Aug 26 2008 3:31PM

A friend recently wrote to me saying that value is what you are offered when you want to sell something. I disagree. What is offered is a price, which may be above, below or at fair value of the item being sold.

For example, we all know that stocks sell at a price that at any time can overvalue, undervalue or fairly value the stock. The same thing can happen with houses.

In the United States, and indeed much of the world, house prices rose in recent years during a period of easy credit in which mortgages and other loans were plentiful. The availability of easy credit always leads to bad investments and money being spent unwisely. Proof of this point is self-evident from the bankruptcy of lenders like IndyMac Bank and the collapse of Fannie Mae and Freddie Mac and other institutions that extended housing loans imprudently.

We are now seeing the inevitable shake-out from a period of easy credit, and housing prices are declining as a result. For example, the widely watched Case-Shiller home price index released today by Standard & Poor's indicates that the decline in U.S. home prices is accelerating. Prices dropped a record -15.9% in the past year.

This decline in the price of homes is wealth destruction. But wealth destruction is not deflation. Many people confuse this point.

Deflation is the opposite of inflation. Both are monetary phenomena. Inflation is an increase in the quantity of money, with the consequence that each unit of money purchases less and less over time as the inflation proceeds. Deflation is a contraction in the quantity of money, with the result that each unit of money purchases more and more over time as the deflation proceeds.

Right now, M3 (the total quantity of dollars in circulation) is growing by over 15% per annum. This rate of growth is highly inflationary, so the dollar is being inflated. This inflation is incurring even though there is much wealth destruction as a result of declining house prices.

Keep in mind that houses were way overvalued a couple of years ago. The recent price decline in homes means that they are becoming more realistically valued, but we must recognize that their valuation is being measured in a currency (i.e., dollars) that is being inflated. Before the current collapse in house prices has ended, many houses may even become undervalued in the ever-inflating currency (dollars) by which we measure their value.

The following chart of the US median home price from 1968 though the 2nd quarter of 2008 is based on data compiled by the National Association of Realtors, ( www.realtor.org). I have taken their data to show the median price both in terms of dollars and goldgrams indexed to 100.

This chart puts housing prices into perspective. Prices in terms of gold have remained within their historical range, so the increase in house prices was the result of an inflated dollar. House prices are now declining in terms of dollars, even as the dollar continues to be inflated.

There is one other important observation to make from this chart. When the price of a house is measured with sound money, a different picture emerges than when it is measured with dollars. Sound money is the best way to determine value, which is the important point. House prices may rise or fall, but a home’s value remains essentially unchanged. Value is derived from usefulness, which in the case of a house is the shelter it provides, and that shelter is the same today as it was ten years ago, regardless what happened to its price. Remember, price and value are entirely different things.

by James Turk

*****

James Turk is the Founder & Chairman of GoldMoney.com <http://goldmoney.com/>.  He is the co-author of The Coming Collapse of the Dollar, which has been updated for a newly released paperback version, now entitled The Collapse of the Dollar <www.dollarcollapse.com>.

Copyright © 2008 by James Turk. All rights reserved.