The Berger Memoranda

I participate in a reading group that has recently been discussing Thomas Sowell’s book The Housing Boom and Bust. Members of this group (like so many people discussing this issue) seem to have some disagreement as to the importance of money to the discussion. Some contend that, because Sowell gives it little attention, money has no relevance to our discussion. Others (or at least I) contend that money represents a central element to the discussion, whether Sowell mentions it at all.

We should not waste time discussing the functions of The Federal Reserve System or government monetary policy. That would digress into details not relevant to the substance of Sowell’s book. The reasons and mechanisms for money creation do not matter at this point. To ignore the role of money in our discussion, however, would amount to ignoring the subject of the book: dramatic changes in prices.

The title of Sowell’s book The Housing Boom and Bust, implicitly refers to a boom and bust in housing prices. Thus, a critical reader should not overlook any element of the prices of houses.

A price states the ratio of the quantity of goods given in exchange for the quantity of goods received. Prices for a group of housing units consist of a quantity of money (number of dollars) given in exchange for a number of housing units. Only these two elements of housing prices (quantity of money and units of housing), acting in combination, cause housing prices to change. Other influences, for example population changes, have no direct effect on house prices; only changes in numbers of houses sold and quantity of money spent on houses effect prices.

Thus, one cannot make statements about house prices without considering both the quantity of houses and the quantity of money. To ignore either of those elements renders any statement about prices and price changes meaningless.

When it ignores the quantity of money, most of the popular commentary about the causes of the housing price boom and bust suffers from fatally flawed logic. Thomas Sowell, whose writing I have admired for years, has fallen into that same logic trap.

The source of money available for the housing market does not matter. The quantity of money, however, does matter. It represents a fundamental element of the ratio of goods that makes up house prices.

Some data might put the importance of money in perspective. From July 1, 2000 from through July 1, 2007 housing units in the U.S. increased from 116,289,877 units to 127,901,934 units (an increase of 10.0%). During that same period the quantity of money (MZM) increased from $4,475 Billion to $7,539 Billion (an increase of 68.5%). (See the chart below.)

During this period one of the two elements of housing prices (quantity of money) has grown at nearly seven times the rate of the other (number of housing units). How can any book, article, or commentary about booms and busts in housing prices draw conclusions about the causes of dramatic changes in house prices based only on the number of housing units?

By making almost no reference to the money supply, Thomas Sowell has made nearly every conclusion in the book subject to doubt. By focusing primarily on the influences of government regulation, Sowell has left unanswered the question of the possible effect of regulation without the massive expansion in the supply of money.

Discussing devastating swings in market prices without discussing the role of money amounts to telling the government, “It’s okay to steal from us, as long as you don’t make it too obvious.”

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In defense of Thomas Sowell, I don’t hear many economists mentioning money in their analyses of the economic boom and bust. Economists discussing prices without mentioning money appears similar to them discussing fractions without mentioning the numerator. Scientific studies, however, prove that 4 out of 3 economists don’t understand fractions either.

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Paul Krugman’s commentary titled “That ’30s Show”, published in the New York Times on July 2, 2009, begins:

O.K., Thursday’s jobs report settles it. We’re going to need a bigger stimulus. But does the president know that?”

He continues with one of his many commentaries advocating more and more government spending, supposedly to “stimulate” “the economy.”

I will let you read the rest of his words and decide for yourself, but we should hoist him on a petard made from just a few of his own words.

Roughly half way through this piece he laments the low probability of passing his “stimulus” plan because:

There won’t be any cooperation from Republican leaders, who have settled on a strategy of total opposition, unconstrained by facts or logic.” [My emphasis.]

I will not defend the actions of Republican leaders, for they have contributed as much to this mess as have Democrat leaders. I just find Krugman’s criticism of Republicans as “opposition, unconstrained by facts or logic” extremely hypocritical in light of these words which appear later in his commentary:

And as an economist, I’d add that many members of my profession are playing a distinctly unhelpful role.

“It has been a rude shock to see so many economists with good reputations recycling old fallacies — like the claim that any rise in government spending automatically displaces an equal amount of private spending, even when there is mass unemployment — and lending their names to grossly exaggerated claims about the evils of short-run budget deficits. (Right now the risks associated with additional debt are much less than the risks associated with failing to give the economy adequate support.)”

Paul, if you want to accuse “so many economists with good reputations [of] recycling old fallacies,” please state the assumptions of yours that would make them fallacious. Answer at least these questions about facts and logic.

About facts:

Did not the government stimulus during the 1930s actually extend the Great Depression for 10 years beyond its natural course? Why did economic activity remain depressed and unemployment so high in the face of an alphabet soup list of government “stimulus” programs?

About logic:

If “any rise in government spending [does not] automatically displaces an equal amount of private spending, even when there is mass unemployment,” where does that money come from? I have always understood that the State taxes productive people, not the unproductive people.

Now I do agree that most economists do make “grossly exaggerated claims about the evils of short-run budget deficits.” Government spending displaces private spending, regardless of the method of financing that spending.

The president’s policies have already sowed the seeds for enough damage in the economy. He does not need you to suggest that he add more to it.

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