A realtor's view from Hubbert's Peak
The End of Cheap Oil and Cheap Money
Hubbert's Peak is the peak of global oil production as estimated by the fossil-fuel geologist W. King Hubbert. At this peak (which could take place in a few years) the world's oil drum, so to speak, will be half empty, with a lot of sludge and poor-quality oil at the bottom of the barrel. As the two-billion-plus Chinese and Indians increasingly drive cars rather than ride bicycles, the competition for the remaining resources will be intense. Oil prices will rise, and along with them transoceanic and transcontinental transport costs for goods of all kinds. Industrial agriculture, with its diesel-fueled tractors and irrigation pumps and its petroleum or natural-gas based fertilizers and pesticides, will no longer be producing cheap food. The petroleum-based plastics that are ubiquitous in today's world will suddenly no longer have a cheap feedstock for manufacturing.
Cheap oil and before oil, cheap coal, have fueled the Industrial Revolution, providing the energy to drive our economy toward greater wealth and complexity. As commentators such as James Howard Kunstler have pointed out, even our so-called postindustrial economy is as dependent on fossil fuels as the "dark Satanic mills" were in William Blake's day. The globalized economy, shipping foodstuffs and goods all over the world, is especially vulnerable. If this becomes no longer viable or practicable, we may have to rely more on local sources of food and goods.
This, in a nutshell, is the "peak oil" scenario, the projected consequences of an end to cheap oil. As the possibilities of relocalization and a return to simpler living are played out in the imagination of peak-oil writers, one skeptic referred to it all as a "hippie's wet dream"! Who knows, he may be right! It remains to be seen whether this is yet another Malthusian alarum ringing through the land.
But we do seem to heading for an end-game of some kind: the geopolitics of oil in Russia, the Caspian, Iran, China, Venezuela, Nigeria; the economic growth of India and China; the reliance of the US dollar and our mortgage markets on Chinese investment; the ongoing disastrous war in Iraq; fundamentalist Islamist movements in oil-rich countries that have declared jihad against us for our military presence in the Middle East; and the overextension of US power and neoliberal capitalism, which is projecting itself into every corner of the globe.
How will peak oil play out in real estate? We'll look at this from three different perspectives:
-- First, we need to understand why real estate has hyperinflated over the past 20 years, and why we will see property prices deflate as oil and gas prices soar.
-- Second, the broader, deeper issue of why real estate has been a kind of *sink* of value throughout history -- though perhaps a *drain* of value is more to the point.
-- Third, the effects of real estate inflation on farmers, and how decreased global trade in foodstuffs and deflating land values will be a godsend for farmers and local economies.
Peak Real Estate
Shortly before Hurricanes Katrina and Rita hit our Gulf and southeast coasts last fall, we reached, I feel, a peak in real estate values that we will probably not see again in our lifetimes. For twenty years prior to these storms, we "enjoyed" a breath-taking inflation in real estate and other assets (such as the stock market, bonds, etc.). To the point that Americans and others were eager accomplices in diverting their savings and pension funds into the aggressive growth of these assets, even accepting reductions in wages and benefits and defined pensions in favor of stock options, 401k's, and home ownership with increasingly heavy debt burdens. Americans felt they owned a piece of this pie, which seemed to be growing endlessly. Mutual fund managers and even CEOs became heroes and heroines, while authors such as Ron Chernow wrote books about "the triumph of the small investor." There was a euphoria in the air (at least among those who were well invested) that only a few party-poopers questioned.
The reasons given were similar to those given in the 1920s and earlier still in the 1890s: global trade, the vastly increased productivity enabled by technology, advances in communication, and so on. Some even speculated that we had stumbled into a new era, or had been transported into a new economy.
Well, unfortunately for the retirement plans of most Americans, these commentators and talking heads were wrong on nearly every count. The asset inflation of the past twenty years was, in my view, due to:
-- The suppression of wage inflation by shipping jobs overseas to low-paid countries with minimal protection for workers or the environment
-- The suppression of goods inflation by importing goods from these same countries
-- The low interest rates of this period were possible because the usual negative feedback of wage and goods inflation was absent
-- Asset inflation (e.g., in real estate or stocks) is never factored in by the Federal Reserve, so then-Chairman Greenspan kept the party going by lowering interest rates and flooding the market with new money every time there was a financial crisis
-- All this liquidity sloshing about the world moved into US assets -- the stock market, bonds, and real estate -- creating the untrammeled asset inflation we've seen over the past 20 years.
This asset inflation made many converts among Americans (those who were enriched by it) to the benefits of neoliberal capitalism (a new laissez-faire capitalism made possible by globalization), blinding them to its deeply destructive effects.
How then will our bloated real estate markets be affected by peak oil?
If we have, indeed, reached the end of cheap oil, and if increasing competition for the remaining resources continues to grow, then the price of oil and gas will rise inexorably. Inflation will spread into every part of the economy eventually, even into wages. And the Fed, blind though it is to asset inflation (since it always has worked for Wall Street and not for the average American), will have to raise interest rates. This will have a catastrophic effect on the young home-buyers whom Greenspan, just several months ago, urged to get adjustable rate mortgages, as well as on Americans who have extracted equity from their homes in the form of adjustable-rate home equity loans. There will be a slew of foreclosures and mortgage defaults. The pool of buyers will dry up as interest rates rise and the economy contracts (increasing unemployment in the process). So we are liable to see a veritable forest of For Sale signs in our cities and towns. Real estate prices will drop like a stone, back to earth as it were.
Another piece of it will be trade with China. First of all, note that China recycles most of its US dollar earnings from this trade into US Treasury bonds (funding the war in Iraq and other government spending) and Fannie Mae's mortgage-backed securities (China and Japan supply most of the funds for our mortgages in this country, and the real estate boom would not have happened without them). So this trade is critical for the projection of our power abroad and for our asset-driven economy.
As the cost of transoceanic transport of goods from China rises, reflecting the true cost of fuel oil, and as China deals with its own internal problems (worker unrest, farmer revolts, the demand for higher wages and better working conditions, their deplorable environmental pollution), we may see less trade with China.
Moreover, if China no longer has as many US dollars to reinvest in our mortgage markets, or chooses not to, this will affect Fannie Mae, the mortgage giant that purchases loans from banks. But by that point, with rising interest rates, the structured finance and derivatives that Fannie Mae has used so excessively will have begun to unravel. The US government will do all in its power to save Fannie Mae, but throwing money at it may not work when this will further dilute and weaken the dollar.
So the prognosis for US real estate is pretty bleak, that is, if the peak oil Cassandras prove to be right.
Real Estate: A Sink, or Drain, of Value
I've touched on the causes for the hyperinflation in real estate over the past twenty years. But there has always been a tendency, in expanding economies, for land values to rise much faster than wages -- probably for a similar reason.
Land was valuable from the beginning because it provided the energy and raw material for living, the grain most of all, but also the produce, the pasture for meat and milch and fiber animals, the wood for crude machines and vehicles and boats and houses. It was the source of all wealth at one time, so it was only natural that land ownership played so large a role throughout history in every civilization.
But as money economies developed in Europe (15th-16th centuries), Japan, and elsewhere, money allowed longer and more complex chains of action and trade. Roads and communications became more important. Debt markets for both states and individuals came into being. It also became easier to accumulate this store of value. With the great liquidity of money, prices became more volatile and there was more money to chase everything: goods, and land too with all its ancient mystique. The increased liquidity of a money economy has always sought a ground, solidity, in land. Gold has that to a lesser extent, but money predated gold and appeared first in the form of clay tokens representing measures of grain and *head* of cattle (literally, "capital"), both land-based resources, like the clay itself.
So, wherever there is a lot of excess liquidity sloshing around, due to irresponsible or ignorant central bankers, or spendthrift governments, or excessive borrowing (which also increases the money supply), it will tend to flow into sinks such as real estate. There is nothing magical about real estate as a "safe investment." We are likely to soon learn that lesson.
Asset inflation is particularly destructive because it is rather like taking the vegetables and even the straw and vegetable matter and manure from the farmland to the city and not returning anything to the soil. Ultimately, it depletes the soil and even destroys it. Similarly, asset inflation impoverishes our world, depletes our social wealth, and makes the lives of most people more careworn and less fulfilling. The concentrated power of global capital markets, for all its wonderful feats, tends to hollow out our world in the end. There is no magic or mystery to capital, Fernando De Soto (author of *The Mystery of Capital*) notwithstanding. Every dollar of unearned profit in stocks and real estate leaves a hole somewhere.
In that sense, then, real estate (and the financial markets) are more a drain of value than a sink of value.
A More Down-To-Earth Real Estate
Henry George, writing his fiery treatise on land economics, *Progress and Poverty*, a hundred years ago, saw the effects of machinery on the concentration of land ownership in England and in the Great Plains of our country: "The steam plow and the reaping machine are creating in the modern world *latifundia* [great landed estates in Imperial Rome] of the same kind that the influx of slaves from foreign wars created in ancient Italy." That is, the power of steam, or coal at that time, was like the energy of hundreds of human slaves, displacing the small, independent English yeoman, with the beginnings of agro-industry. Fossil fuels gave agro-industry its impetus, too, in the tractors and irrigation pumps and forced farming of the Great Plains, which created the Dust Bowl of the 1930s. And later, after World War II, the influx of petroleum-intensive fertilizers and pesticides and other diesel-fueled farm machinery tended to concentrate ownership of land and to treat both land and food animals as the raw material of a factory.
The purpose was to wrest as much value as possible from the land, which was now a dead soil without the living organisms that bring a soil to life and create nutrients. Indeed, the effects of capitalism can be seen most clearly in industrial farming and the industrial food chain---the externalization of costs that create unhealthy food, unhealthy animals and unhealthy consumers; a depleted soil; diseases fomented by monocultures; aquifers polluted or drawn down to unsustainable levels; toxic runoff into streams and lakes; hybrid varieties of vegetables and fruits created not for their taste or nutritional value but for their transportability and adaptation to machines; and the terrible impersonality of the entire process (the growing and eating of food of all things!). Once you internalize those costs and create a responsible money system, all the vaunted profits suddenly evaporate.
In industrial farming, then, land had become another resource to squeeze dry, even as the mystique of land ownership grew for an uprooted modern America. It was wondrously easy to exploit this nostalgia in the early suburban developments of the 1920s. The names still linger, all bucolic or reminiscent of English manors and country estates.
But for the farmer, it posed a more serious challenge. Debt incurred by the purchase of machinery; low prices for his produce due to long-distance shipment of foodstuffs and huge factory farms; pressure from developers; the grind of working a farm without sufficient help; the lack of interaction with the soil, the animals or his consumers.
Yet the aftermath of peak oil could change things quite dramatically for small farmers, especially organic farmers interested in marketing their produce and meat in nearby markets or at the farm gate itself. With the high cost of oil, you may see more draft horses and less debt from the purchase of expensive machinery. The cost of shipping foodstuffs cross-country or around the world will be prohibitive and this will allow prices to climb to their natural level. Lower land prices will make it feasible once again to expand pasture land or cropland. Then there is the joy, too, of interacting with the people benefiting from your labors, as well as with the land and with your animals.
Farming should be the base of any humane economy. In the more localized economies of the post-peak future (if this scenario plays out), food and the productivity of the land will once again become the main source of value in land. And real estate will, at long last, come back to earth.