Serving the Pioneer Valley of Western Massachusetts

War and Property Inflation

                                        by DAVE HOPKINS

What conceivable link could there be between the military expenditures in Afghanistan, Iraq, and elsewhere in Central Asia, and soaring house and land prices?

It is fairly simple, but you'll need a bit of background first. So bear with me as I walk you through it.

First of all, the engines of war have always been fueled by money. Naill Ferguson describes the rise of the "warfare state" admirably in his book The Cash Nexus. He quotes the Roman orator Cicero: "The sinews of war ... [are] unlimited money" (Nervos belli ... pecuniam infinitam). Ferguson goes so far as to say that the very history of finance is an attempt to close the gap between the staggering needs of a state at war and its limited resources (by helping governments borrow money). The Duke of Wellington may have defeated Napoleon not because he and his officers developed character "on the playing fields of Eton," but rather because the City of London invented the bond market to supply the British Empire with the borrowed funds it needed. Napoleon, on the other hand, preferred to conquer and tax rather than borrow money from abroad. He strangled, instead of tapping into, the Amsterdam capital market, the world's largest at the time. This may have been his real undoing (Ferguson, p. 269).

This wartime borrowing generally had devastating effects on the working people of the debtor nation, as the debt service was extracted by regressive consumption taxes and land taxes, which squeezed farmers. Moreover, it created a class of rentiers, who lived off their gilded bonds, and in effect on the backs of working people and farmers. William Cobbett wrote insightfully and vigorously in Rural Rides about the destructive effects of war debt on the English countryside and the pauperization of English working people. Indeed, the entire working income of the nation and the productivity of the land had been mortgaged off to pay for the Napoleonic Wars. "This is how our crew beat the French people." But at what a cost, as Cobbett goes on to say, perceptively pointing out that this massing of capital in the bond market was creating a new elite, ushering in industrialism, even as it impoverished the countryside and the great mass of the people.

So where does property inflation come in here? What's this got to do with real estate in western Massachusetts in the year 2005? Well, things have changed. Today, the US president does not need gold reserves to back up his money supply, and with the US dollar as the international reserve currency, he can run deficits and borrow endlessly, seemingly with impunity. The Chinese, the South Koreans, the Japanese, the Taiwanese, even the Vietnamese--they are producing our goods, building up their dollar reserves, and lending these dollars to us to pay for the Iraq war. In Gore Vidal's quip, this is "the Yellow Man's Burden," producing for us yet restricting their own consumption and saving their US dollars, which they lend back to us.

To borrow back these dollars, this is the charade: we issue US Treasuries (a note from the borrower to the lender). These Treasury notes can be created in any quantity with the approval of the Congress, and sold on international debt markets to acquire funds for the war in Iraq, for example. When they are created, new money enters the picture in a sense. We get back the dollars we paid to China, but China still has a note for the same $81 billion, say, which it can cash in at any time it chooses. So the money supply has increased by $81 billion in effect.

This increases what they call liquidity, that is, money in various forms sloshing about in the economy. More money chasing goods, workers, services, houses---this is what causes inflation. Thirty years ago, it would have resulted in rampant inflation, with wages and the cost of goods skyrocketing. This, in fact, is exactly what happened during the Vietnam War, with its aftermath of stagflation and wage and price controls. But today, with cheap goods being manufactured offshore in China and elsewhere, and with wages being kept down by exporting jobs overseas to low-wage countries, this liquidity is flowing into real estate and the stock market, inflating their values far beyond what the fundamentals justify. The money is chasing houses and stocks now, not goods and workers so much. This is called asset inflation, and the US Federal Reserve has ignored it, even encouraged it, by deliberately keeping interest rates low and money cheap.

These military expenditures are not the only source of asset inflation. The debt markets in general, especially mortgage markets, have this effect (see my earlier article on "Why Home Prices Are Going through the Roof").

The expenditures of the Iraq war not only increase the debt burden of future generations; they also increase the burden of Americans in purchasing and paying for homes. Home buyers today cannot pay off their mortgage in 8 years as they could on average in the 1930s. Today, to buy a home, they are mortgaging their income for their entire work life. Sure, one generation may profit from the inflation in property values, but it cannot continue. All this profit from asset inflation, in real estate and in the financial markets, is hollowing out the real economy. Every dollar of profit from asset inflation diminishes our social wealth. It is infinitely more destructive than wage and goods inflation.

The message? Look skeptically at the debts incurred by your government, and at the structured finance and derivatives of the mortgage markets. All of this, even as in Cobbett's day, is impoverishing our world, making us work harder for a living, and eroding our quality of life.