Getting real

Dollars are not wealth.

Your wealth is the stuff you have.  It’s the knowledge in your head.  It’s your ability to create goods and services.

Markets — aka. pushing little pieces of paper around — cannot create wealth.  They can facilitate the creation of wealth by transferring resources from the less productive to the more productive.  When a market does this, we say it is being efficient.

But dollars…  Dollars merely denominate wealth.  In the end, they really are just little pieces of paper with ink on them (or little ones and zeroes in a computer).

Now, why am I on this rant?

The real value of a house depends on the real incomes of the people in the neighborhood and their willingness to spend their incomes on housing.  Period.  If the production of real wealth by people in the neighborhood — or in the county or in the state or in the nation or on the planet — is declining, then so will the real value of housing.

As we all know, the Federal Reserve is about to create $500 billion to purchase mortgage-backed securities and $100 billion to purchase Fannie/Freddie debt.

Will these operations be reserve neutral?

No, these operations will be financed through the creation of additional bank reserves.

(h/t Alea)

But that was yesterday’s news.  Today’s news is…

WSJ: Treasury Considers Plan to Lower Mortage Rates to 4.5%

The Treasury Department is considering a plan to revitalize the U.S. housing market by reducing mortgage rates for new home loans … The plan, which is in the development stages, would use mortgage giants Fannie Mae and Freddie Mac to bring loan rates down as low as 4.5%, a full percentage point lower than the prevailing rates for 30-year fixed mortgages.

The Federal Reserve and Treasury cannot create wealth, and therefore they cannot affect the real value of anything, except to the extent that they foster an environment where real people produce real wealth via their real labor.  And unless they can reignite the housing bubble — which I suppose is possible — they cannot affect the real price of anything, either.

The housing bubble was the most inefficient market and the worst misallocation of capital in the history of the world…  And so real house prices have a long way to fall.  Ratifying that misallocation with taxpayer funds or printed money is unlikely to help anything.

However, the Fed and Treasury might be able to prop up nominal house prices by manipulating interest rates.  But just as you cannot change your real height by measuring it in centimeters instead of inches, the government cannot change real house prices or values just by manipulating interest rates.

This is lunacy.  Either it won’t work, or it will destroy the currency; and either way, it will be expensive.

In short, I am not a fan of this proposal.