Thursday, 19 July 2007

Capital Gain, Capital Loss

Consider this hypothetical - and very common - situation.

Your house is for sale. You bought it five years ago for $200,000 and because of current high property values you now have it listed for $400,000. You haven't renovated the house in that time but have maintained it well. It is in much the same condition as when you first moved in. How do you feel about this?

For some people, this is good news. The asset has increased in value and they have an extra $200k in their bank account if they wish. If you are one of these people, you may not have asked yourself where the extra money will come from. So where has it come from?
It will come from the person who buys your house, not just at the time of sale but for the next 25 to 30 years. Your gain of $200,000 is being funded by the next person. Your gain is their loss.

You might suggest that in return they get an asset that is worth $400,000. But is it really worth that much? Did you add $200,000 worth of renovations to it? Not likely. You might suggest that they can sell the asset to pay off the debt. But where will they live?

The buyer is in a difficult position. The amount of money they must save to even enter the property market has more than doubled. Furthermore, the amount of money that they must earn in order to pay off the interest has more than doubled. If we total the interest payments for the larger loan, will it be worth less than the increase in price? Probably not.
So, your gain is their loss - and it will be their loss for many years to come. Will they require two incomes to pay for it? Probably. What effect will this have on the children that they raise?

In short, the net effect on private home-owners of each transaction like this is negative. Extra labour must be produced in order to hang on to the same physical assets. The social cost of this extra labour is enormous.

We like to call this event a "capital gain" because the amount of capital has increased. This feels like a good thing, but remember that capital is nothing other than the general equivalent of labour. An increase in $200,000 plus interest now demands the additional labour that will total $200,000 plus interest.

I cannot call this an elephant in the capitalist's living room, simply because most capitalists do not even know that it is there. They cannot ignore something that they cannot see. Now, the conundrum for you the home-seller is that you might feel that you have over-priced your house. At least until you think of the price of the next house that you want to buy. How will you afford it? You can only afford it if you use the increased value of your current house to get it. And you can only use that if you are willing to pass on the additional burden of funding your new house to the one who buys your current house.

Eventually, it will all be paid for by people who do not now own houses. Either they will pay it when they buy the first one, or they will pay it in the rent to the one who owns it. People who do not own property are funding the increase in property assets. The property owner can set whatever price they like, but the people who will foot the bill are ultimately those who do not currently own property.

The terror of this situation is that the people who can least afford it are the ones who are forced to pay it.

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