Friday, January 22, 2010

Implied Prices

This is a follow-up to my post on "reverse rents" from a few days ago.

I don't know if any attempt has ever been made to calculate the sum of all things for sale in an economy, if as a practical or theoretical matter anyone has ever needed to do it. But to substantiate the cash-inventory equivalency, that is what I find myself doing. For now, before touching actual figures, I am developing a model for how to approach it.

There are different ways items in an inventory are sold. One is that they are produced and awaiting purchase on a store shelf or in a stockpile somewhere. This is the classic reference to inventory. If all items were for sale that way, we could just add them up and compare it to the money supply. But goods can also be rented on a monthly basis, like apartments, or similarly labor. Then, there are goods and services produced on demand.

I addressed the rental problem a few days ago, by pointing out the similarities and overlap between renting and paying a mortgage, and concluded that when a rental property is on the market, it should be accounted into the inventory at its purchase price—in other words its "reverse rent," or the inverse of its financing cost.

Now, this is pretty unintuitive. If a house is bought, then an actual sum is transferred, either from the buyer to the seller, or from the bank to the seller and then the buyer settles things with the lender over time. For rentals, all that is transferred is the rent and deposit, so why should the full cost be factored into the inventory? Isn't the point of renting, one of them, to allow procurement of a dwelling without a large lump sum?

Consider, if you will, three scenarios: A. a landlord sells a rental property to another landlord, and at the same time the old renter moves out and another moves in, which one can label L1·R1 -> L2·R2; B. the landlord sells the unit, but the renter, being a good tenant, stays there, or L1·R1 -> L2·R1; and C. the renter moves out and a new one moves in, or L1·R1 -> L1·R2.

Scenarios B and C are variants of scenario A. All scenarios can be portrayed as L1·R1 -> L2·R2, where in scenario B: R1 = R2, and in C: L1 = L2. During a rental transaction, the landlord can be viewed as selling the property to himself. During the tenant change, the cost of selling the unit is added to the inventory because it is tied up with the landlord.

Still, it remains counterintuitive at least to me why this "implied price" would be factored into the inventory as a landlord buying a property from himself. Can't we all just sell air to ourselves and blow up the inventory to infinity that way? The rental is the transfer of a tangible item, one the landlord could have sold, but held on to the unit instead to rent to the next occupant.

Another way of looking at it is: whether the item is paid for instantaneously or over time, its burden on the money supply will be counted as the same. Intuitive or not, that is how calculations will proceed for the time being, and any further insights or clarifactions can be added in upcoming posts.

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