What really drives house prices?

Low interest rates and loose regulation just don't seem to cut it. They only explain the short period starting around the turn of the millennium.

It could be currency. Or in the simplest terms, the real value of the dollar in terms of gold -- as in the gold bullion held by the SPDR Gold Shares (GLD - Get Report)  exchange-traded fund -- has a huge impact on the trend in home prices. While it doesn't explain everything, it does explain at lot.

If the dollar is weak vs. gold, then home prices grow faster. The pattern is pronounced enough that it makes blaming weak home prices on the Federal Reserve and bank regulators start to sound hollow.

Here's a recap of how different periods of huge home price growth were as different as the Amazon jungle and the Sahara desert. For that reason, some more holistic reasoning is needed.

Over the period from January 1972 through January 1980, the median price of a new house jumped from $24,700 to $62,900, according to data from the Federal Reserve Bank of St. Louis. The average annual compounded growth rate was more than 10%.

It wasn't loose regulations or easy monetary policy.

  • Interest rates were high. The 30-year fixed rate mortgage was always above 7% in the 1972 to 1980 period, according to government data.
  • Adjustable-rate mortgages, or ARMs, which eventually made home buying easier for some borrowers, didn't exist for most people.
  • Banks were largely restricted to doing boring things by the Glass-Steagall Act. They weren't gambling. 
  • The securitization of mortgages was not a major factor in the market at that time. Three decades later, mortgage-backed securities let capital flow to previously underserved potential homebuyers.
  • The 1970s were the opposite of the freewheeling years from 2000 through 2006, which ended in the Great Recession.

During the two decades from 1980 through 2000, annual home price growth slowed to an average of 4.7%, according to government data. There were occasional price bursts, but there were also price collapses. 

Real estate prices started a new trend, rising as much as 18% a year over the period from 2001 through 2006, with most of the steep increases occurring in 2004.

That latter period also saw the stock price of homebuilder Toll Brothers (TOL - Get Report)  rally from $4 at the beginning of 2000 to a high of more than $50 in 2005. The SPDR S&P Homebuilders (XHB - Get Report)  ETF, which tracks a basket of homebuilder stocks, was introduced in 2006.

So what was the difference? The price of the U.S. dollar in terms of gold.

Gold started the 1970s at $35 an ounce before President Nixon took the U.S. off the gold standard in 1971, after which it rallied to a high of $850 in 1980. In other words, the dollar would buy a fraction of the amount of gold at the end of the decade that it could have at the beginning.

The next two decades saw gold retreat to less than $300 an ounce by 2000, before taking off again. As gold rose from 2001 through 2006, the housing market heated up. It wasn't just in the U.S.

"It's a weak currency phenomenon in absolute terms and that's why it was global," says John Tamny, scholar at Reason Foundation, and author of Who Needs the Fed? "If you try to blame the Fed, how then do you explain that housing prices went up around the world?"

Tamny notes that when people see the value of any paper money decrease, they try to protect their wealth.

"Housing is an inflation hedge that you can live in," he says.

What the gold price explanation doesn't wholly address is why house prices continued to rise over the two decades when the dollar was stronger against gold. That may be because houses got bigger over the period, or it may be for other reasons, but it's certainly worth looking at.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.