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The housing market in Israel is a tad… how should we put it? Exuberant? Irrational? Noooo says the government, at least not according to the article printed by the newspaper Yediot Aharonot. The housing market in Israel is just… in a trend up… yes… that's it. It's just trending up. Nothing to worry about folks, nothing to see here, just a housing market trending up, and up and up. Move along… move along.

But before you do, don't you worry, the government is near. According to the same article titled "Netanyahu promotes price control of apartments" this illustrious leader of Israeli people and quite obviously a genius economist has decided that the trend up should be curbed. Just a little. In order to do so, they will regulate by decree the target price of apartments nationwide.

Voila! Problem solved! We can't really imagine why is that people are having so many problems in the rest of the world. We can just decree what the economy should do and it will do it!

Right?

Right?

Why is nobody nodding?

PUTTING THINGS INTO PERSPECTIVE

Since a picture is worth a truckload of words, let's take a look at the "trending" housing market in Israel.

Israel Housing Price Index

As you can see from the picture it's been growing quite rapidly since 1983, had a pause between 1997 and 2008 but then it resumed its march upwards. Do you really believe that the market is "just" trending up a little? Or do you believe, as we do, that it is in a full–blown bubble?

The government tried to "cool down" Israeli impetus for buying houses before with no effect (see Mortgages Limited To 30 Years And Half Salary More Stupidity To Come). Now, they are taking decisive action and do whatever it takes to prevent the bubble from exploding.

The question is, will they succeed? Will they win against the market?

In order to answer this question, we need to do some research.

THE RESEARCH

When prices go up at an gigantic scale and for decades, there are only two possible explanations: there is a gigantic economic growth or there is a gigantic amount of Central Bank printing or both.

Let's assume that Israel had an astronomic increase in economic activity over these decades. If this is the case, then the GDP (a measure of general country economic activity) should so show. Let's take a look at the graph:

Israel %GDP

It could be, it could be. The growth in the GDP seems to indicate that Israeli people are increasingly wealthier.

Now, let's take a look at Central Bank printing. For that, we will use something called M1, which is a measure of liquid money supply (meaning mostly cash). This is not an ideal statistic to measure Central Bank printing, but, since the Israeli Central Bank does not provide any other more meaningful statistic (what a coincidence…) we will use this one. To the graph!

Israel %M1

Humm… it would see that the Central Bank has also been very busy while the economy was growing. Could this be the culprit for the housing bubble? It could be, it could be.

But we want a more definitive answer. Here is an idea! Let's superimpose both graphs!

Israel %GDP and %M1

This graph tells a completely different story. As both statistics are in percentages, they are indeed very much comparable. So that we all understand what's going on, let's clarify.

%GDP is the percentage the economy grew since 1980 (the blue line)

% M1 is the percentage of money the Israeli Central Bank printed since 1980 (the red line)

Let's now perform a thought experiment.

Let's suppose that the country of Appleland produces only apples.

Furthermore, let's assume that the entire yearly production of apples is 10 (yes, it is a very small country indeed).

Let's also assume that the Central Bank of Appleland has printed a grand total of 10 Apple Dollars (APD). Therefore, if we divide the number of apples into the number of APDs, we reach the conclusion that 1 Apple is worth 1 APD.

Now let's assume that through a gigantic feat of Research and Development, the production efficiency of Appleland grew. It now produces 11 Apples per year. Let's also assume that the Appleland's Central Bank, in all its wisdom decides to print 1 more APD. If we recalculate, we come to the conclusion that 1 Apple is still worth 1 APD.

In other words, manufacturing increased by 10%, the amount of printed money increased by 10% and therefore the price did not change.

Let's now take a look at what would have happened, if the Appleland Central Bank decided to "reactivate" the economy and print 2 APD instead of 1 (or 9% more than before). Let's recalculate.

Price of 11 Apples = 12/11 = 1.09 APD; the price of Apples just went up by 9%!

From this simple experiment we can conclude that:

If the percentage of printed money is roughly the same as the percentage of economic growth, prices must not change.

And the opposite:

If the percentage of printed money is higher than the percentage of economic growth, prices must go up.

The last graph allows us to do just that. It compares the economic growth against the amount of printed money. It is absolutely clear from the graph, that the amount of money printed was about 500.000 % while the GDP growth was about 500%.

Humm… this would mean that the Israeli Central Bank printed 499.500% more money than what the economy grew since 1980. Do you think prices are going to go up?

That's right. The Israeli Central Bank printed so much money that it literally dwarfs the economic growth. It is for this reason that in the previous graph the blue line representing %GDP growth is flat. It is not, what happens is that printing is so monstrously large that in comparison the %GDP did not move!

And now that we know that it is the Israeli Central Bank printing that raised prices in the first place and created the housing bubble, any rational person would think that if the goal is to cool down the bubble the obvious solution is to stop printing. Right? Thanks you for nodding.

Alas, this is not the proposed solution! It is never the proposed or implemented solution!

THE GOVERNMENT SOLUTION

What is the governmental solution? Price caps.

A builder will continue to pay increasing costs (because the Israeli Central Bank has not stopped printing) but it won't be able to transfer these extra costs to the buyers. In other words, the profit margin will shrink, and shrink and shrink.

Do you think that builders will be happy with this? Or do you think that what they will do is to take the money, stash it in a bank and wait until this madness subsides? Of course! they will. Every time a government introduces price caps the supply dries out and as a consequence (since the demand has not changed) the prices skyrocket.

Expected result? Higher housing prices and a burgeoning "black" (or more precisely, free) market. The experiment will backfire.

CONCLUSION

In this round of the Israeli government against the market, they will lose. They have been playing with forces they can't possibly control and they are reaching the limit of what's left to do to delay the inevitable. This is not to say that Israel is the exception, of course not. Israeli economic machinations are the world-wide standard. We simply pointed out this problem in Israel because it is so actual, so immediate.

The moral of the story is that you should be aware of where your country is located in the debacle cycle. It is always a good idea to look at the number, however flawed and "massaged" they may be. Realistically speaking, there is nothing you can do about this, other than use this knowledge to make as much money as possible in order to insulate yourself from these and other governmental economic debacles. Or not. Your choice.

Note: please see the Glossary if you are unfamiliar with certain words.

 

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