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Wednesday, September 26, 2007

 

America’s Addiction to Cheap Money and the Resulting Effects on Sprawl

America seems undoubtedly addicted to cheap money, since 1984 the Federal Funds rates has not gone above 10% and has spent the majority of that time below 6%. The current rate, 4.75, is still lower then LIBOR, which is the rate that most of the rest of the developed world borrows at. There has also been a trend developing, the spread between the Fed Funds rate and the LIBOR rate has been widening. Although there has recently been a small correction down in the LIBOR rate, the spread and the trend still exist. This means that most every other developed country realizes that this rate is too low to sustain without dramatic inflation and other consequences.

In a supply and demand world, however, these low rates have been a blessing to our economy and real estate. Being one of the primary drivers of our economy, real estate values have seen large appreciation values in the past 20 years. This is due in part to people making more money then they were 20 years ago and wanting to have a bigger house, but with such low interest rates it is possible for people to demand more expensive houses then they could have otherwise afforded. This has not only caused an increase in property values inside the city, but also in the suburbs, leading to some people moving even farther away from the center of the city.

Sprawl is, among other things, the outward expansion instead of the upward growth of a city. This is undoubtedly being caused by our addiction to cheap money. Since 1984, rates have dropped from their highs and stayed relatively low, this is where we get into the supply and demand issue. Since price of money had been falling people have been spending more (Americans on average spend more then they make) and with a house being the most expensive good that most people buy, home prices have been greatly effected by this increase in demand. With the low price of money more people have been demanding newer, bigger, nicer houses, resulting in higher prices and greater appreciation of house values. This higher demand has lead to people moving to where they could build the same house for cheaper, the suburbs. People will even move out to a small town just outside the city and commute in to work (i.e. Monument, CO). But now, as the two cities have grown together, even they have a small suburb developing, Flying Horse. Good or bad, sprawl is happening and is due, in part, to the low interest rates.

The demand supply equation is out of balance in this case, although the housing supply has reacted accordingly to demand, the money supply has not. It is being kept at low levels to feed our addiction. This is not just one person’s opinion, but the majority of the world also agrees with me. This can be seen from exchange rates (found at finance.yahoo.com) and the dollar’s weakening value compared to other stable currencies. For example one US dollar is now worth one Canadian dollar, where as just five years ago, it was worth almost 1.6 Canadian dollars. There has also been a steady trend in this direction, not just in Canadian dollars but also in Euros, Yen and other major currencies. This shows that other people around the world see the inflationary potential that keeping a borrowing rate this low has.


Comments:
I'm not sure about this idea. It seems to me that the demand for different parcels of land will be very much influenced by the transport cost from each parcel to various economic activities. I'm with you that low interest rates make it cheaper to purchase land or to purchase a home, I'm thinking it makes it cheaper to purchase a home at any location. And, it makes it cheaper in exactly the same amount, regardless of location. If so, then I think this means the demand for each of the parcels is unchanged across an urban area because of a lowered mortgage interest rate. If the demand is unchanged, then I think there should be no change in the real price of each parcel in the urban area.
 
All things staying the same, I would say that you are correct. But, I believe there has been a trend toward purchasing newer and larger houses, which are more readably available in newer developments. So while all parcels of land are being made cheaper by the same amount, the publics demand for these bigger houses coupled with the cheaper money (which makes it easier to purchase the desired houses) is one component to the complex equation of sprawl.
 
Not to be nitpicky, but since when do Americans, on average, spend more than they make? I mean, I don't disagree with you, but this is a fact I wasn't aware of, and if its true, it is quite disturbing.
 
I apologize for not having posted a link to back up my claim earlier, I couldn't find what I was looking for but I knew I had heard that America was at a negative savings level and thought that it was still negative. Fortunately, for Americans, I was wrong. Although we were at a -0.5% savings level for 2005 (as reported here http://www.msnbc.msn.com/id/11098797/) on average, it has not been consistently below zero since then, although it has dipped below a couple of times (as can be seen here http://research.stlouisfed.org/fred2/series/PSAVERT)
 
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