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18 June 2008  |     mail this article   |     print   |   
This article is part of the series: Interview series Albert Spits
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'House prices collapse by 60% in 7 years'
Listen to or download part 1 of the interview with financial expert Albert Spits. In Dutch, MP3, 18 Mb, 17 minutes, recorded on 23 May 2008.
Interview by Daan de Wit
Transcript by Trudie Beverloo and Michiel Bezemer.
Translated by Ben Kearney.
In the interview Spits explains why and based on what facts huge collapses are to be expected, resulting in housing pices dropping by 60% in seven years.

My name is Daan de Wit. With me here today is Albert Spits from the Frédéric Bastiat Foundation. We met each other at one of the info-dinners hosted by Willem Middelkoop, author of the bestseller (Dutch only) If The Dollar Falls. Mr. Spits, you are an advisor for pension funds.
I am.
-But you are also clearly interested in the mechanisms behind money.
-And this interest of yours is incorporated into the advice you give. Could you first talk about what your work involves and how much money we're talking about here?
The advisory organization that I work for deals in the millions of euro's, hundreds of millions, and that involves personal advice, actuary, pension administration, and everything associated with that. We're talking about pensions with an average turnover in the hundreds of millions.
-So the advice you give has a fair amount of impact?
-Talk a little about your background, as well as your interest in the mechanisms of the financial world, and how you ended up at that dinner with Willem Middelkoop.
Albert Spits: It actually began 25 years ago in 1983. At that time I was still living in New Zealand , where I was studying Pedagogy and Psychology, and because New Zealand was going through some awfully difficult economic times - we were coming out of an economic crisis - I became more interested in the how and the why of the economy, and why it was looking so bad.

I became absorbed in four economic schools of thought. I started with the Keynesian School , which is the one most widely taught at universities in the Western world. I also studied Monetarism - the Monetarism of Milton Friedman - also called the Chicago School . The supply-siders - not so well known in The Netherlands, but more so in the English world, the Anglo-Saxon world - that's the school of Jude Wanniski , who was one of Ronald Reagan's biggest advisors, hence the term ‘Reaganomics'. And the last school that I studied was the Austrian School of economics. Strangely enough that was the school which interested me the most because it came closest to what I call the essence of economics. This school came about in the 19th century and came to the conclusion that the economy worked differently than the Keynesians and the Monetarists would have us believe.

The reason was that the economy was actually controlled from the standpoint of value, not so much from the standpoint of trust like we know now, but from the point of view of value - that there should always be a benchmark for value. But without getting too deep into all that... The reason I found out about this, that was only after 11 years of study, in 1994 (I started in 1983 and actually came to the discovery in 1994), and since then I've been more occupied with the Austrian School and at one time gave a number of lectures on it. At that time I worked at a corporate training agency. I utilized this information in financial training of production managers, department heads, etc.

In 2002, together with Sander Boon and René van Wissen, I founded the Frédéric Bastiat Foundation, and since then we've been engaged with the analysis and research of the economy. My studies of the Austrian School totally preoccupied me... I started in 1993. The book that actually set me on the path was 'The Road to Serfdom' by Friedrich von Hayek. That was a book from 1944 in which he explained that socialism would lead to serfdom. I found that really interesting. After that I read some of his other books, and gradually I came around to Ludwig von Mises, the biggest exponent of the Austrian School in the 20th century. It was tough going to get there because I first had to wade through all these other schools of thought and I was also busy reading articles on the economy - articles from the Financial Times, The Economist, Business Review, etc - which continually led me toward that same Keynesian way of thinking, and that put me on the wrong path for roughly eleven years.
-And you were doing your own research the whole time, never with the intention of for instance writing a book...
No, it was never my goal to write a book. I certainly accumulated a lot of information that I was able to use later on in my lectures, in my articles, etc. Right now I'm working on a publication.
-Eleven years of doing your own research, has that payed off in your work as a consultant for pension funds?
Yes, it really has.
-Have you come to a conclusion after all these years of research?
Yes, I have come to a conclusion, and that conclusion is that the fiat currency system... I'll just explain what the fiat currency system is. The fiat currency system - the system that we have now - is based on trust, trust in paper money, trust in the government. That trust is always temporary. That's why we experience upheavals, revolutions, etc. The more say that you allow a government to have, the more a government is going to abuse it. That's the conclusion that I have drawn from history. Having said that, you can see that a specific monetary standard is necessary, a fixed standard. You can't base everything on trust, because trust will simply be abused - history has taught us that. So you need a specific standard, like the gold standard or the silver standard or a bimetal standard, which means gold and silver together. That means that people will keep their promises. You prevent the government from printing money...
-But that's what's happening now... What to do?
That's right. The credit crisis is now the end point, the final phase of sixty years of credit expansion. And I am specifically not talking about the expansion of the money supply, because those are two different issues. You have credit expansion and you have monetary inflation. Monetary inflation is, in and of itself, printing money. Credit expansion is based on the promise to pay money back. Banks lend money to people hoping that it gets paid back because those banks are obliged to pay back the central bank. The central bank approves the credit that the banks lend to individuals and companies. If people are no longer able to pay it back because they've gotten so deep into debt, then the banking sector can't meet its obligations to the central bank either. That results in bankruptcy. And what we're now seeing - the first signs of this with the credit crisis - is that a few banks have already gone bankrupt. Bear Stearns, Northern Rock…
-But is that caused by the public or by governments?
That's caused by the government. I don't know if the term 'moral hazard' says anything to you. Moral hazard means the longer that things are going well, the more people there are who dare to take risks, the more risks there are being taken. And those risks translate into more credit. We have now generated a huge bubble that since the 1990's has totally exploded, and under normal circumstances this could no longer be paid back. In reality this means that everything needs to be reorganized.
-That also means that by definition the situation cannot be resolved.
Not with this system.
-Yet I'm reading reports that we've seen the worst of this credit crisis...
No, we haven't even seen the beginning of it yet, or at the very least we're just now at the beginning of it. We have a huge problem with hedge funds, which have issued a whole lot of money or credit. The housing market is only now starting to collapse, but soon it will be coupled with huge collapses...
-Are we talking just about America here, or Europe as well?
Europe too. Actually the rest of the world as well - they're coming right along with us. This is the first fiat currency system on a global scale that we've ever had in history. In the past it was localized, regionalized: for example there have been specific countries that did this, while other countries made use of the gold or silver standard. So you had other countries that could then straighten things out again.
-So you could say that it's never been quite as bad as it is now...
It's never been as bad as now. We have a credit bubble of roughly... The Gross World Product is currently 45 trillion dollars. The derivative time bomb heading our way is in upwards of 500 trillion dollars, so there is actually a bubble amounting to more than ten times that which the world produces each year.
-Will that by definition collapse?
Yes, because it's an exponential occurrence. At the time that the options market first began in the 1980's - initially the derivatives market - at that time there were but a few million dollars that were sunk into it worldwide. Now we see that that has grown in the 28 years since to almost 500 trillion dollars. So it's exponential. That also has to do with the desire to take risks - if things are going well for a long period of time, people are going to take more and more risks. But they're not getting corrected by a gold standard that would force you at a given moment to pay back your money to your creditors or to the banks. Debts are getting loaned out anew, in the form of a 'CDO' - a Collateralized Debt Obligation. They get bundled together - mortgages, loans... It gets put back into the market again in the form of financial instruments.
-Yes, at which point it's no longer subject to oversight.
Right, no one is keeping track of it anymore. It's not even known how much credit is currently outstanding. Someone once said - I don't know exactly who it was - 'Money is always scarce, and as soon as it is no longer scarce, it is no longer money'. And that describes this situation quite well. Particularly in the 1990's, we know that people here in The Netherlands took out credit for kitchens, roof dormers, vacations, big cars... All that credit was taken out against the mortgage. Because the value of homes kept rising, it was possible to keep borrowing against it. That has come to an end. In America they have the same problem. People were using their home as a sort of ATM. As long as housing prices kept on rising, that could be easily financed. Now housing prices are no longer rising, they're falling; that began in 2005. The credit crisis, which began in 2007, is a direct result of that.
-There is also the American government, which has been spending money like it's water and dumping it into a black hole in Iraq . It's as if it doesn't matter anymore.
Yes, that' true. Look, they're living off of credit. That's not money. The word "credit" comes from the Latin 'credere' meaning 'to trust'. You trust that you'll be paid back. But what happens if no one gets paid back anymore? What happens when people are in a state of bankruptcy? This is going to result in a contraction of credit once this credit crisis is over. In the past those with the worst credit could get money or mortgages or loans. Now those with the best credit will soon no longer be able to get a loan. We're now seeing the beginning of this contraction, because most banks are now wary of financing real estate projects, for instance. So we're seeing this all around us. This problem is going to express itself at the level of the individual consumer. What we're seeing with the credit crisis is just the beginning of what is to come, and it will probably be resolved in eight to ten years time.
-If possible, could you paint a picture of what the future holds.
The housing market is going to collapse.
-In The Netherlands as well?
In The Netherlands as well. Take a look at history - in Florida in 1925, 1926 the housing market collapsed to twenty percent of its value. If we look at Japan during the 1990's, the real estate market fell by 13%. To say that there will be a collapse of ten to twenty percent is very optimistic. Because we're talking about a deflationary situation, not about monetary deflation. We're talking about credit deflation, i.e. when credit is no longer available. People just plain need credit in order to purchase a home, a mortgage. Nobody can pay for that out of their own pocket. So homes won't be purchased anymore. Not only will it be a buyers market, but it will become a buyers market without any buyers.
-But are we not in a unique situation in The Netherlands because we live in such a densely populated country, where home prices always remain quite high?
Well, take a look at the 1920's. In the 1920's there was a housing shortage in the Netherlands , and in the 1930's that was resolved. A lot of people don't know about the Housing Act homes - the Dutch Housing Act dates back to the beginning of the last century. Because of World War I there weren't many homes and that prolonged the housing shortage into the 1920's. By the 1930's the housing shortage was over.
-But can you translate that into today's terms.
Well I think that the housing shortage that we have now... There is no housing shortage, there is a shortage of affordable housing. And that's only because the value of homes has risen so much. So someone who has €300,000 can easily buy a home. But someone who doesn't have that money or can't get any credit, that person faces a problem, and so has to go looking for a rental, which is harder to find.
-So home prices in The Netherlands are going to decline?
They are going to decline, yes.
-In England there was a cabinet minister photographed with a document, the text of which was so sharp that you could read it on the photo. It was Minister Caroline Flint. On the document it said that ‘‘at best' prices will tumble this year by five to ten percent'. That was in reference to England . It's widely known that home prices in England will most likely fall. What percentage do you expect for The Netherlands , and over how much time?
Well, I think you should figure on a drop of at least sixty percent. I'm working off of ratios. There was a great article in The Economist in 1987 that talked about the ratio of the housing market - average income versus the average price of a home. In 1987 the average income in The Netherlands was not the modal, see, the modal is higher. The Netherlands is one of the few countries that uses modal income, the rest of the world uses average income, which is lower. At that time the average income was 42,000 guilders, which converts to around 20,000 euros, and the average price of a home at that time was 145,000 guilders. So you end up with a ratio of roughly a little more than three. Historically the ratio is between three and four. If you look at the average price of a house and then assume the average income today - that's something like 30,000 euros - then you'd have to calculate the average price of a home at 120,000 euros. But where is it now? It's at 240,000 euros. So in order to get back to the average, it has to drop by 50%.
-You mentioned 60%, how long until then?
In Japan it lasted from 1993 until 2000. So you have to think in terms of a time frame of 6 to 7 years from now.
-But what should you do, you still have to live somewhere?
That's true. For those who are renting: Wait to buy, because an enormous buyers market is on the way. Try to build up a savings. For those who have their own house with a decent mortgage, I would advise putting 10% of that mortgage into gold or silver.

-But not to sell the house and get a rental?
You can sell and rent. But it's a difficult market for sellers right now, and that's when you're still living in it. If you want to sell, then I would get going on it quickly.
-With selling?

With selling.

-Tell me about this 10%. 10% of the mortgage.

[Part 2 of the interview will follow soon].

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