John Maynard Keynes – does that name ring a bell for you?

Well if you are someone who has studied economics, it will definitely ring a bell.  Those who haven’t well, this English Economist was influential in helping the world get through the Great Depression, by convincing governments to use fiscal and monetary stimulus to kick-start the global economy with his macro-economic theory around business cycles and how government can manage cycles better to avoid large scale booms and busts.

Many governments today have adopted his Keynesian economic theories in developing their own marketplaces, including Australia.  Only recently as part of the GFC, the government of the day used a huge stimulus program to steer us through the worst of the crisis. By stimulus I mean a spending program for which they borrowed money to keep economic activity up, when nations all over the globe were in dire straits.

In layman’s terms the theory works on the premise that if you keep the wheels of the economy spinning the government revenues (taxes) will improve enough to pay back the debt once the cycle returns to a stronger upward cycle – therefore avoiding a long drawn out period of recession or even worse, a depression, which has a massive impact on the quality of life and standard of living of its people.

Now that’s an example of Keynesian economics at work when a ‘big event’ like the GFC happens. However, we also see the likes of the RBA using monetary policy as a means to better manage economic cycles to prolong the growth cycles as best as they can, whilst the government of the day works on fiscal policy to keep the good times rolling.

There is a reason this man was one of the most influential and important minds of the twentieth century, and the above example is a very important one.

The other example of this man’s brilliance which I wanted to share and is my main driver for this article revolves around his own personal investing.  It is believed he made large amounts of money trading on the stock exchange by working out that the market wasn’t an efficient market at all.  By efficient market, again in layman’s terms, I mean that the price of the share should remain in line with market information about the stock and its fundamentals.

But John Maynard Keynes resolved that ‘human nature’ also played a big role in the price variations of stocks.

If stocks were going down below their so-called fair market value, for an economist this would signal a buying opportunity but John Maynard Keynes worked out that more often than not the share price continued to fall and the same was true for rising prices.  Often prices would rise above what the stock fundamentals would say they were worth, driven by market sentiment as humans were making the decisions and not the economist.  So we would buy stocks when the price was rising and ride the wave to generate profits.  Today studies continue into a term they call behaviour finance, put simply – how and why humans make financial decisions like they do.

This brings me to Property and what I’ve always been saying about property investment and that is, residential property is a study of human interest and human behaviour (Human Nature), just as John Maynard Keynes advocated almost one hundred years ago.  Let me explain how this works with property.

For the past two to two and a half years the property market has been soft, some areas have even gone down in value and others remained flat.  During this time, the masses decided to stay out of the market, unsure of whether it was going to go lower or not.  Whilst there is soft market activity, demand is building up behind the scenes and supply is constrained because no builders want to build what no one will buy.  Then rates start to fall and the market sentiment starts to turn, and now we are in a phase where the masses are starting to get into the market, almost getting confidence of others who are thinking or doing the same.  All this demand and the limited stock will only result in one thing, higher property values.

Although some mainstream economist will once again argue that property prices are overpriced, they continue to fail to put into their theories and macro-models, one critical ingredients, which would help their models determine that property values aren’t overprice, and that ingredient is ‘emotion’.  And it’s because they don’t have an accurate measure for it, that they can use it.  Yet with 70% of all purchases being undertaken by owner occupiers who are all buying on emotion, under competition, there is only one way that prices can move over the long term and that’s up.

 

Remember, knowledge is empowering if you act on it.