much, leaving him no better off. Not all homeowners are richer already, only if the homeowner can dispense with the need to live in the house, and hence gain the ability to sell the house, can he actually be richer. Price Sustainability The second issue is the validity of previous market price when applied to future sales. If one is to sell at yesterday's price in future, then this pricing must be maintained in the interim. A quick rule of sustainability is: For a price level to be maintained, the number of people trying to cash out must not overwhelm the number of buyers able to pay in, over the period in question. Skeptics of a price rise will often say something like "they can't all sell at these prices, if all the houses went on the market at once, who would buy them? prices would collapse" This statement is just a cheap trick. It is merely plugging in two most extreme and most unlikely factors into the rule of sustainability. Of course if everyone tries to cash out immediately this will overwhelm the buyers. There's no real danger of that happening. The real danger would be if there is a predictable surge of sellers, or a predictable dearth of buyers, such as would occur if prices get too high. Let's review a normal house market. Typically around 5% of all houses will change ownership each year, some of these going to first home buyers. Often the seller of a 1st home will take the proceeds and buy a 2nd home, the seller of which will use the proceeds to buy a 3rd home. So it is fair to say that perhaps 2% of houses are first homes for young families. These 2% of sales underpin the entire 5% of houses traded, which underpin the unrealised capital value of the entire 100%. 2% equates to the entire housing stock going from old to young buyers over a 50 year period. So that seems realistic. The fact that a small number of sales underpin the "value" of the entire housing stock is not by itself a cause for alarm. If prices are normal then there is no reason to ever think that sellers will overwhelm the buyers. If the prices are fair and stable then the situation can continue indefinitely. There is only cause for alarm if prices are too high or going too high. If so then all derived values and expectations are suspect. Consider price sustainability in our orange example. As the orange squeeze progressed, prices rose to $10, at which point only 1 in 10 boys could afford one. This dearth of buying power could be easily overwhelmed by an attempt to sell the oranges, so it is unlikely that all 2035 oranges could be sold at this price in a reasonable space of time. Even worse was to take the rising price trend and extrapolate future prices. Frank thought his freezer would be worth a billion dollars and many Sydney homeowners expect their houses to "double" every decade. Frank did not understand that no child could afford to pay $20 for an orange, and likewise the average Sydney family will not be able to pay 100 times salary for a house. In the case of the oranges the situation was unsustainable because there were fewer and fewer boys able to buy oranges, a trend that could not continue. In the Sydney housing market each year the average age of first home buyers rises and the percentage of income used in debt service rises. This cannot continue. I can't tell you what the future holds or exactly what future buyers will be able to pay. But today's average price of 10 times average salary has been paid by only a small group at a terrible cost (like one $10 orange). It seems unlikely to me that all houses can trade at these prices. And with some sellers expecting houses to be 20 times salary next decade, and 40 times salary a decade after that, it seems simply impossible. Not all homeowners are richer already, only if the current high prices can last until the homeowners are ready to sell will they be richer. Wealth Source The third issue is where does the actual wealth come from, and when? When one house in a suburb sells for a bit extra, then every homeowner in the suburb feels richer. It is as if these owners feel that they all have obtained an increase in wealth from this one same transaction. This is nonsense. An increase in wealth has not already occurred. If an increase in wealth does occur, it will be in future and the wealth will come from multiple buyers from multiple future transactions. i.e. each owner gets richer when he sells his house to someone, not when his neighbour sells a house. If you buy bread at a bakery and watch the baker place 1, 2 or 3 loaves of bread in your bag, then clearly you already have this bread. There is no reason to think you cannot get the bread out of the bag later when you want it. People often talk about high house prices as if it is money "in the bag" like this bag of bread. They talk about their house that "went up" from $100k to $800k as if something actually happened to their house, it went up, and now contains a lot more dollars. They talk as if the wealth transfer has already happened, and getting the dollars out of the house, when they want it, is a sure thing. These people are wrong. The wealth increase is potential, not actual, and if it happens the wealth will come from future buyers, not from something that has already occurred to "the market". Understanding the wealth source is fundamental to deciding if higher prices are good or bad. How do you feel about this burden on future buyers? In the orange parable, the orange shortage was soon causing profits of more than $20 per day. This was clearly a transfer of money from the boys to the canteen that had already happened each day. The mistake came when the headmaster and economist figured this made the canteen worth $100,000 and was a very good thing. The dumb men figured a wealth gain of $100,000 had already occurred. The truth as recognised by the mothers was that this $100,000 of unrealised capital gain represented a projected future burden on boys buying oranges from the canteen. The mothers correctly thought this was a very bad thing, and so they fixed the problem. The situation with the Sydney housing shortage is very similar to the orange parable. When a small number of current buyers are forced to pay too much for housing, then a small transfer of wealth from buyer to seller has already happened. There is a huge disparity in the attitudes of Sydney people toward the situation. Many homeowners mistakenly think a huge increase in housing wealth has just been given to the entire city and think this is very good. But in reality the unrealised capital gain represents a huge burden on future buyers, a very bad thing for them. Should a majority of voters ever decide to fix this problem, then unrealised capital gains will disappear along with the burden on future buyers. Even if Sydney's high prices are never reduced, the truth of the burden will affect today's smug older homeowners. The next generation of overburdened house buyers will simply not have enough resources leftover to pay high taxes to support a today's huge govt and tomorrow's huge retiree population, nor solve other expensive problems facing society such as peak oil, and environmental degradation. Remember: Not all homeowners are richer already, only when a future buyer can be found to pay the high price, will the homeowner be richer. To summarise the three missing links of wealth, keep in mind what has already happened vs what might happen later. If one house on a street sells for more, then what has already happened is that one buyer paid more to one seller. If 100 people on the street now feel richer, they are not already richer, but this might happen in future if: 1) All 100 must lose the need to live in their houses and put them all up for sale. 2) Market prices must hold at the higher level in the interim. 3) 100 new buyers must come along and actually pay the money to the sellers. Taking Equity Out of the House Some people would argue that higher house prices do make a person richer even if they cannot sell, because they can borrow against the higher value of the house which they term "taking equity out" of the house. Taking equity out of a house is a misnomer, and does not make a person rich because they must repay the money or lose the house. In reality you are not taking anything out of the house, you are risking ownership of the house in order to borrow money from another party. If a desperate gambler borrows money from a loan shark, knowing he will have his leg broken if he fails to repay, we do not say this gambler has "taken equity out of his leg". We know that this foolish gambler has risked his leg in order to borrow money from the shark. Borrowing money against a house is not always foolish or reckless, and having this option might be considered a good thing. However the ability to borrow money is not the same as being truly richer, so it should not be confused with real wealth. Political Pressure When unrealised capital gain is wrongly considered to be wealth, there is a powerful political constituency supporting price rises, and it becomes extremely difficult, politically, to stop the rises. Imagine an example where something bad has caused a house price rise and one buyer pays more to one seller. Now 100 homeowners on the street feel richer. The one recent buyer also feels he has bought good value and will be richer because prices are "going up". So 101 people are happy as a result of a bad thing that caused a price rise, all because of a misunderstanding of the meaning of unrealised capital gain. Under this situation of wealth illusion any person trying to tell the truth, that 100 are not richer and 1 is poorer, will find himself unpopular. Any politician trying to correct the injustice, remove the bad thing, and drop prices, will also be most unpopular. In the orange parable I showed the canteen men, headmaster and economics liked the higher prices. In Sydney housing we find that a majority of people like high house prices, even though the rise is caused by a reversible bad thing and represents an unjust burden on the future generation, not a real increase in wealth. It is important to understand how perception and politics is the real driving force behind the Sydney housing disaster. Ask Australian voters "are you prepared to sacrifice your unrealised capital gain on housing, in order to give a fair go to the next generation?" The answer is a resounding "No". The Meaning of Price Very few people properly understand price. So when the price of something rises, most people are mistaken as to what this means. Price only exists where society chooses to ration a resource via a market. With societies and markets you must decide which is the horse and which is the cart. Many PDUMs (People who Don't Understand Markets) make the mistake of thinking the market is the horse and society the cart. These PDUMs worship the market and think the book of life starts with a supply and demand chart, and they want all other people to live according to "the market" (which they rarely define). This type of PDUM can't imagine a given resource being rationed via any means other than his preferred design of market. I think that's nonsense. There are many other ways of rationing resources, such as "equal bites", "women and children first", or "whatever you say boss". The headmaster made a classic PDUM mistake. He feared to question the market. If the market said an orange was worth $5, then that must correct and no child with less that $5 should have one. This was foolish because there were other ways of rationing oranges that the headmaster did not consider. With Sydney housing, many market-worshipping PDUMs make a similar mistake to the headmaster. These PDUMs think that if a family cannot pay the market price for a house, that it is therefore right and proper for that family to be houseless. The minds of these people can never consider that there might be a problem with a market. It is against their religion. "The market is always right" say these callous PDUMs. Other PDUMs admit there is currently a problem, but are sure it is temporary because a market is in operation. "The market will solve the problem" these nonchalant PDUMs say (from the comfort of their own homes). We do not have space here for a treatise on markets. So we will skip over the basic questions of when and why a market should be used and jump straight to the advanced question of the meaning of price when a market is being used. Supply and Demand Here is a typical supply and demand chart that you might find in an economics book.
As usual the vertical axis has price and the horizontal axis has quantity. Where the demand curve hits the supply curve gives the market price and the quantity traded. This S&D chart is typical of a reasonably competitive market for something where supply and demand are highly elastic. The blue demand line leans leftward to the extent that demand is elastic, and people want less at a higher price. The red supply line leans rightward to the extent that supply is elastic and can be increased if price moves high enough to justify it. Although most items that we buy are sold in reasonably competitive markets like the above graph, many readers would also be familiar with a market where both supply and demand are relatively inelastic. The market for oil (and hence the price of petrol/gasoline) is such a case. Oil demand is inelastic, because despite higher prices, most people must drive the same car the same distance to work each day. Supply is inelastic because our oil rigs take a long time to get going and are already pumping at full capacity. Therefore supply can not be increased much for a higher price. The result is that over recent years, oil has increased in price by more than 200% whilst quantity increased by less than 10%. (There is more to this story, but my point about elasticity is valid) The word elastic refers to the ability of quantity to change with price. Quantity is elastic if it can be stretched and shrunk by the force of price. High prices will squash and shrink the quantity demanded, and high prices will stretch the quantity supplied, and vice versa for low prices. Rigid Supply The extreme case of inelasticity occurs when supply and demand are rigid/fixed and cannot be changed by price. A rigid demand is where people need the same amount of something regardless of price. A rigid supply is where regardless of how much people offer to pay, there is only that fixed amount available. The orange parable had rigid demand because every mother insisted her boy eat one orange per day. The orange parable had rigid supply because a fixed number of oranges came from the farm or were sold by the canteen. The infamous sinking of the Titanic is a real-life example of rigid supply and demand. There were roughly 2500 people and 1000 lifeboat seats when the Titanic sunk. To survive each person needed exactly one lifeboat seat, and sadly there weren't enough seats.
In a case such as the Titanic, it would be hard to justify using a market to ration the scarce essential resource. Had the gun-toting Titanic crew sold the lifeboat seats in a market, the survivors might have included less women and children, and more rich people and bullies able to get the most cash at the time. The market would also have transferred money from buyer to seller, but that's beside the point here. With a fixed number of lifeboat seats and a fixed number of people we can calculate the number of people who must miss-out (and perish). We don't know who, but we do know the number. Although markets and money could be used to ration the resource and change who gets a seat, money could in no way increase the quantity of the resource and change the number of people getting seats. Therefore money-focused schemes such as offering low interest rate loans, or giving lifeboat seat buyers grants would not have increased the total number of people who were able to buy a lifeboat seat. These bizarre financial schemes on board the Titanic would have been completely useless; just like re-arranging deckchairs on that very same boat. Competitive Supply Joy The most joyful situation is not rigid supply and scarcity, but abundance from eager best suppliers. We want that supply curve to be an almost flat horizontal line, the opposite of the vertical line from the Titanic disaster. Often the best way to get abundance is for govt to create a competitive market so that the best suppliers compete with each other to maximise supply and minimise price. Every market comes into existence when the most powerful entity (the govt) licenses scarce resources to create a definition of private property. This private property concept (enforced by govt) creates a market with associated "market forces" aka price. The market rations scarce resources and has wealth effects on the citizenry. In taking scarce resources and licensing them to citizens, govt confers benefits. These benefits are conferred somewhere along the elitist/equality spectrum. In the worst extreme govt can give great privilege to elites via monopoly. With the best extreme govt gives equal benefits to every citizen via competition. This best case is the competitive market. Prices in a competitive market have a special meaning: In an ideal competitive market, price is a signal of best use and best supplier. The price signal directs best activity by telling consumers which item is best to use and which item should be conserved. Price tells competing suppliers what best to produce and the price paid by a consumer provides perfect compensation to the supplier. Ideally the price paid covers and only covers all the true and fair costs associated with the production of the resource. In a competitive market what you buy is effectively created for you by your payment. What I mean is that the supplier will make it for you on the spot (like a hamburger) or will sell you one out of inventory and then replace it soon after. Essentially they make it for you. Essentially your buying does not deny the resource to anyone else in the long term. You payment pays for it, so no one is hurt by the entire process. Since the supply curve is near horizontal, price increases are near zero as buying is increased. Since supply is effectively unlimited, there is an equivalence between money and supply. We can talk as if money is equivalent to the item. A person lacking the item lacks money. Getting more money is equally good to getting more of the item. Competitive markets are a special case, a kind of ideal where the use of a market is most justified. Every item that sells in a competitive market is amongst the most competitive and price is set by the marginal, or least best, item. Since, in ideally competitive situations no supplier has an advantage, all supply is marginal. Therefore: In competitive supply joy, price is the cost of production. Rigid Supply Horror - The Strongest Loser In a rigid supply situation the situation is completely different and price means a completely different thing. It is vital to know this, and most market-worshipping PDUMs don't. If rigid supply exceeds demand then the price will be zero. Air is priced at zero. If the Titanic carried 5000 lifeboat seats, they could have been sold for zero also. A price of zero means there is excess supply. It does not mean the item has no use value. For example air and lifeboats seats can clearly save lives despite being free. If demand exceeds the rigid supply then price is not zero and has a different meaning. A shortage, combined with the govt decision to ration the resource with a market, will cause "rigid supply horror" prices. In shortage, prices no longer reflect the cost to produce an additional item but jump to reflect the cost to outbid other people on the same item. Price is not what it takes to make the thing, but what it takes to beat other people out of it. That is a profound difference. In shortage prices jump above production cost to just above the buying power of those who must miss-out. In shortage the exchange value of govt licences (aka private property) jump to reflect the potential wealth transfer from buyer to seller, which is unearned wealth. These are two artifacts of the decision to ration that particular resource with that particular private property licensing scheme. In rigid supply horror there is no equivalence between money and the item. The supply curve is vertical which means no amount of money can obtain more supply. If a person is short of the item, we cannot say he is short of money, because more money cannot solve a shortage caused by rigid supply. In a rigid supply market, price is the buying power of the marginal loser. The losers (who miss-out on buying) are those with the weakest buying power. The marginal loser is the strongest of these losers. Therefore: In rigid supply horror, price is the buying power of the strongest loser. Two Meanings of Price By looking at two extreme cases in the use of markets we can see there are two disparate meanings of price. When markets are used under ideal circumstances, price is a guiding light toward best activities, perfection, justice, fair compensation and joy. But when markets are used under the worst circumstances then price is a measure of shortage, horror, injustice and profiteering. It is hardly surprising that a tool can work well or poorly in different cases (the market being merely a resource-rationing tool). What is surprising is that some people are so foolish as to take the meaning from the successful cases and infer it upon the cases of failure. When a market is used correctly then supply and demand and price will get a good result, and this good result justifies the use of that market in that particular case only, not in all other cases. PDUMs (People who Don't Understand Markets) assume that every market must be like the ideal one in their textbook, and therefore the result of every market must be perfect. That's what they are really saying when they appeal to "capitalism", "supply and demand", "the market" or similar. It is a dangerous dogma to infer market character from one case onto all markets. Market zealots making this mistake are like a boy who is sure the tiger at the zoo would be nice to pat, because the boy knows how friendly his pet pussycat is. The disparate meanings of price and the implications can be shown by a simple example: Imagine a McDonalds store selling hamburgers. In a competitive market like hamburgers, the suppliers can provide a practically unlimited quantity at the current market price. If a McDonalds burger costs $1 and I am stopped at the door by 5 tramps who tell me that they are hungry, then I can give each one $1 and I have effectively given them a burger. The same applies no matter how many begging tramps there are. Because hamburgers have an abundant supply curve that is horizontal, we know that giving money is equivalent to giving hamburgers. Contrast this with a rigid supply situation where the Mona Lisa painting is being auctioned at Sotheby's. Imagine if the painting is expected to sell for one billion dollars and 5 art collectors stop Bill Gates at the door. Even if Bill gives $1 billion to each of them, it is impossible for all 5 of them to buy the Mona Lisa from that auction. Because the supply curve is vertical, that situation is rigid supply horror and more money is not equivalent to more of the item. Sydney Housing Horror Now that we understand the meaning of price, we must decide if Sydney housing is competitive market joy or a rigid supply horror show. It is clear to me that the Sydney housing situation is much closer to rigid supply horror than it is to competitive market joy. Whilst the price of many goods falls to reflect lower production costs, the price of Sydney houses rises to reflect the higher buying power of the families who miss-out on housing. Richer and richer young families are missing-out as price rises. That's the strongest loser effect! For Sydney housing the demand is ever so slightly elastic. Although you might think every Sydney family needs exactly one Sydney house, this is not quite true. Some Sydney families can share a house with friends or relatives. And some Sydney families become so desperate that they uproot themselves and leave Sydney. Therefore the Sydney situation is not quite as bad as on the Titanic where to miss-out meant certain death. Sydney housing supply however is very much like the supply of lifeboats on the Titanic in that it is completely rigid and unresponsive to price. Govt planning and zoning defines a precise number of houses that are allowed to be built. The price of housing depends on what it takes to outbid weaker families on the fixed (too few) number of houses permitted by govt. The price does not reflect the cost to produce additional dwellings. If govt has zoned fewer houses than families exist then some families must miss-out on independent housing. This simple fact escapes most commentators on the Sydney housing crisis, who seem to think the problem is dollars. Don't they understand that if population grows until there are 4 million Sydney families, but govt has only permitted 3 million Sydney houses, then 1 million families must miss-out on exclusive use of a Sydney house? That is primary school mathematics. No matter how much money people offer to pay, govt does not increase the supply of housing permission. That's inelastic. That is rigid supply horror. Supply of house-building permission is not market-based, but is politically-based. If you take money to a council and offer to pay for a permit to build an additional house, then you will be arrested for offering a bribe. Sydney housing permission is not a competitive market. To see why Sydney housing is not a competitive market, compare it with the qualities that I earlier said a competitive market would have:
Bastard Market “Houses
cost what someone is willing to pay for them. It's not anyone's fault
it's called supply and demand.” It is ludicrous to claim that Sydney house prices are justified or legitimised by the working of supply and demand. Such statements show profound ignorance of markets, and a failure to examine what is behind supply and demand in Sydney to see what is really going on. All markets lie somewhere on the govt/individual spectrum where the result is determined partially by govt and partially by individual choice. Some "free market" touters claim that the free market is the point at which individual control is 100% and govt control is 0%. Let us examine the Sydney housing market to see where it lies on the spectrum of govt vs individual control. Let us look further into supply and demand factors to see to what extent the situation reflects choices made by private citizens and to what extent it reflects govt decisions. Does the Sydney housing market have 0% govt influence? Might we be dealing with the hallowed "free market" here? With Sydney housing you have supply fixed by govt via the zoning laws. A house cannot be built without permission from govt. Therefore: Supply is fixed by govt. Sydney housing demand comes from families. The largest number of new families comes from local population growth. These families are the children born 20-30 years ago. Since their number exceeds the number of families who die out, extra houses are needed. This demand is essentially fixed, since it is too late to stop these children from being born and growing up. Most demand is fixed. The 2nd largest component of housing demand comes from immigration. Govt fixes the level of immigration as it likes. So we can say: Demand is fixed by govt. It gets worse. We know that in a shortage the price will reflect the buying power of the strongest loser. Most home buyers in Sydney will use a home loan to pay for their house. Therefore their buying power depends on their borrowing capacity. Who sets the interest rate that determines the repayments and hence the borrowing capacity? It is the govt's central bank that fixes the interest rate on loans. * Govt determines the level of supply of new housing in Sydney via zoning. * Govt is behind the largest variable component of demand via immigration. * Govt is pivotal to the funding of housing via interest rates. "I
don’t accept that the government is the major problem. It is a free
market controlled by supply and demand." Please don't be swayed by some clown referring to housing as a "free market". Anyone who uses free market theories to justify the state of Australian housing is a charlatan. If there is such a thing as the free market, Sydney housing aint it. This is an abomination of a market, a bastard child of govt. The Sydney housing crisis, the prices of housing, the location of housing, the size and style of housing and the infrastructure that supports it in no way reflects the ideals of regulation via price in a market, these being expression of free choice by citizens and selection of best activity via price signals. Sydney housing demonstrates nothing close to the ideals that support the use of markets in society. I don't see private property used for efficiency or fairness. Licensing doesn't give benefits to consumers by creating competing suppliers. Licensing is done to confer privilege on favoured developers and landowners, and to transfer wealth from the young generation to the old. My belief is that the Sydney housing crisis is not a deliberate conspiracy, but is the result of gross govt. incompetence. I see it as an egregious failure of central planning, shamelessly excused as being the fault of "the free market". We do indeed have a market here, but it is a bastard of a market. The Meaning of Sydney House Prices Now is the time to apply our knowledge of markets and price and determine the meaning of Sydney's house prices. We understand the difference between competitive market joy and fixed supply horror. We know that Sydney is rigid supply where price reflects the buying power of the strongest loser. Firstly we need to recognise that every house is unique, so we must group them in order to make sensible comments about each group. If a starter house now costs more than it did 10 years ago, this means that the people now missing-out on starter houses have more buying power than the people who missed-out on starter houses did 10 years ago. If a median house price has risen from 4 times salary to 10 times salary in the last 20 years, this means that all families with buying power of less than 10 times salary will now miss-out on a median house, whereas before only families with less than 4 times salary buying power would miss-out. If the very same house that sold for 5 times salary in 1970 now sells for 20 times salary unrenovated, this means that a family with 19 years salary buying power is now getting a worse house than a family in 1970 with 5 times salary buying power could get. A fool might look at prices and say that the Sydney housing situation is wonderful:
However, since we are smarter than fools and know the real meaning of prices we can see that Sydney's housing performance has been very poor:
CONTACT
INFORMATION The opinions of FSU contributors do not necessarily reflect those of Financial Sense. |
